Masterclass with Super Investors is a curated compilation of in-depth interviews with some of India’s most accomplished stock market investors. Hiren Ved is the co-founder and whole-time director of Alchemy Capital Management, an asset management company. According to the company's website, Alchemy Capital Management is the vision of Lashit Sanghvi, Ashwin Kedia, Rakesh Jhunjhunwala and Hiren Ved. Ved has more than 2 decades of experience in the Indian equity markets. As his bio reads on the company's website, "he has created a solid foundation in bottom-up research and stock picking with extensive coverage of companies across sectors through management/company meetings." Ved is a qualified cost accountant and holds a Diploma in Banking & Finance.
Following excerpts feature an interview with Ved:
You have been investing for the last 25 years. What has worked in different markets?
The best time to buy is when the macro is bad. That’s when you get the cheapest valuations. Growth and quality has always worked in India. Also in times like these, when the growth is not broad based, quality outperforms. When growth becomes broad based, value will start outperforming. Now that the markets are getting more institutionalized, if you think there is a thematic or sectoral play, you should just buy the best and the largest company. You will make the fastest money on a risk-adjusted basis. That will hold true unless you have a small/ mid-cap company, where the growth is really disproportionate as compared to the industry, or it is highly undervalued.
When markets become expensive, going down the market cap or quality curve has generally been a mistake. However, it could also be about how you allocate capital. We would have higher allocation to the market leader. Then we could have a flanking strategy where we buy a basket of these second tier companies that are like a leveraged play on the main theme. But we won’t sell the leader and buy the second tier. You can invest 60-70% in the leader and the rest in the second tier stocks. But you can do this in homogenous industries like sugar or steel, not in specialist sectors like pharmaceuticals. In 2002-07, we bought many EPC companies like Gammon/ IVRCL/ Jyoti, etc. and didn’t buy L&T! We were lucky that we sold most of these in time. But in hindsight, after a detailed analysis, we realized that we should have done the flanking strategy where we bought the best quality leader as the main engine and then balance allocation to the smaller companies.
When managing external money, I have realized one thing - keep the beta of the portfolio low and you will be happy. People fear the downside more than they applaud the upside. So if you can protect the client’s downside, it has a wonderful impact on your business.
What are your learnings from the market cycles in India?
Every few years, or once in a decade, we get into a macro crisis in India. When you try to solve the macro crisis, the micro gets impacted. I came to the stock market in 1991. We had a foreign exchange crisis. Then PM, Narasimha Rao and FM, Dr. Manmohan Singh, started the reform process. After the first phase of reforms, everyone got euphoric. Harshad Mehta took advantage of the market, but the numbers didn’t follow, so the whole house of cards came falling down. If you look at the numbers between 1991-93, the earnings growth was flat to negative. The markets took off in September 1993, and earnings started to spike from September 1994, so the markets pre-empted the earning recovery. Now, let’s come to the current period. 2013 was the low point. Then FM, P. Chidambaram and RBI Governor, Raghuram Rajan, did a few things to start correcting the macros. Then PM Modi came, and the markets started rallying on the expectations that everything will be good. But when you are pulling back to improve the macros, it takes a few years to get it correct. The scale is also much bigger now. The earnings growth has been low till now but the markets are probably pre-empting a recovery, a year down the line.
People talk about P/Es, but you have to understand where you are in the profit cycle. Risks to the markets are the highest after you have gone through an earnings up-cycle, because people tend to project the growth into the future. In the period of 2004-07, the earnings grew at a tearing pace – around 28% CAGR. On top of that, a higher P/E was assigned. So people were giving a higher P/E on a rising curve, and then if something happens to the earnings – it is a disaster. Right now, earnings are at a trough and the markets have gone up. There is risk of a pullback. But overall, expensive valuations have no meaning because there is no earnings growth on an aggregate basis. There are always a few sectors that do well. The aggregate earnings growth has a certain story to tell – whether the breadth of the economic recovery is big or not. The breadth is always narrow at the start and then it builds and broadens. When it broadens, you are in the midsection of the bull market. I still think that we are yet to cross the first section of the earnings recovery – the P/E expansion has happened.
The interplay of EPS and P/E is beautiful. Most people tend to just look at the earnings. But P/E is the leading indicator and not the EPS, which is the lagging indicator. But P/E is a very ephemeral concept – it has to be seen in a context. P/E goes up because there is liquidity, or there is confidence about the future, or it is pre-empting an earnings recovery. Even during market downturns, like in 2008, the companies initially were not much affected in terms of earnings, but the P/E got compressed. Companies said that there is no problem here in India; the problem is in the US. The actual earnings fall happened in the last quarter of FY2009. But the markets bottomed out much before the earnings fell. So I think where people get blindsided is that they look at earnings and earnings have no meaning at turning points – either from top to down or the other way round. Earnings have a meaning in the middle part of the cycle, when the trend has already established itself. Then you can look at the trajectory and project forward. One of the advantages of being around for 25 years in the market is that you can step back and look at the whole picture. In the initial stages of investing, you are every bit part of the picture – there is no historical context on how to see the environment.
To that extent, the US is a great market, because there is so much data and history. For example, I never thought about when value outperforms and when growth outperforms. Classical wisdom says that you have a certain style – stick to it and it will work out over cycles. With the benefit of hindsight, I would say my philosophy is not rigid and we have to be adaptive. Today, when the growth is not broad based, quality will get disproportionate value, so I should keep that in mind when taking a decision about the time to sell quality stocks. I should not be extremely hasty in selling quality stocks that have become expensive. All the liquidity will chase the same high quality companies. The context is different now as the quantum of liquidity is much higher now. The earlier norm was 25 P/E, but the new norm could be 45-50 P/E. I am not justifying it. I am just saying that you have to keep the context of the macro in mind– what I call ‘contextual investing’. So you keep your style of investing intact, but are aware of the context in which you are investing. There is a layer of global macros, your country macros, and where you are in the market cycle. If you can broadly get that, you can invest accordingly.
Master Class With Super-Investors contains interviews with Ramesh Damani, Raamdeo Aggarwal, Govind Parikh, Hiren Ved, Kenneth Andrade, Rajashekar Iyer, Anil Goel, Vijay Kedia, Shyam Sekhar, Bharat Patel and Chaitanya Dalmia. The excerpts have been carried with the permission of the authors.
The book is available only at . http://altaisadvisors.com/masterclass/book