PMS tax has been blown out of proportion as investors care about net returns, says Alchemy's Alok Agarwal

Alok Agarwal of Alchemy Capital

Investors care about net returns and while a higher churn might increase tax liabilities, the focus is on holding winners and cutting losers, which usually results in long-term capital gains, says Alchemy Capital's Head of Quant and Fund Manager, Alok Agarwal. Quant-based investing helps remove human biases by following predefined rules, offering a distinct advantage over traditional active management, he adds while highlighting that sectors like industrials and defence, which were once dormant, are now poised for significant growth as India’s power generation and defence production surge.

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There is no active fund management involved. We look at macro and micro factors, including fundamentals and price points. For stock selection, we evaluate growth, balance sheet strength, earnings quality, and valuations. We don't use a funnel system where you start with a large universe and gradually filter down to a smaller list. Instead, we look at multiple factors, and a stock can still qualify if it scores well in some areas, even if it doesn't perform well in others.

The market cycle matters a lot. If a stock is an underperformer in the current cycle, it is less likely to be picked. For example, if the market is up 35% and a stock is only up 20-25%, it’s considered an underperformer. However, if other factors—like growth or valuation—are strong, the stock might still get selected, assuming it could reverse its performance.

Quant-based investing simply follows predefined rules written by people. The machine processes the data, but it’s still based on human input. There are investors who miss out on opportunities due to personal biases, like avoiding expensive stocks or PSUs. Quant funds help eliminate those biases. However, I wouldn't say quant is superior to active management. It’s just a different approach and with availability of more data now, one can use it.

Our churn is around 1 to 1.2x annually, which is lower than most other quant funds that churn at 300-400%.

Investors care about net returns. While a higher churn might increase tax liabilities, we focus on holding winners and cutting losers, which usually results in long-term capital gains. In our portfolio, the churn that's happening is ensuring a laggard is moved out, and a potential winner is brought in. So, when these winners get booked, then bulk of the profits will get booked. And because winners are likely to stay longer, bulk of the gains are likely to be long term capital gains. So, there is some extra tax, but that difference is not as big, if your alpha generations is higher to set off the extra tax, then it is worth it, otherwise not. I feel that people have blown this issue out of proportion.

The sector was sleeping for more than a decade but started recovering post-COVID, as order flows improved. Companies in power, railways, and renewable energy, are seeing substantial growth. Industrials are cyclical, so in good times, their earnings can grow at a much faster pace. We aim to catch these cycles. Sometimes, we hear that valuations are too high, but when coming out of a downturn, market valuations may be looking ahead at future earnings, not just current numbers.

Take one of our top defence holdings. A year ago, Bloomberg consensus estimated 6% earnings growth, but the company delivered 40%. Estimates sometimes miss the real picture. India spends about Rs 6-7 lakh crore annually on defence, and for years, this was mostly used for salaries or imports. Recently, there’s been a focus on domestic defence production, leading to growth in the sector. I compare it to the auto sector in the 90s—there’s a long runway for growth.

HAL is a fundamentally strong company. In addition to domestic orders, India has been receiving more export orders. The key is ensuring deliveries are smooth, and that seems to be on track.

Colgate and Varun Beverages. After the management change, Colgate has been performing very well. And Varun Beverages, it is growing at such a scorching pace, it possibly has the growth rate for two companies put together. The company is expanding geographically, which is driving growth. Previously, they had exposure to only part of India, but now they are expanding to other regions and even looking at other countries. Their execution levels are strong, and they’ve launched a few products that are performing well.

Transformers are essential for converting high voltage to low voltage during power transmission. As India's power generation increases, so does the demand for transformers. With more renewable energy sources connecting to the grid, and power being generated from remote locations, the need for transformers continues to rise.

India's peak power demand is about 220 gigawatts, with a deficit in supply. Over the next 5-7 years, an additional 100 gigawatts of generation capacity is needed, indicating significant growth potential for companies involved in power transmission, including transformers.

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