Alpha Moguls | Why #AlchemyCapitalManagement’s Hiren Ved is betting on manufacturing companies for the alpha generation and why he believes Engineering R&D companies are doing better than IT services. #BQLive
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00:00 Thanks for tuning into Alpha Muggles, a show where we speak to some of the finest investing
00:12 minds about their portfolio creation strategy for creating alpha over the next 20 to 24
00:18 months. Our guest today is Hiren Vaid of Alchemy. Hiren, pleasure having you. Thanks for taking
00:22 the time out.
00:23 Thanks, Neeraj. Always a pleasure to be on your show.
00:26 Thank you. Hiren, I reckon the rising tide carries all boats, but the last 6 to 12 odd
00:33 months, have they been difficult to generate alpha or has it been possible because the
00:37 broader end of the spectrum has ranted even more than what the indices would have?
00:43 So Neeraj, I think, you know, the cycles that we've seen in the markets is that whenever
00:52 there is either a domestic or a global macro headwind, the market tends to become narrow.
01:02 Right. And when there are tailwinds or some of those headwinds tend to recede, you tend
01:11 to see improvement in the breadth of the market. And that is what we are seeing, especially
01:22 I would say more than instead of 6 months, I would say in the last 4 months since April
01:27 onwards, we have seen a significant improvement in the breadth of the market. The number of
01:34 sectors and stocks that are hitting 52-week highs is of a very different order. And that
01:43 tells you that the quality of this rally is far superior than the quality of many rallies
01:51 that we see where the markets tend to be very, very narrow. Right. And a lot of that has
01:58 to do with the fact that two or three things. One is that last year, we had significant
02:07 headwinds on margins and there was negative operating leverage for a lot of companies,
02:15 especially non-BFSI companies. And you had rising interest rates and therefore you had
02:25 a compression of P multiples in high growth stocks. Right. So you had a double whammy.
02:31 You had a margin compression and you had an impact on P multiples because of rising rates.
02:40 This year, you have the exact opposite. You have falling commodity prices and margins
02:48 are coming back and rates, one could argue that there may be another rate hike or two,
02:56 but by and large, we are towards the end of the cycle rather than the beginning of the
03:01 cycle. Last year, we were just starting the rate hike cycle. This year, we are almost
03:07 towards the end of the rate hike cycle. And therefore, you see a dramatic change in the
03:12 way the markets have responded. Right. And therefore, I think that if that continues
03:22 to be the construct where margins will improve and rates seem to be toppish, the breadth
03:31 of the market will be reasonably strong. Okay. I'm just trying to think tactically
03:39 in the portfolio. One, I mean, are you fully invested currently, part one. Part two, there
03:45 are people who are saying that with the recent Fed commentary or the big four central banks
03:50 commentary, if there's a bit of a liquidity withdrawal, then we might see a bit of a corrective
03:54 move as well. I'm trying to think tactically, are you preparing for something like that
04:00 in the second half to maybe take advantage later on? Or are you convinced about the long
04:04 term so much that you're not making wholesale changes to the portfolio?
04:10 So Neeraj, I'll tell you, first of all, we are completely convinced that we are in a
04:20 long term structural bull market in India. After a long time, a lot of things are falling
04:30 into place. Right. That does not mean that in any long term bull market, you may not
04:37 have phases where there are corrections or sideways movements in the market. However,
04:45 having played a couple of bull markets in the past, the lessons is that do not try to
04:54 optimize within a bull market. If you are convinced on the big picture, right, you may
05:02 make a few tactical shifts between sectors here and there. All that is fine. It really
05:08 depends on each investor or portfolio manager's philosophy. But one big learning is that you
05:19 do not try to optimize by saying that, OK, there could potentially be a correction because
05:25 of withdrawal of liquidity. And therefore, let me keep some cash and then I will reinvest
05:31 it later on. And the risk with that is no different than, let's say, six or eight months
05:40 ago when there was a big expectation that the US economy will go into a recession. Right.
05:48 And everybody was talking about it. The fact of the matter is that the US hasn't gone into
05:54 a recession. And the problem, therefore, in terms of making these macro level forecasts
06:03 is that you don't know whether you will be right or wrong, no matter how strongly everybody
06:09 believed that that would be the scenario. Right. So I do not want to change anything
06:17 or my positioning in the portfolio based on some hypothetical event that may or may not
06:25 occur in the future. Right. I think it's important that at the very baseline level, we believe
06:32 that we are in a good market cycle. We are in a good economy cycle. There will be challenges
06:40 and headwinds in between. There will be events in between, which could be elections next
06:46 year, which could be, you know, you could still have a slowdown in the second half.
06:52 The cumulative impact of all the rate rises might come a little later. We don't know.
06:59 But I think one thing is very clear from our perspective is that this is a bull market.
07:05 Don't get off the horse. Stay on the horse. OK, point well taken, Hiren. In which case,
07:12 let me ask that is your portfolio, currently your portfolio materially different from what
07:19 an average portfolio construct would be in that a bit of financials, maybe less IT or
07:24 no IT exposure to some of the B2G sectors, etc. That seems to be the common consensus
07:29 currently. Are you different there? How are you? What is your thought when you're building
07:34 out or when you're living out the portfolio construct that you have in place currently?
07:40 So Neeraj, if you remember, I think we interviewed with you last year and or maybe even before
07:50 that. And for a reasonable period of time, our view has been that we were very bullish
08:03 on manufacturing as a sector. My view is that we are going to see the kind of sector leadership
08:14 that we saw during the 2003 or 2002, 2003 to 2008, 2009 bull market, which is industrials,
08:25 capital goods, auto, auto ancillary power, real estate. Now you can throw in renewable
08:31 energy, electronic manufacturing services, defense, because every cycle has a couple
08:37 of new leaders, hotels, hospitals, right? Pretty much very similar to the cycle that
08:46 we saw from 2003 to 2007, will broadly repeat in terms of the sectors that sector leadership
08:57 that will outperform, right? Now, having said that, I think we clearly, based on that conviction,
09:08 we clearly, not today, but over the last 12 to 18 months, we have been infusing manufacturing
09:20 companies, capital goods companies, and we believe that these are the investments or
09:30 teams that will run for a fairly long period of time, right? And therefore, we have a balance.
09:38 You mentioned, so yes, we have the big banks and financials. We have a lot of stuff in
09:48 that manufacturing bucket across many of these sectors that I mentioned. And we do have tech,
09:55 IT investments also. Now, IT has gone through obviously a cycle where we are seeing that
10:06 there are a few headwinds in the IT services sector, but largely as you know, Neeraj, that
10:13 we have, our exposure is not to the big cap IT services sector, but largely to the ER
10:22 and D companies. And you've had people like Kishore of KPIT on your show several times,
10:31 and you can see the difference, right? And this quarter was most instructive in that
10:36 sense. None of the companies were able to deliver a 7, 8% Q on Q growth. KPIT stood
10:46 out. So we have to ask the question, why that given the environment that we are seeing,
10:54 some companies are able to grow much faster. And that was our theme for a long time when
11:03 we saw the ER and D companies structurally growing faster than IT services. So I think
11:10 that we continue to stay with that theme because we do believe it's a long-term theme. Yes,
11:19 there was a phase post COVID when even they grew faster. And now maybe there is a little
11:25 bit of a moderation, but structurally they are still growing faster than IT services,
11:30 right? So I think that's how we are positioned, if you ask me. And then finally, the area
11:37 which has been very soft is the consumption space in general, because obviously we have
11:45 seen that we've had a K-shaped recovery. So consumption at the lower end is not doing
11:53 that great, but consumption at the higher end has done okay and has held out. But there
12:01 again, our view is that we are more invested in the discretionary consumption bucket where
12:14 there is premiumization happening, because we believe that as our per capita income crosses
12:22 $2,500, there is more money available to spend on premiumization across the board. So whether
12:32 it is liquor companies or whether it is in apparels or so on and so forth, we continue
12:40 to have exposure there because we believe that premiumization as a trend is likely to
12:48 continue. And even in this consumption cycle, we have seen that, that it is more people
12:54 at the lower end which got impacted rather than people at the higher end.
12:58 Got it. Thanks, Hiren. This answer gives me the opening for three different questions.
13:06 Now, viewers, you remember that sometime three years ago, four years ago, maybe you don't
13:11 remember, but Hiren Mehta had given us a gem in terms of how to make a switch, wherein
13:17 he had mentioned that if a stock is corrected quite a bit, and a stock that you wanted to
13:21 buy also is corrected by that equal sum, then don't think of booking a loss here, but think
13:24 of making a switch so that you actually get the stock that you want. Hiren, I want one
13:29 more idea about a mental model that you deploy. Now, I'm using an ER&D company as an example
13:36 here. This is not a recommendation in any stretch of imagination. But Hiren, what I'm
13:40 trying to understand is, how do you tell yourself to be convinced about holding on to an investment
13:48 in an expensive stock, wherein the narrative from the sell side is that, oh, things are
13:53 looking very expensive, the whole sector might be going through a bit of a drawdown, but
13:58 this is standing out? How do you deploy the mental model to stay invested or invest more
14:04 in such companies? So, Neeraj, I think that it is very important to understand why you
14:16 have bought something that you bought. What is the core hypothesis behind that? And if
14:26 you see all the high growth companies of the past, one argument that I hear when you ask
14:41 a lot of investors why they missed a great growth company, more often than not, it is
14:48 valuations. And therefore, when we were looking at and we were studying, everybody does these
15:00 studies about companies which have delivered consistently, compounded at a very decent
15:07 clip, 20% plus over years and years. And when you try to dissect what makes these companies
15:16 tick, why is the market willing to give a higher valuation to these companies is because
15:24 there is visibility of higher above average growth. So, two things here are important.
15:35 Above average, so you can find out a sector average, broadly speaking. If your growth
15:42 is above average and there is reasonable visibility that this growth will continue for some length
15:50 of time, the markets continue to trade these companies at higher multiples. That is what
15:58 history has taught us. And therefore, when I tend to look or what convinces me to hold
16:07 on to these companies is that every time when I look at the numbers or I reflect on the
16:16 numbers or I read on these companies or I interact with these companies, I am only checking
16:23 at two things. Will the growth rate continue to be higher than average? And do I have a
16:32 reasonable confidence in the probability that this will continue for some length of time?
16:42 If one can convince oneself on these two, and obviously, other things being equal that
16:50 your return ratios are reasonable, your governance is good, you're not doing any capital misallocation
16:55 during that time frame, then the market is willing to live with higher multiples. Unfortunately,
17:07 there is no science what that higher multiple could be. In the heydays of HDFC Bank, four
17:15 times price to book multiple was a high multiple. In the heydays of Bajaj Finance's growth cycle,
17:24 six or seven times price to book was a new norm. There was no historical context to it.
17:32 Today, if you look at the ER&D companies, you're all at 50-60 times multiples. There
17:42 is no historical context. But there is one historical context is that if there is a reasonable
17:49 runway for growth, and if companies are delivering reasonably high returns about capital, then
18:00 I think the markets are willing to give a higher P. Now, obviously, we must also understand
18:07 since you asked this, you know, and ask the viewers to kind of take away something from
18:15 this is that one of the downsides of investing in growth companies is that you're also susceptible
18:25 to sometimes sharp drawdowns when things because your valuation assumes that there is no error
18:38 in execution, or there are no, you know, pitfalls for a couple of quarters, exactly like you
18:48 mentioned when you interviewed the CEO of Loris Labs, right? I mean, we don't own it,
18:54 but I'm just saying that it did phenomenally well. And then every growth company maybe
19:02 sometimes goes through a patch where it is changing the business, there are a few headwinds,
19:08 it is making investments, the numbers are not as great as you would like them to be.
19:15 And you could see a disappointment on the stock price for some time before it gets back
19:22 onto the growth path. So one has to be careful that while the journey from A to Z may look
19:30 very, very tantalizing, because the CAGRs that you can make or the returns you can make
19:36 are obviously above average, but the journey may not necessarily be as smooth. And that's
19:41 where your conviction matters the most. And I think that how do you build that conviction
19:51 is the most important secret sauce in it.
19:54 Yeah, I know. And I think a lot of it comes with experience. I think people have to stay
20:00 in the game and keep on playing it and refining it every single day to try and get it. But
20:04 this is lovely. Thank you for this. It was a really, really nice way you put this into
20:09 perspective. I have one final question, but which is more not about a mental model, but
20:14 the here and now before we wrap up this conversation, which is how are you deciding at any point
20:20 of time or currently, for example, how do you allocate more to a particular manufacturing,
20:26 a particular space within manufacturing versus some of the others? Because almost every company
20:32 that you hear, the condom of order flows, the book to bill ratios, the call calls from
20:38 the companies are all looking very optimistic. So how are you deciding what is the first
20:43 amongst the equals?
20:46 Yeah. I think, you know, the thing is that it is not easy. Because many of these stocks
20:59 have, I mean, their evaluations do tend to capture some of these tailwinds. Right. And
21:10 therefore, the question is, how do you incrementally allocate money to those names? Well, I think
21:19 what happens is that if you are coming, first of all, I believe that we are still at the
21:25 early stages of the cycle. So optically, the valuations may look higher. Also, these companies
21:34 would have delivered, you know, some of them have delivered 100 plus percent return, some
21:40 of them 40-50 percent way higher than what the markets have delivered. Right. So maybe
21:47 intermittently, even in these high growth companies, you may get a phase where you have
21:53 a time correction till the earnings catches up. Now, again, the thing is that it's all
22:01 about as long as earnings growth keeps coming in, you will be fine even if you enter at
22:10 a higher level, maybe your returns from there on would matter more than what somebody would
22:16 have made historically. Right. Now, what we do is that and we also understand this is
22:22 a challenge. And therefore, currently, what we are doing is that while we continue to
22:30 deploy money in some of these companies where the manufacturing sector across whether auto,
22:37 auto ancillaries, cap goods, etc., we do start with a slightly lower weightage than what
22:46 we would have done historically. Right. Because if you do get a time or a price correction,
22:54 that gives you the ability to add because you're still playing for the longer term because
22:59 your view is that you are still in the early stages of this cycle. So that's one way to
23:03 do it. Secondly, I also believe that there is always a hunting ground for good quality
23:12 companies in sectors which are currently not doing well. Right. Which, for example, in
23:21 discretionary consumption, where you know, these stocks haven't done anything great.
23:29 They are still bouncing around their bottoms rather than bouncing around their tops. Right.
23:37 But where the risk reward is very favorable to you because all the headwinds are priced
23:46 in today. Now, people want to wait till they see the first signs of improvements in their
23:55 numbers. Right. But investing is all about the future. It's not about the past. And your
24:02 judgment of whether most of the bad news is already in the price. And if you believe that
24:11 it's not that India is going to grow and only manufacturing is going to do well, you know,
24:17 healthcare will do well and consumption will also do well. I think then how you allocate
24:25 your money in the portfolio to some of those sectors which may not be in favor today, but
24:32 where structurally, you know, that the business model is good. It's just the external environment
24:39 that is tough. Once that external environment changes and consumption comes back, which
24:45 eventually it will at some point in time, then these companies will start to perform.
24:54 Now the question is, are you a just in time investor? Or are you willing to say that,
25:00 okay, a part of my portfolio is in this high growth, secular growth bucket. But a part
25:07 of my portfolio is also in companies which are very strong, but currently going through
25:15 a tough phase. But it's already in the price because these stocks haven't done much. And
25:20 nobody's chasing these companies today, everybody's chasing the former. So you have to create
25:26 a mix of risk reward in your portfolio, where you have a combination of these secular growth
25:34 stories. But you also have exposure to companies or sectors that are not doing well. Now suddenly
25:42 people are figuring out, okay, what should I do in pharma? Because, you know, suddenly
25:47 pharma is doing well, if you had asked anybody a question three months or six months ago,
25:52 people wouldn't have cared about what is happening. So and I think the definition of a bull market
26:00 is that every sector participates finally, even the laggard sector will participate.
26:07 Maybe it participates right at the end. But every sector and there is continuous sector
26:13 rotation that keeps happening. That's how a bull market keeps going. And I think something
26:18 similar like that will happen in this bull market, it's already happened.
26:23 Great. Cross fingers for all of that. Hiren, fabulous talking to you today. Thank you so
26:29 much for taking the time out and giving us your thoughts.
26:32 Thank you. Thank you so much, Neeraj. Pleasure.
26:35 The pleasure is ours and yours. Thanks for tuning into this edition of Alkamaa Bills.
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