Taking a step back helped beat competition: Fund Manager Shreyash Devalkar

Shreyash Devalkar of Axis Mutual Fund was able to deliver enviable returns by moving away from the herd even as mid- and small-caps struggled

For mid- and small-cap companies, the rally which started in 2013 seemed stretched towards the end of 2017. Such situations can be dangerous and Shreyash Devalkar, fund manager of Axis Midcap Fund since 2016, was no longer comfortable. He decided that such frothy markets require to be treated carefully. 

He reduced his exposure to small-cap companies. The investments in mid-cap counters became more concentrated, and there was a shift to fewer companies which were also doing well from a fundamental perspective. The move helped him record gains in a year when most of his peers were struggling to avoid losses; and netted him the best equity fund manager award (mid- and small-cap equity) at the Business Standard Fund Cafe 2019.

The one-year return of the fund was 8.15 per cent compared to a -3.14 per cent for the benchmark S&P BSE MidCap Total Return Index. It had a weighted average Sharpe ratio, a measure of additional return generated for every unit of extra risk taken, of 0.29. This was the highest among its peers in the short-list, many of which had negative ratios. 

The idea was to remain focused on good-quality companies which also show high growth, he says. 

But his gains in the past also involved looking at companies which were perhaps not doing well, and betting on a turnaround. While it is often said that turnarounds seldom turn, Devalkar has a strategy. 

“I don’t generally get into the company just because it has fallen, and then hope that it will turn around. The flipside of this is that you may not be able to capture the bottom of any stock. But for me, it is okay. You can leave that initial 20 per cent upside on the table as long as you believe that the stock is going to double and the J-curve, the inflection point is coming. And that’s how I work. This is my way of avoiding that error of investing in something which may not improve or which may further deteriorate,” he says. 

This is reflected in his retail picks, where a number of companies showed good growth after a period where the entire pack was written off because of the entry of e-commerce.  

The coming together of multiple factors acted as tailwinds. Weaker players exited, lessening competition. A slow real estate market lowered costs in terms of rentals and helped with availability of space. Many companies corrected their models after past experience and mistakes. They focused on improvements, including better inventory management even as the need for touch-and-feel among Indian consumers asserted itself amid the e-commerce boom. 

While Devalkar didn’t catch the bottom of the market, the retail picks he made contributed significantly to his outperformance in recent times. His picks included firms involved in footwear, grocery, apparel, and jewellery plays, too. 

He also had exposure to the right kind of stocks in the financial sector. His fund had non-banking financial companies (NBFCs), which were relatively insulated from the troubles which affected rest of the space. The NBFC segment has been facing problems in raising capital after the Infrastructure Leasing & Financial Services (IL&FS) default in 2018. Many of these and other troubles are still weighing on the stock market and smaller companies in particular. Many investors have been taking money off the table. 

Selling can be a difficult decision. 

Legendary American investor Warren Buffett has famously held on to companies such as Coca-Cola for years, while other investors have worried about when they should sell their winners. Devalkar depends on a different framework that looks beyond an exit price. “We don’t sell for price at all. Price should be in thecontext of value addition, the industry structure — those things matter more, whether the industry structure is in favour or not,” he says. 

He gave the example of some companies that are among his top holdings in industries where the structure is highly favourable to the leading companies. Such firms become virtual monopolies or duopolies in their space. “So then, we don’t get into this argument of ‘expensive so sell, and then buy again’ there is no point,” he adds.  

Such firms typically become part of the long-term portfolio by default, according to him. Others where the underlying story is not as robust require fund managers to act when conditions change. 

“I normally deal with whether quality and growth are changing. In 2017-end, I thought that growth was changing, and not quality in some companies. I then acted on it. The flipside again is that you may not capture the top of the stock while selling. At the same time, I may not capture the bottom of the stock also while buying,” he reiterates.

He holds that when one has an eye on key indicators including return on equity (RoE) and whether the structural advantages are changing, then you can typically hold on to the firms long enough to make money. This also involves looking at softer issues. For example, Devalkar believes 

it is important to look at the second rung of management, and how firms treat their vendors and employees. 

Ultimately, firms only make money over the long-term if all stakeholders are treated fairly. While this may not immediately reflect in the numbers, things have a tendency to catch up over the long-term and will eventually affect returns, according to him.   

This investment philosophy has allowed for interesting contrasts in his portfolio. While a pioneering technology company with strong recall among the younger generation is among his top holdings, another pick is an old-world hospitality firm. The bet on disruption is clear in the first. But he also believes that there is a story worth exploring in the latter kind of firm as well. The bet in the second case is on a segment which could, because of brand or location, pull customers without depending on an intermediary platform, and may well be able to resist the technological disruptions that can affect lesser firms. 

Nevertheless, he advises investors to not expect outperformance only because of the recent slump in mid- and small-cap stocks. Good returns will be available, but investors shouldn’t expect extraordinary gains only because of the current levels in many stocks, he says.