He knows the art to deliver robust alpha to investors from extraordinary events on Dalal Street. As a result, his PMS strategy Special Situations has managed to deliver over 112% return to his investors during the past one year. Meet Arun Malhotra, founding partner and portfolio manager at CapGrow Capital Advisors. In an interaction with Money9, he said mispricing of securities that arise from market inefficiencies, and analyst biases have helped to find some great investing opportunities.
Q: Your PMS strategies CapGrow Capital Special Situations and Capital Growth have delivered robust returns in the past one year. What is your investing strategy for these funds?
Malhotra: “Special Situation” approach is where we offer a very niche and differentiated approach to investing that is in specific situations that arise from corporate events like spin-offs, mergers, buybacks or delisting that unwind value, and we combine this with our fundamental approach to make sure the investment ticks on the basics of our fundamental approach to investing. On the other hand, the “Growth” portfolio involves investing in the comfort and high-quality stocks: mainly midcap to large caps that have high earnings visibility, strong and capable management and high capital efficiency. There is little room for any negative surprises.
Q. Do you believe in the philosophy that certain bluechips are to be held for a lifetime?
Malhotra: Yes, I strongly believe that compounding of wealth happens over a longer period of time. Bluechips are like Sachin Tendulkars of the world — consistent in performance with higher long term averages in stock returns. Reliability in earnings growth and confidence in management ensures that the performance will be delivered across economic and business cycles. These bluechips certainly need to be held for longer-term. Any bad quarter or two may pull down the stock price, which is to be treated as buying opportunities.
Q. Which pockets are looking attractive to you in the midcap and smallcap space?
Malhotra: Investing in small and midcaps is complex as there exists asymmetric information, issues of liquidity and high impact costs. Midcap and smallcap investing is cyclical, which exhibit boom and bust cycles, and it requires more of a bottoms-up approach. Best returns can be harvested when you catch the cycle right: post a bust and economic distress. One critical factor while evaluating stocks in this space is the capability and integrity of the management. We, as a PMS, are more of a balance sheet investor in these companies and are very focussed on the cash generation as well as any related firm transactions, or working capital issues or any other deviation that could lead to the destruction of value.
Q. What are the mistakes investors should avoid?
Malhotra: Most recommendations in television and social media have vested interests and investors have to be extra careful. Any mistake can lead to a loss in profits as well as original capital. Avoid leveraging and use of derivatives except for hedging purposes. Stick with managements with high integrity and outstanding capabilities, and focus on the balance sheet and cash flow. It is important to note that analysts face “recency bias” and are often hesitant to give sell ratings especially when the recent financial performance is good even though the company may be facing some challenges in the industry.
Q. How much annualised growth do you expect from Sensex and Nifty in the next 10 years?
Malhotra: Equity markets have historically delivered over 14% CAGR in the medium to long term. I believe that this figure is indicative of what should happen going forward. However, I am a strong believer in active fund management, the right selection of stocks and adding risk when markets are bleeding, which can add few basis points to the performance. Market distortions happen every 2-3 years and it makes very strong sense to add risk during those turbulent times.
Q: Who is your investment guru and which books are you reading currently?
Malhotra: I get fascinated by the concept of behavioural finance and how it works in stock markets. Our stock selection also has some portion of this when we analyse the management of companies. My investment Gurus are two people with whom I have worked very closely — BR Bagri, Chairman, BLB Ltd, under the guidance of whom I started my career 30 years ago and where I learnt the concept of risk/reward and how to trade fearlessly. Another one with whom I was so fortunate to work closely was Randall Smith, founder of Alden Global Fund, and one of the pioneers of distress investing and a strong believer in special situation investing. He has a tremendous track record, and he taught me to take risks in life as well as the concepts of contrarian investing, “hold outs” and adding risk when the whole world is in economic trouble.
On books, I just finished “Misbehaving- The making of Behavioural Economics” by Richard M Thaler. It is an excellent book on behavioural finance.
Q: What would be your advice to an individual investor?
Malhotra: Be greedy and aggressive when others are fearful, don’t invest based on social media recommendations, and increase your time horizon while investing in equities for wealth creation. Additionally, Robinhood kind of investing should be avoided at all costs and any investments should be routed through investment managers. The excitement of online trading is fraught with risks and can take away the gains made along with a significant part of invested capital when the market turns.
Q: What prompted you to become an investment manager?
Malhotra: My father was a part-time investor and has played a significant role throughout my journey. He would always encourage me to take calculated risks, and I would skip my college just to attend annual general meetings (AGMs) during my days of engineering. The trigger came during the stock market boom of 1992 and part of the credit goes to Uday Kotak, Founder and MD of Kotak Mahindra Bank for showing me that equity markets have a lot of potential for wealth creation. We as a family had submitted 42 applications for the Kotak Bank IPO in the year 1992. And guess what, I was the lucky one. We got one allotment out of 42 applications, and it was in my name. The market price we sold after the listing was Rs 1,600 per share while the IPO price was Rs 45. A gain of Rs 1.50 lakh in a matter of 2 months, and my job stipend in an MNC was Rs 36,000 per annum. I understood the concept of investing, the opportunity size in equities and the leverage to get rich quicker in equity markets and this idea fascinated me. I quit my job within a week and joined as an equity research analyst with BLB Limited. And since then, have learnt all facets of equity markets, right from trading, arbitrage strategies, risk management and finally the investing piece.
Q: What does your typical workday look like and what are your hobbies?
Malhotra: My typical day starts with yoga and meditation. Meditation has helped me a lot to improve my temperament, especially during downturns when a lot of patience and control on emotions is required. I spend the other part of the day in research and attending company meetings and any industry-specific conference calls. Gaining knowledge and learning is a constant part of my life. My other interests include swimming, which I love and can engage in any part of the day. As for recreation, I love watching movies and comedy programmes for recreation.
Q: Can you put some light on your investment philosophy when it comes to picking up a stock?
Malhotra: Our investment philosophy revolves around a couple of things: one of them is finding themes that will do well as we feel companies in the same industry are driven by similar economic drivers. And on the contrary, when analysts and investor opinions go sour on the industry because of poor financial performance or any regulatory changes, there can be a lot of buying opportunities that can arise because of the biases and short term outlook of the street analysts.
We call ourselves a big fan of “Delta investing” as we try to configure the drivers for change in earnings and the near term direct catalysts that will help us unwind value and drive the price performance. These changes could also be due to corporate events, whether it may be mergers or demergers or key management changes as a lot of operational changes will drive higher profitability. Essentially, we look for mispricing of securities that arise from market inefficiencies, and analyst biases that help us find some great investing opportunities.
Q: Where did you fail and what were the lessons from these mistakes?
Malhotra: I witnessed a lot of failures in the early part of my life, and I credit them with teaching me valuable lessons. I realised at the peak of 2000 IT boom that most investors, including me, were sitting with the maximum risk in our portfolios at the peak of the stock market boom and irrational exuberance, which is contrary to my investing philosophy. I was more careful and well prepared in 2008 and well covered in 2018 before the small midcaps busted. Another investing lesson was the cost or price at which you bought stock has no relevance. Everyday price is the new cost from where the returns are to be delivered. This comes in significance when averaging is done in stock when the price falls.
Q: How do you plan to capitalise on the unlocking trend?
Malhotra: We believe that most of the crisis creates opportunities for investors and the majority of the analysts underestimate the pace of recovery as well as the quantum of recovery – we witnessed this last year. The pandemic has created opportunities and the market is already expecting lower impact post the second wave as this time the economic activity, especially the manufacturing was operational and not completely shut down. The under valuations did not come except in sectors related to hospitality, where I believe the recovery would be substantial but the damage to some of the retail and SME sectors would take time to recover. Our portfolio is already positioned for earnings that were less impacted by the pandemic.
Q: What is your biggest investment in life?
Malhotra: My biggest investment in life has been belief in the philosophy of striking the right balance between family, health and career. Any disturbance in one can lead to distortions in the other two. My biggest investments are in myself so that I can always have time for my health and my family. I took 3 years of sabbatical to make sure I spent time with my kid before he goes to college. I believe that more than 80% of the time kids spent with their parents is before college. As age catches up and especially after the pandemic scare, health has become the most critical part of my life and avenue for future investing.