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A diversified Equity fund concentrating on FCF generating businesses
Ajay Tyagi - UTI Mutual Fund

MF Live: How has the structure and allocation to various stocks in UTI Equity Fund been conceptualized? Please provide an overview on this.

Ajay Tyagi: The stock selection pattern is the investing philosophy of UTI. The focus is on what generates money. The intrinsic value of a business is nothing but the discounted value of future cash flow. If a business does not generate cash flow it does not have intrinsic value. A business makes money and generates economic value, if it is able to generate cash flow on a consistent basis over time with an increasing pattern.

For instance, Oil & Gas stocks are selected by public as there has been a price correction in the stocks. Expectations are that these stocks will outperform and give good profits to the investors. In such cases, have we checked that oil & gas have made enough of cash flows? Are they sustainable? Are they having debts?

A debt is a sign that not enough positive cash flows are generated.

Healthy cash flow generation is a predominant driver for long-term economic value creation. Successful strategy over a long term is investing in businesses that that generate cash flows even after the spending on CAPEX.

A business which generates value and wealth creation for shareholders needs to have healthy cash flow. If this is ignored buying and selling happens on the conjecture of what will under or over perform, but it is not based on the inherent character of the underlying business.

MF Live- What are the other factors apart from cash flow?

Ajay Tyagi:

Quality: Business having strong (Return on Capital Employed) ROCE.

Businesses generating ROCE less than the cost of capital cannot generate economic value. A strong ROCE from cash flow means a business has a certain quality.

Growth & Valuation: Hygiene check for stocks is Growth and Value.

Portfolio of UTI Equity Fund is an intersection between quality and growth.

There are about 50 stocks in the portfolio of UTI Equity Fund and they are all at the intersection of quality and growth.

P/E and intrinsic value are mathematically interconnected. They cannot be seen in isolation.

A business trading at Rs.1000 and generating Rs.10 of FCF is actually trading at 100 times FCF. A business trading at Rs.4000 and generating Rs.80 as FCF is trading at 50 times Price to FCF. The latter business is cheap.

In simple words, “My portfolios will always have very high P/E stocks but they will be cheap on cash flow. And, I think what matters is cash flows. In my framework P/E’s don’t matter as much.”

MF Live: What has been the approach for portfolio construction of UTI Equity Fund?

Ajay Tyagi: It is a Bottom-Up approach. “I will have absolutely no regards to what’s there in the benchmark. For e.g., I have zero percent exposure to energy. And I think Energy is13% in the benchmark.”

The first point of portfolio construction for me is to not look at the benchmark and then pick up the stocks followed by position sizing. UTI practices that in some of the other funds, like large cap fund, where we say that it is an index trailing fund.

“This fund is a blue-blooded bottom up fund, selection of greatstocks with a vision of 5-10 years. It is highly divergent from benchmark. It’s a multi cap fund with 60% of the fund in the large cap and 40% in small & mid cap stocks.”

MF Live: Large cap selection is relatively less risky compared to mid and small caps, due to availability and reliability of information. What is your approach?

Ajay Tyagi: Rules remain same for all of them. Nothing changes with mid and small caps.

“Once Geeta has been written you don’t selectively choose between tenets, you follow everything.”

Unless and until the business has demonstrated quality we won’t touch it. Quality is the DNA for any company. Business built on the principle of gaining size and scale and not on the basis of gaining cash flows, will persist.

MF Live: When you took over to manage the UTI Equity Fund in 2016 number of portfolio stocks has reduced. Please elaborate this.

Ajay Tyagi: The fund manager earlier was AnupBhaskar and obviously any 2 individuals would have different style of selection. He was more comfortable with 75-80 names. The minute I got UTI Equity fund, I simply aligned it to other fund that I was managing in the offshore space. This fund is now very similar to the other funds that I have been managing for 10 years now, in the offshore side.  I am comfortable in running with 50-55 stocks rather than diluting to 75 stocks. The fund today has got an AUM of Rs.7500 crore and I am reasonably comfortable that upto Rs. 15,000 crore we can easily manage the fund between 50-55 stocks.

MF Live: Pharma sector is not organized. Every company has their own unique business model. One to one comparison is not possible. How are Pharma stocks chosen?

Ajay Tyagi: Again, rule book remains the same.

This portfolio has 7 or 8 stocks, some of them are US generic focused, few are India focused. Two of them are basically CRAMS (Contract Research and Manufacturing Services) players. Each of the stocks has unique business models.

Each one of them over the last 10-15 years have figured out, what works best for them.

Last 2 years US generics have been disastrous, but the opportunity that lies in the US is too huge for anybody to shut their eyes. Good times and bad times keep coming in and out. If over the next 5-10 years one feels that yes my stake in the US, we can generate huge economic value by generating strong cash flows and growing the business, regardless what has happened in the last 6-8 quarters.

 “You make money in the long term because you were buying on the underline business and its future growth path and the ability of the business to generate positive cash flows.”

MF Live: With Total Return Index, how easy it is to deliver alpha today?

Ajay Tyagi: It is only logical because between total return index and price return index there’s a difference of 1 and half percent on an average. So basically they have raised the bar for us by 1 and half percentage. If we were let’s say, outperforming the benchmark by 3% earlier than which was PRI then we will now outperform TRI by 1 and half percentage. But does it change anything for me? It doesn’t change anything for me.

MF Live: Sometimes, stocks which are very much high dividend paying are included. How do you generate a portfolio?

Ajay Tyagi: Ideally if it’s a high dividend paying stock, unless and until there is short term mispricing. The high dividend paying stocks is not getting avenues to reinvest that cash flow. First of all, stocks which will be high dividend yielding stocks have to generate high cash flow. The other thing that is, high cash flows  have huge reinvestment opportunities.

If you generate cash and you are able to invest for future growth having a high dividend yield makes sense for those who say I have a lot of cash flows and aren’t able to reinvest. They will return it back to the shareholders. They allow shareholders to decide what to do with excess cash. Companies might invest the excess cash in some other business that’s when it makes sense. This is a very strong capital allocation decision on the part of management.

A fund manager along with his team of 15 analysts is researching companies and making a portfolio. Now essentially how we can argue except for the expenses, which are 1.5% and passive funds have 0.5 %. There is a difference of 1%.

In fact passive funds miss out opportunities all the time. Majority of the investments are going through index funds.

MF Live: UTI Equity fund has a very low turnover ratio. How often is the portfolio of the fund reviewed?

Ajay Tyagi: The low turnover ratio is because of the conviction to the fund.

We give a time frame of at least 5 years that’s the reason Pharma is 11% of the fund and it’s not that we have built Pharma position today. Pharma position has been there for 2 years and for 2 years it has been an underperformer for me. But still we feel that pot of gold is lying there, it is just the wait has become longer. If we stay in the course we will still be rewarded and that kind of hypothesis we have been carrying across sectors and business.  Bad performer for a couple of years is not a concern for us. It matters if there is no positive movement for 5 years.

In 5 years if there will be growth, economic value generation in business, it’s not going to be cheaper.

Conviction plays an important role; provided the business has not changed.

In markets the beauty is, for patient investors, short term always get magnified, both on the upside and downside. If the stock price is moving up, speculators help the stock to rally more. Whereas, if the stock price is coming down speculators make it available at cheap prices to value investors.

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