HNI Investors: ETMarkets PMS Talk: How this fund manager delivered over 60% returns to HNI investors in a year using the eQGP approach

The Alchemy Smart Alpha 250 will celebrate its first anniversary in August. Congratulations on that. Could you also tell us about the fund’s performance?
Alok Agarwal: Alchemy Smart Alpha 250 is a Large and mid-cap strategy which invests only in the top 250 stocks by market capitalization. So it is essentially an entirely large- and mid-cap stock strategy.

It turned one year old just a few days ago, and I am very happy to report that in its first year, the strategy posted a net-of-fee return of 61.8%, compared to a benchmark return of close to 35%.

Impressive performance and profitability, over 60%. From a user’s perspective, how much wealth would investors have generated if they had invested say 50 lakh in NFO a year ago?
Alok Agarwal: If you had invested 50 lakh and added another 61.8% to it, the 50 lakh would have approximately become 81 lakh during this one year period.

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On the market front, the Sensex and Nifty hit record highs in early August, but most of the wealth was generated in small-caps. Why should we focus on large- and mid-caps at current levels?
Alok Agarwal: It’s an interesting question. In fact, over the past year we’ve heard a lot of strategy notes suggesting that markets appear to be overvalued. Rather than looking at markets in terms of market capitalisation, it’s more useful to break them down by sector to determine which sectors are performing best. You’ll notice that those supported by earnings growth are performing well, while those struggling with earnings are not performing as well.

Over the long term, at the index level, large-, mid- and small-cap companies typically offer similar returns. However, the potential for higher returns is typically greater for smaller-cap companies, which also leads to higher volatility.

In a stability-volatility matrix, larger market capitalizations provide more stability, while smaller capitalizations offer the potential for higher gains and earnings growth, albeit with less stability.

We choose a mix of large- and mid-cap companies, with large-caps providing stability and mid-caps offering greater growth potential. This creates a strong sweet spot for our strategy.

How do you choose stocks to invest in? I believe you also use the eQGP framework. Could you explain that to us?
Alok Agarwal: The idea behind launching this strategy was that stock markets, including ours, are cyclical by nature. Most strategies focus on a particular investment style: growth, value, quality or special situations.

These styles are logical and perform well over the course of an investment cycle. However, to achieve consistent alpha throughout the entire investment process, a strategy must adapt to changing market conditions.

To achieve this, we developed the eQGP framework. The last three letters (Q, G, and P) stand for quality, growth, and price action, respectively. These are the three viewpoints through which a company’s strengths are assessed.

To compare companies, an overall score is calculated by adding or averaging these scores. However, when a simple average is used, equal weight is given to growth, quality and price performance, which may not be ideal depending on market conditions.

This is where the first letter, E, comes into play. The E represents the market environment in which we operate. In a bullish, risk-on, or aggressive market, price action becomes more important, followed by growth and then quality. In a bearish or defensive market, quality becomes more important, followed by growth and price action.

Instead of a binary approach, the environment is scaled from 1 to 100, allowing for 100 different combinations of weights, depending on whether the market is bullish or bearish. In bullish markets, price action is emphasized, while in bearish markets, quality is prioritized.

In terms of sectoral weighting, you have more than 10% in the industrial, financial and consumer discretionary sectors. Is that where wealth is being generated? What is your opinion?
Alok Agarwal: According to our benchmark, these sectors show solid figures. In terms of quality, most of these companies report ROEs that are much better than their historical figures and their peers.

Their debt figures are improving, operating cash flows are increasing and they are currently the market growth leader. In terms of price action, both absolute and relative performance are strong.

Industrial, utilities (especially energy-related supply chains) and financial sectors (dominated more by NBFCs of public sector enterprises than by private banks or banks of public sector enterprises) are showing significant growth.

We are currently in a risk-off mode, and all three sectors (industrials, consumer discretionary and financials) are performing well in terms of price action, growth and quality.

How do you manage the fund’s risk, especially when markets are rising rapidly?
Alok Agarwal: Our approach is to let the winners go ahead and weed out the laggards. I compare it to gardening: we water the flowers and pull out the weeds. In this portfolio, we weed out the weakest links and replace them with stronger ones.

Using the eQGP framework, the top 25 weighted average-rated stocks are included in the portfolio. If a stock’s rating falls below a certain threshold (say 45, though we don’t disclose the exact number), it is removed from the portfolio and the stock with the highest rating is included.

This method may not allow us to sell at the peak, but the idea is to participate in most of a stock’s growth path, even if it is not 100% of it.

What is the ideal time horizon for someone investing in this fund in 2024?
Alok Agarwal: Any time horizon of less than three years is extremely short for stock investing. To get the most benefit, you should aim for a time horizon of at least three years.

I am confident that the fund will be able to deliver on its promise and, given the excellent first year performance, I believe that investor experience will encourage holding the fund for longer periods.

Are there any sectors you are underweight?
Alok Agarwal: You will notice that there is almost no exposure to private banks, a very low weighting in FMCG and almost zero weighting in large IT companies. These sectors have significantly underperformed the Nifty 500 or the BSE 250 mid-cap and large-cap index.

Their growth figures are not keeping pace with the broader market, resulting in them ranking low in the first two important metrics: price action and growth.

This portfolio remains true to its mandate and if no stocks in these sectors make the top 25, we can have zero exposure to them.

However, if these sectors start to deliver better growth figures, their rankings will improve and we will be happy to include them in the portfolio.

The consumer sector, especially after the budget, was expected to benefit. What is your take on this, considering that it has not yet delivered the expected numbers?
Alok Agarwal: Short-term developments often lead to optimistic projections. When the budget was being prepared, there was speculation that the government’s dividend bonanza would lead to a surge in capital spending and consumption.

While more was spent on consumption than capital spending, ultimately the bottom line and earnings growth should materialize.

If these numbers improve, my model will start to pick them up, but I haven’t seen any clear signs yet. These are high-quality franchises in a high-quality industry, and I wouldn’t want to miss out, but I don’t want to get ahead of myself unnecessarily.

Indian markets have managed to navigate major events like elections, budgets and geopolitical concerns without any major setbacks. What is driving the rally? I am sure it is not valuations.
Alok Agarwal: Yes, valuations have been a concern and Indian markets have been seen as overvalued compared to emerging markets, which are generally more commodity-oriented.

However, how many markets of this size can boast consistent double-digit nominal GDP growth, corporate earnings growth of around 15% and ROE of around 15%?

Add to that the diversification into more than ten sectors and you have a unique market. With India’s per capita income of around $2,500, which is likely to double every eight years, we have a bright future ahead of us.

In recent times there has also been a significant increase in participation in the domestic market through institutions, investment funds and retail purchases. Financial savings as a percentage of household savings were low, but have been improving.

A shift in mindset — recognizing that stock markets can create wealth over the long term, just like fixed deposits and real estate — is also driving the rally.

(Disclaimer: The recommendations, suggestions, views and opinions of the experts are their own and do not represent the views of the Economic Times)