In the latest episode of Coffee Can Investing, watch Saurabh Mukherjea, Founder of Marcellus Investment Managers, in conversation with Rajeev Thakkar, Director of PPFAS
In the latest episode of Coffee Can Investing, Saurabh Mukherjea is in talks with Rajeev Thakkar, Director of Parag Parikh Financial Advisory Services (PPFAS). His tenure began in 2001.
He is a strong believer in the school of value-investing, and has been indulging in something called parallel investing. He is among rare Indian mutual fund managers who invest across the world along with Indian market.
Edited excerpt of the conversation:
Saurabh: We have seen you as an investor over the years but from what I understand, you grew up in a family where investing wasn’t there. So, we would love to know little bit more about the early part of your life.
Rajeev: So, I had an opportunity which unfortunately today’s generation may not have because today we have PDF versions of annual reports. And again, the books may be Kindle versions or just lie on the device and you really don’t know what your parent is reading. In the earlier era, I saw physical copies of investment books at home. I saw physical annual reports coming in and a child-like curiosity as to what are the grown-ups doing.
S: Your dad was the reader of these annual reports?
R: Yes. He was not so much of a reader but at least the annual reports would come home.
S: He was a shareholder, right?
R: He was a shareholder and the reports would come in. And again, the books gave some early framework. It was unfortunately not one of the well-known books, not the Intelligent Investor or Philip Fisher, but still, it gave an investment framework rather than a trading or a speculating framework.
S: So that was your beginning in the world of investing?
R: True. So, that created awareness that there is something called stock market and you can invest in shares and earn profits out of it. As a book like Outliers would say, many things depend on external circumstances. If I had been born five or six years later, maybe I would be a techie today because that was the in thing.
My graduation year was 1992. It was Harshad Mehta boom period. That was the period where finance professionals were on cover page of magazines. The first one crore salaries in that era and people were quitting foreign bank jobs to join investment houses. So, I think it was also the spirit of the times kind of thing. So, I don’t claim great insight into or great intrinsic motivations to come into this field. Partly, it was just the spirit of the times.
S: Another interesting influence on your life was the great late Chandrakant Sampat. Some people say he is India’s Warren Buffett. How did you meet Chandrakant Sampat? What was his influence on you?
R: So, Chandrakant Sampat and Mr Parag Parikh’s father were close friends. And, Chandrakant Sampat was never a stock broker or employee of any organisation. But in the BSE trading ring days, the BSE authorities found him so important that he had a special pass which was only for dealers and he could enter the ring at that point in time. And given that he was Parag Bhai’s father’s friend, he was a mentor to Parag Bhai.
He would come every day to office, spend a few hours with the research team, pick their brains on what they are looking at and typically demolish most of their stock ideas so that was a down side to interacting with him every day. You got so quality conscious that most stock ideas would not pass his filter and eventually your filter.
S: What did Chandrakant Sampatji look for in a stock idea?
R: If he were alive today he would be probably somewhere between Buffett and Munger’s age. And independently, he formed a framework of looking at return on invested capital, free cash flow and things like that. And, his primary mantra was not growth or low multiples. His primary mantra was return on invested capital and low capital expenditure (capex) kind of businesses. He was typically into FMCG names like Nestle, Colgate, Lever, Gillette.
S: How did late Parag Parikh influence you? You worked for him longer than anybody else I ever met.
R: I joined the firm in 2001. And, even before I joined the firm my first introduction or my first awareness of him as a person came by way of media articles that he was writing. This was maybe in the year 2000 or somewhere thereabouts or early 2001. And that was the first time I came across a terminology called behavioural finance.
S: In 2001 it was an unknown concept…
R: He was taken up by that field and he spent lot of his time reading up on that and inculcating some of the learnings from that. So, while individual company analysis and stock picking was Mr Chandrakant Sampat’s domain in terms of mentoring the research team, Mr Parag Parikh’s mentoring was on look at your own behaviour and essentially the stock is the same, the sector is the same at certain periods of time people make rosy projections other times they are depressed. So, that is essentially market playing with your mind and how to keep that influence under check. That was his contribution.
S: You are a rare Indian mutual fund manager who invests across the world and you have been known to have positions in American technology stocks in your mutual fund. How did this approach arise and what have you learnt from this parallel investing in the developed markets and in India?
R: Sometime in the late part of last decade, 2010 onwards, so again, given that Mr Chandrakant Sampat was a mentor, we used to like companies such as Colgate and Nestle and all, gradually the Indian consumption space became so much of a consensus trade as it is called where everyone today just loves those stocks, the valuations are at levels we have never seen in the past.
We saw that the parent companies of these same companies were available at far cheaper valuations and it is not that they were only developed country place. Some of these parent companies get almost 50 percent of their revenue from emerging markets which are again high growth areas. Further, they get royalties from the subsidiaries which don’t come to minority shareholders in the domestic market.
So, Nestlé shareholder in India will not get the royalty. The shareholder of the parent company will get that. So these plain and obvious arbitrages, valuations arbitrages, were being seen. That led us to look at some of the overseas companies. Again, some of the opportunities were not there in India. So let’s say the e-commerce, internet related businesses.
S: Basically, you are saying two things took you abroad. One was that for the same Indian company MNC parent was available cheaper than the Southern India. Second was all these tech place, specially, which we were using in India but we didn’t have any access to them in the local market.
R: That’s correct.
S: Has parallel investing, both in terms of making money and learning, has it yielded fruits for PPFAS?
R: Definitely. It’s been an amazing journey. So one is, given the linkages that we have overseas, global commodity like metals, prices are driven overseas or oil, ONGC, for example. IT Services company business models will be the same for Accenture or a Cognizant like that of Wipro or Infosys or TCS.
Generic pharma analyst here has to look at what Teva or Milange is doing. So given that we have these strong linkages, it makes sense to have a wider coverage to look at global stocks. Again, a lot of large Indian companies have overseas subsidiaries which contribute a large portion of value for the Indian company. You can’t be a Tata Motors analyst without having a view on Jaguar, Land Rover.
S: Let’s delve into subjects which you’ve spoken about a lot. This whole concept of moats, and comparative advantage and great management teams. So we will unpeel this onion in few layers. Just to begin with, management competence — so, if you don’t have access to the financials of a company, you don’t know their ROCE, or return on equity, but you meet the management team. What do you look for to gauge the competence of the management team, leaving aside the financial matrix?
R: So typically, someone who’s a first generation entrepreneur and who has built a company ground-up will have some sector knowledge or some industry competence. We are not early stage investors, so we don’t look at investing in startups, or someone who just says that ‘I have a brand new idea, bet on me’. To an extent that person has already proven. It may not necessarily be financial matrix but someone who has established proof of concept, who provides a good auto service for which people are willing to shell out real money and if it is first generation guy and again it is not inherited positions.
S: You are saying that you are looking at a credible business person who has created the business out of scratch. And to your mind that itself is a proof of considerable competence?
R: Yes. And otherwise in the family-owned business, typically the younger generation will start working with the organisation. And if that person has stuck around for reasonably long period of time — without going into too much of IPL or Formula 1 and things like that — who is a serious business person, one would take that as proof of concept but finally proof of the pudding is in the delivery of numbers.
S: So, you are saying if you break it in two parts, proof of concept and proof of commitment…
S: Let’s come to another element of this whole concept of moats which is brand right. Whenever I interview bright young graduates they seem to believe brand is a comparative advantage, perhaps it is, but some very clever people such as Bruce Greenwald of Columbia University have argued persuasively. They have said persuasively that a brand is neither a competitive advantage nor a form of a moat. A slightly different school of thought says that even if brand is a competitive advantage, thanks to services like Amazon and Flipkart, whatever moat was around the brand is getting shallower because it is so easy now to go to Amazon and buy something which is guaranteed by Amazon. Your thoughts on this whole concept of brand competitive advantage?
R: I am more leaning towards Bruce Greenwald kind of thinking. I think brand used to be a big moat in the past era. Increasingly it is not so much now. What has changed in the world in the last two decades mainly is the coming of internet. Let’s move away from the investing world, let’s look at movies for example. Two decades back, the only criteria for a person to watch or not watch a movie was maybe what Khalid Mohammed wrote about the movie in the Times of India. Increasingly, these days after the first show you have Twitter trends which say whether the movie is good or not. It does not depend on one particular reviewer nor does it depend on what the star cast is. The consumer poll is real time.
S: The consumer validates the movie…
R: Yes. If a product or service does not deliver, it does not matter what the legacy of the brand is, what the experts are talking about it or how much media spend the product or brand has. The product or service will fail or live by its own merits. So increasingly, I think brands are losing relevance and pricing power and one can see, you mentioned Amazon; one is seeing in products like batteries where they are outselling probably Duracell and Energizer, in some categories.
S: That then raises a follow up question, in B2C therefore, the consumer through social media can validate the product? In B2B services, B2B manufacturing will brand continue to resonate? Do you think that’s something that we will see will come true in our country?
R: Brand as a proxy for reducing search cost or proxy for trust that may be losing relevance. The other source was of moat. Let’s say switching cost or if the component is not that bigger cost in the overall scheme of things for a business consumer and the person may continue to consume tried and trusted brand. But the importance is going away with the information asymmetry going away.
S: You have brought a fascinating linkage here. We are having this discussion at a time when branded companies, consumer companies are trading at epic multiples in India right?
S: And yet we are saying internet, Amazon etc., is perhaps reducing the moat. Have we sort of got too enamored by this concept of moat because you know someone like Warren Buffett, a great investor, has coined this very easy to understand term and we all got enamoured… and almost sort of asking, using things like ROCE, return on invested capital as proxies for moat… and we turn it into self-fulfilling prophecy and pump the stocks to the sky. Is the whole concept of moat sort of outlived its usefulness, have we overdone the concept?
R: I was just joking with some of my investor friends saying the moat concept itself is of an older era. You had castles, you had a moat and people would come on horseback and bows and arrow and swords. After the airplane was invented, bombs and missiles are there, how does a moat matter?
So, is technology a potential disruptor or is the consumer voice increasingly a disruptor? You have seen the likes of a Dollar Shave Club, taking on Gillette, or Indian startup brand like the Paper Boat seeing good growth vis-à-vis flattish kind of trend for traditional cola companies. So, increasingly people are trusting each other’s comments more than the media spend and are willing to try out newer things. A brand like Nokia did not have traction and Xiaomi and Oppo and all came out of nowhere to grab market share.
S: Now, coming into our industry and in a way one of the very striking features of the mutual fund industry in which you are participating is that there are 6-7 mutual funds that dominate the industry — both in terms of AUM, profitability so on. And yet when I’ve looked at the industry in detail and I have looked at fund performance, what astonishes me is the vast majority of mutual fund equity AUM is in large cap schemes, most of which give you returns little better than the Nifty itself. Now these are basically glorified tracker schemes often with expense ratios often with fees of around 2 percent. While SEBI has taken steps to bring those fees down, to pay 1 to 1.5 percent for glorified tracker funds seems like a lot of money. Yet Indian investors are flocking to these largecap MFs. Data is abundantly available on the mediocrity of performance but the customer seems to disregard it, perhaps because of the brands of these house. What do you think is happening here? Why are Indian consumers so insensitive to fund performance and so focused on large brands?
R: That would be the case in any product or service category. The end consumer is not evolved enough or does not have the wherewithal to do all of these things. It may be a simple thing for you and I to compare fund performance or to really select a scheme. The consumer is driven by what his or her advisor or bank manager or chartered accountant or whoever is advising.
R: Distributor. In a pharma company, for example, we will buy the medicine the doctor prescribes us. We will not do a comparative analysis. When the financial media focuses on Index funds versus active managed funds, expense ratios, we are missing one larger point here. A lot of money goes into chit funds, traditional LIC policies, life Insurance policies which are toxic to the consumer returns of 6-7 percent. The first challenge is to get more people into the fund space and then increase the focus on expense ratios, index funds versus active funds and those kinds of things. Even if people come into a fund which is not the best, or the most optimal one, they will do better than the LIC policy buying gold or just bank FD.
Yes, I take your point. As the size of the AUM grow, it becomes increasingly difficult to meet the benchmark and all the investing greats have said that, size is an anchor on performance which will play out and people will face TER (Total Expense Ratio) pressures because of performance because of competition from index funds. In the largecap, the time is probably coming where index funds will be serious competitors.
S: And in a way the TER caps that SEBI has imposed on the larger fund houses could themselves turn the largecap MFs into index funds. Whether they explicitly call it that or not is a different matter. Now, you are one of those few people I have met who has both run money in a PMS construct, you are running money in a MF construct, I am sure you have got friends who are running money in an AIF Construct. What is your take is running money in a PMS construct very different from running money in a mutual fund construct?
R: Sure. So firstly, I run an MF today. So, my view may be biased to that extent. So you are asking a barber whether is it the right time for a haircut. But I think MF from a customer’s point of view is a better vehicle than a PMS or an AIF if one is going for a long only equity, or long only bonds or whatever asset classes mutual funds you can invest in. Firstly, it is an on boarding, ease of investing is easy, expense ratio is typically lower than a PMS or a AIF and also taxation wise they are more investor-friendly.
S: Tax friendly.
R: So from that point of view, I would these would make sense. I do realise that some of good managers run only an AIF or a PMS product, in which case if you want to choose those managers the investor may not have a choice but otherwise as a vehicle, I would any day go for a mutual fund vehicle. If one is running a long shot strategy or a leverage strategy, obviously AIF only can do it, a fund cannot do it.
S: Right. That’s very useful. You are a frighteningly well qualified person. You are a cost accountant and you have the US CFA Charter as well. There are lots of investors out there who are trying to figure out how to become a professional fund manager like you. What advice would you give them if they are in their late teens or early 20s? What advice would you give them as to what course of education they should follow if they want to become someone like you?
R: There are different paths. Some people have come from engineering and management background. Some people have come from accountancy, finance background. Some people are CFA charter holders, some people are none of these and some other qualifications. So there is no one right answer, but in my case what I found useful is that the two years of audit experience that I had in a chartered accountancy firm where I would go on stock taking to various plants, or I would see how the annual accounts are prepared that gave some insight into how to interpret them. I have done the same curriculum in CFA as well but that is more at an academic level versus actually auditing companies and preparing the accounts. So you take those numbers less seriously and you really know where to underline which are the points to really look into.
S: I am a big fan of the Indian Accountancy qualification. I think there are few better courses which prepare you to drill into financial statements. The CFA helps on the valuation front but you have helped identify the Indian Accountancy qualification has very few equals. Leads us on to books. Books which have influenced you which you think youngsters should read, they will find useful whether it is in investing, accounting or corporate strategy.
R: I think all of those the usual name and usual suspects are there. I will probably with your permission give a book which has influenced me not directly from the investment field. It’s a book called Deep Work. It’s about being productive in a distracted world, how to focus on the things that are really important given that we have these internet connected devices in our pocket all the time it’s becoming increasingly difficult to focus on one thing for one or two hours at a stretch and we get into this multitasking mode all the time. For a young person this book Deep Work would be very relevant.
S: Deep Work by Cal Newport?
R: That’s correct.Saurabh: Fantastic. Thank you for that recommendation. I think I need it as well. I’ll be the first person to buy this book and read it. Thank you very much Rajeev that was extremely insightful and useful.