Originally published July 25, 2016
Rajeev Thakkar possesses over 15 years of experience in various segments of the Capital Markets such as investment banking, corporate finance, securities broking and managing clients' investments in equities. He is currently the Director and Fund Manager at PPFAS Mutual Fund.
Rajeev's tenure at PPFAS began in 2001. His passion for researching and analysing the fundamentals of companies was evident from the very beginning and very soon, he was heading the Research division at PPFAS. His responsibilities soon expanded as he was appointed the Fund Manager for the flagship scheme of the Portfolio Management Service, titled "Cognito" in 2003.
Rajeev is a strong believer in the school of "value-investing" and is heavily influenced by Warren Buffett and Charlie Munger's approach. In his interview with Safal Niveshak, Rajeev shares his wide investment experience and how investors can practice sensible investment decision making.
Safal Niveshak (SN): Could you tell us a little about your background and how you got interested in value investing?
Rajeev Thakkar (RT): A lot of it is luck and lot of it is the ovarian lottery, as Buffett talks about. I think a lot of credit should go to my father in this regard. He has been an equity investor since 1980, if not earlier. In those days of no internet and physical annual reports, I used to see annual reports coming in with some regularity to my home. That made me curious about equity investing. We had those conversations when I was eight years old. I didn't start investing like Buffett at an early age but I knew about equity investing at an early age.
Also, my father was somebody who was not into the tipping thing or trading. At that time, he would subscribe to two magazines. One was Capital Market and other was Dalal Street Journal. I did not have exposure to Benjamin Graham and Warren Buffett at that time. For that period, we had few investing books. One I remember was by an Indian author who spoke about investing in India, which had the basic concepts about balance sheet, equity base, earnings per share, dividend yield, etc. But the framework wasn't as robust as Philip Fisher's or Benjamin Graham's or Buffett's. Basically, it spoke about investing rather than speculating. It was a big advantage to be exposed to such a thing as an eight-year-old.
My graduation year was 1992. That was the period when India was getting transformed in terms of licensing being removed and at the same time there was some glamour attached to the stock market. Harshad Mehta and the stock boom happened, a lot of which was because of manipulated stocks. But still the stock market was being seen as a place where a lot of wealth could get created.
So post 1992, I went in for Chartered Accountancy but the plan was always to get into stock investing. From 1992 to 1994, I did my normal articleship. In the third year of articleship, you're allowed to be in a company instead of a CA firm. So in the third year itself I moved to the investment banking field. It wasn't direct equity research, it was more of IPOs and stuff like that.
At least I was interacting with the capital markets, knew about companies, and could look at various businesses. Another big pivot was when I joined this organization [PPFAS] in 2001 and had a chance to meet with Mr. Chandrakant Sampat. He was a well renowned investor in India, and almost a contemporary of Buffett and Munger. I learned a lot from him.
So the whole grounding, of looking at quality of business, quality of management and capital efficiency, came in after meeting Mr. Sampat. Prior to that it was only buying cheap stuff like net-nets, stocks with good dividend yield, or ones with low price to earnings.
SN: Great! You mentioned about starting from buying cheap stocks, learning about Buffett and then getting involved into what Mr. Sampat taught about capital efficiency. It's very difficult for us to let go of what we have learned in the past and unlearn and relearn new kind of things. So how smooth was the evolution for you?
RT: I am a living example of how difficult it is to let go of things. Somewhere, intuitively I clearly knew that an equity investment held over long term will give you superior returns than owning a bond. Another thing that I roughly calculated in my mind was that if a stock's P/E is, say, 5x then its earnings yield was 20%, i.e., if a stock with a P/E of 5 is earning 20% and if part of that is paid out and the other part is deployed sensibly, what can go wrong?
That was a simplistic way of thinking in those very, very early days. But understanding about capital efficiency, understanding the nuances of how some of the FMCG companies expense out their capex, how all the brand building gets expensed out or the idea of "capacity to suffer," or how without deploying capital earnings can grow dramatically - those things were not known to me.
Incidentally, I have spent a few years doing government bonds and doing fixed income securities. So for me letting go of Graham has been a very difficult process. Even when I recognize good quality names, I am not very comfortable in paying seemingly expensive looking valuation. Many of my mistakes are in terms of not paying up enough rather than overpaying. That's where I stand currently. I have recognized that there is a different price that you have to pay for a higher quality business. But beyond a point, I just let go.
SN: I have seen a lot of value investors evolving from Graham, i.e., focusing on what's cheap, to paying up for quality. Does Graham's philosophy really work now? If we keep aside the margin of safety principle, purely in terms of business analysis, is it possible to get Grahamian ideas?
RT: Some of the things like getting net-nets may be very difficult, but otherwise buying statistically cheap stocks works. The only difficulty is that you need to go in and come out. It can't be a buy and hold kind of scenario. And these won't be compounders. These will be things where you buy at 50 cents to a dollar and get out at 90 cents to a dollar. Then go out and buy something else.
When the overall market is at a higher level, sit on cash or twiddle around doing some workouts or risk arbitrage. It works, but it's more hard work and probably less rewarding. But sure you can beat bonds any day and you can grow your money in a low risk fashion.
SN: Have you done that in your career or have you always been a long-term investor?
RT: I have done that. Even in Graham plays you have to wait out 2-3 years for that to really give returns. I have done a bit of that.
SN: What about now? Currently, you focus on long-term compounding stories or you're still open to statistically cheap bargains?
RT: It's alluring. You can't let go of it completely. The other thing is that investing is an opportunity cost game. It's an activity where you look at your alternatives. So if you're sitting on cash and workout comes around, rather than let that cash be in the money market, you can deploy it for a few months in a risk arbitrage or something. So I keep looking at that space.
SN: Talking about Mr. Parag Parikh, he seems to have had a great impression on you. What are some of the key learnings from working under him? Can you talk about a few big lessons from him, which have helped you in life as well as in investing?
RT: The impact has been enormous. One key thing has been the concept of an inner scorecard. It's been articulated by Buffett but Parag Bhai was a follower of that. Whether it was about his decision to not go for opening branches all over the country in the brokerage business historically or hiring an army of analysts to get into the institutional brokerage business to gain market share at the cost of profitability. He let go of the fear of what other people think or what a competitor is doing. He always, whether in business or in life, went with what he felt was the right thing to do and never got into the trap of imitating others or being afraid to take a path less travelled.
Another amazing thing was the concept of work-life balance. He wasn't someone who would slog from 9 AM to 9 PM. He always believed in devoting enough time for exercise and physical health, devoting enough time to pursue some hobby or personal interests.
Behavioural finance was something I came across through his writings even before I joined this organization. I read his article in 2000. That was something that helped a lot in understanding the traps that we fall into, the shortcuts that the mind takes and mind games that are played by us on ourselves. Those were the key learnings.
SN: You talked about behavioural finance. In managing your own money and managing someone else's money, I think the behavioural biases that we fall into can be different. So what are the key behavioural issues you often come across while managing other people's money?
RT: The first key thing, if you're managing other people's money, is to get the right kind of investors. If there is a mismatch between what you can deliver and what your clients' expectations are then you are headed for trouble from day one. Although, we run an open-ended mutual fund, from day one we have been communicating that if your investment horizon is less than 5 years then this is not the place for you.
I was going through Safal Niveshak's website and in the "About Us" section you tell your audience that if you're looking for short-term quick fixes or get-rich-quick stock tips then don't waste your time over here, but if ever you learn your lessons and come back, you will be welcomed with open arms. Essentially we are that. In our communication with clients and distributor partners, the key message is that our mutual fund scheme is not a vehicle for the short term. We don't have a dividend plan in our mutual fund, because this is not an income generating asset class. This is an asset class to grow wealth and to compound money. It's not something which will give you predictable returns every year.
A lot of funds, to encourage people to invest in their funds, don't have exit loads. For us the money generated from exit load is not an income for the fund house. Exit load is ploughed back into the scheme so that it benefits the remaining investors. We have said that if you try and time the market, come in and go out in short intervals, we will levy a penalty on you. So that also acts as a barrier for people coming in for a short period of time.
So once you have aligned the kind of clients that you have with your investment process, I think a lot of problems go away. Because then you can manage the money exactly the way you would manage your own investments. So that is the first starting point. And the second is, if you look at it as a profession rather than a business, as John Bogle keeps saying, then you have to completely let go of the fear of losing assets or losing clients.
As someone has said, it's better to lose half of your clients than to lose half of your clients' money. If you're willing to accept that, then there is no problem at all. When it comes to insurance underwriting. Buffett and Ajit Jain do not write the insurance at all if the premiums aren't right. Your current underwriting may be 10 percent of what you did last year or it can be 10 times. Unless it makes sense, one shouldn't do it.
Anyways, let me now answer a corollary question you have in your list - How we behaved in 2009 and whether it was a difficult period for us and were we able to buy stocks at that time? Actually 2008-2010 were the best years for us. And it was very easy. The most difficult year for us was 2007. In 2007, we were underperforming the indices by huge margins. And this was the period where the favourites of the market were the likes of DLF, Unitech, GMR, GVK, and all the commodity companies - Sesa Goa, Tata Steel, SAIL, etc.
We couldn't understand any of those. We were having zero exposure to infrastructure, commodities, and real estate sectors, and we were hugely underperforming. For fresh clients, we were holding cash. Most of the clients who had been with us for long, who understood the process, stuck around. Those clients who were jittery or were impatient went away. So the message by Parag Bhai was clear - "Keep your cheque book ready; anyone who wants to exit let them go. We shouldn't change our investment process because of what market is doing."
And within a couple of years, all the performance numbers came back on track. All that frenzy went away. The cash that we had helped us to buy a lot of good stocks at throw away prices when the markets were down and out. Our clients also gave additional money, because we hadn't lost money for them in the downturn. Some of the out of favour stocks like FMCG and pharma companies strongly rebounded at the time of the global financial crisis. For us, runaway bull markets are actually more difficult to manage than bear markets.
SN: It talks a lot about having the right kind of process and sticking to it. Right?
RT: Right kind of process and right kind of clients. A lot of a fund manager's behavior depends on the kind of clients he has. If there is alignment and if there is commonality in thinking, it goes a long way.
SN: I think this is in line with what Charlie Munger says about knowing where he was going to die, so that he never went there. So you don't want the clients that can kill you. And that takes care of lot of biases. That's great insight Rajeev! Anyways, you talked about sticking to high quality businesses through ups and downs. Can you list down some key characteristics of high quality business, or a checklist that you use to identify such businesses?
RT: We don't have a long checklist running into many pages and breaking down each variable. Broadly, the starting point of the checklist was, as Buffett has been saying all along, promoters with competence and passion for their business. Then high return on equity, high return on capital. Businesses with some kind of moat or barriers to entry. Less leverage so that it's not vulnerable to a down cycle. There shouldn't be liquidation risk and it should be within our circle of competence - something which we can understand. And finally it should be available with some margin of safety in terms of reasonable valuation. That's the basic checklist. Within that we can have very detailed break ups.
Of course there is Atul Gawande's book The Checklist Manifesto. Munger has spoken about it. Even Mohnish Pabrai keeps talking about it. I think there is an investment book about it too - The Investment Checklist. It's not a printed manual for us where we keep tick marking each box but broadly these are the 4-5 factors we look at. The questions that we ask in our internal presentations and in the brainstorming session - what are the risks that are there in terms of the thesis we envisage in what could go wrong.
SN: That's a simple yet very effective checklist. Now, what are the rules for exit that you follow? When do you decide to sell a stock from your portfolio?
RT: We start with the same criteria as entry and then look at exit as the opposite of an entry. Our criteria for entry are - great promoters and management in terms of competence and passion for business, high return on capital, high return on equity, some moat in form of entry barriers or some sustaining power, a business that we can understand, low leverage and a price with reasonable amount of margin of safety.
In most cases, the beginning part remains the same, only the price changes. Sometimes, out of five buying criteria, we have four positives and one negative, then the selling becomes difficult. Especially when we know that intrinsic value is not a point estimate, it's a range. You can't say the intrinsic value of a stock is Rs 1,562. You can say the intrinsic value is between Rs 1,000 and Rs 2,000. It can be a broad range also. So if the entire margin of safety is lost plus the price is moving beyond the upper bound of our intrinsic value estimate then we start selling in stages.
Since we don't know the precise intrinsic value and typically such stocks start becoming a bigger and bigger proportion of our portfolio, we try to bring down their portfolio weights and gradually exit at a price, which we feel is not justified by fundamentals. It would happen in stages, not in a single shot where we wake up one day and completely exit the stock.
Whereas, if there is deterioration in any of the other factors - let's say we assumed that the promoters were honest and they turn out to be crooks or we invested in Kodak and suddenly see that digital cameras are gaining traction and photo film will be out of action i.e., the whole business characteristics have changed then it may require a sale even at a loss. In this case, it would be an exit in a short span of time. There are these two different kinds of exits.
SN: Have you ever faced a Kodak moment in your investment career? I mean a case where you have sat on an investment thinking it's going to recover but ultimately you had to sell off.
RT: Not exactly a Kodak kind of thing but it comes down to a common theme on investment mistakes. One common theme that I can see in my mistakes in the past and especially true in the Indian context is that you can place only a certain percentage of reliance on free market capital or free market economies. Finally, there is public perception, populism and regulatory mechanism. Somewhere things will not pan out the way you envisage even if you have taken care of everything because of people not willing to honor the contract.
I'll give you some examples which will help understand the concept. Look at oil marketing companies. What's their business? Take the crude oil, refine it and sell the products to the networks. An oligopolistic business. HPCL, BPCL, IOC - mainly three players, all PSUs. Many years back they were quoting at extremely attractive valuations and crude oil price started rising continuously after that.
So the economic theory will say that these oil companies will have to keep increasing the retail selling price of their products in the marketplace. But populism demanded that price increase shouldn't be allowed so government clamped down on the retail selling price, while forcing these oil PSUs to take losses. Some subsidies were given but still it was a huge financial burden for these oil companies and subsidy was also given in terms of bonds.
The other example one can think of is domestic pharma companies, where price controls keep coming up every now and then. The third example I can think of is - toll road operators. A lot of these people raise capital, create infrastructure, or improve the infrastructure but suddenly if public expectation is there - no this should either be free or priced at a very low level - things may not work out as planned. Or look back to the Enron fiasco in India. The Dabhol power project.
Enron thought it had a great deal. Government guaranteed contract, dollar denominated returns and everything. But people said - we can't afford it. We'll not honor the contract. And they had a problem. Even in the US context, Martin Shkreli who jacked up the prices of the generic drugs by a factor of 10 or 20 and then there was a hue and cry. Hillary Clinton called it unethical. So what he did was legal, may not be morally right but within the bounds of the law. This could apply to even private sector hospitals.
People may feel that the medical care cost is similar to what you would pay in Singapore and somewhere else in Europe and America. We may have the best doctors and best equipment but if the patients feel that it's excessive then there could be a riot and political agitations. In Delhi, we have seen power companies where suddenly the government intervened to cut down the power cost by half. Wherever there is government involvement, be extremely wary of shareholders' rights being protected.
In HPCL, BPCL, and Air India, we have seen those things happening. And even if you're in the private sector, if there is a possibility of a political agitation happening or if so-called public interest factor being thrown in, then don't rely on a patent or a contract. My capitalist rights will not be protected when push comes to shove. The government, the bureaucrats and the judiciary will always side with the agitators. Don't rely on contracts to make your investment. That's one recurring thing. I have seen that in PSUs. We have a mixed economy. Whenever a politician could get involved and lead an agitation and say I'll determine what price you can charge, in that business there is a risk.
SN: Being a fund house, how do you feel about holding cash for long period of time across market cycles? You mentioned that you did well with the right kind of clients and the right amount of cash during the 2008-09 crisis, but overall, what's your philosophy about cash? How do you treat cash?
RT: We don't deliberately try to keep cash at all points of time. Since our hurdle rates are very high, we start out with an objective of delivering a 15% kind of return, which is a reasonable bond beating returns from equities. Cash is what's there as residue after we have deployed in equities and not finding significant opportunities. So typically, cash would increase where valuations are very high and we are constrained for opportunities.
At such times, we're not averse to holding cash. We don't start out saying we want to be 20% or 10% in cash. Some amount of cash always needs to be maintained to meet outflows and redemptions, etc. But every small inflow we don't run out to buy shares and similarly every small outflow doesn't require us to sell shares. The final portion of cash takes into account inflows-outflows. But beyond that, it's essentially lack of opportunity.