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Interview with Manish Sonthalia, Director at India Zen Fund

India Zen Fund is a long-only bottoms-up approach equity fund that specialises in investing in Indian Mid-cap securities. It is sponsored by Motilal Oswal Asset Management (Mauritius) Pvt. Ltd. which is Mauritius domiciled Investment Manager and promoted by Motilal Oswal Asset Management Company Limited (MOAMC) of India.

Motilal Oswal Asset Management Company (MOAMC) provides Investment Management and Advisory services to investors based within and outside of India and having Portfolio Management Services (PMS) business, ETFs business and Mutual Funds business. The firm’s total assets under management (AUM) is little over US$700 million across different products.

In 2003, the organisation started its third party capital management business, the management of which has been overseen by Mr. Raamdeo Agarwal (as the Chairman) for the last 11 years.

  1. The Next Trillion Dollar Opportunity (NTDOP) strategy which the India Zen Fund follows has had a solid track record of focusing on long-only investments in the Indian stock markets, having been in the business over 7 years. Please share with our readers a bit of history about your fund and its investment team and your decision to launch an off-shore hedge fund offering.

    I joined Motilal Oswal in 2004 as a part of the Equity research and client portfolio strategy team.

    In 2007 we launched a dedicated mid cap fund under the name ‘Next Trillion Dollar Opportunity’ in the asset management company. Given my extensive experience in researching mid-cap stock ideas, I was allocated to the asset management team and was made the manager of the fund and have thereby been managing it since inception. Returns for the fund have been quite good and I have managed to beat the benchmarks quite convincingly since inception and been consistent in our outperformance since the beginning.

    Given my investment track record and the ideal opportunity of going global with our proprietary investment philosophy, our focus is now to nurture and promote India Zen Fund to global institutional investors.

    Our team comprises of Ankit Bengani who is the director heading the Business Development efforts, Priyankar Sarkar who is the Investment Analyst, Raashi Chawla who manages Investor Relations and myself as the Portfolio Manager.

    We have launched the India Zen Fund in December 2014.
  2. Please walk us through your investment process – where do you generate your ideas, research potential opportunities and how do you follow up on your investments?

    We are ardent followers of Warren Buffet and aspire to emulate his style of investing. Our stock selection philosophy rests on the principle of investing in business that:
    • We understand,
    • Have favourable long-term economics,
    • Are run by able and trustworthy management teams, and
    • Are available at a discount to their intrinsic value
    In having a process for selecting individual stocks, incorporating the above broad filtering criteria, we follow the proprietary investment philosophy of ‘QGLP’ curated over 18 years by Mr Raamdeo Agrawal who is member of our Advisory Board and a distinguished name in the Indian capital markets.

    Q stands for Quality. We will always buy good and great businesses as measured by the strength of their franchise and earnings power and that are run by a capable and integral management team.

    G stands for growth. We look to buy businesses which can double their profits in the next three to four years or can do better than that.

    L stands for longevity of growth. India as a destination offers good growth opportunity in many sectors. We want to buy companies which offer secular and profitable growth opportunities over long periods of time. I.E. for the next 10 to 15 years. Understanding competitive advantages in companies is the key to understanding longevity of growth. We believe that markets are generally erroneous about evaluating longevity of growth.

    P for Price. There has to be some difference between value and price. Value is the present value of future cash flows of a company and price is what we see on the ticker on a daily basis. If there is a disconnect between the two, that is an opportunity for us to buy.

    On the basis of this process we run screeners, filter the companies, carry out a detailed ground level due-diligence and then only invest in companies - where our understanding of these businesses remains superior to that of the other market participants. Once we invest, we keep a vigil on the company on a 360 degree basis to understand whether the company is performing based on our expectation.
  3. Can you describe the ideal type of company that your fund looks for? How do you screen through the entire universe of stocks to find those that meet your requirements and how much time does your team dedicate to researching each pick?

    We would only buy good and great structural businesses which have crossed their emergence phase. Emergence phase, as defined by us, are those companies that have crossed certain ROE threshold and have demonstrated some previous track record of profit growth. We would generally filter out global cyclicals in this phase only.

    Our next step is to run screeners and find out companies which have doubled their profits in the past three to four years and which have maintained ROEs above the threshold.

    We would then evaluate these names to understand where we have some edge in understanding these businesses and whether these companies are run by an integral management team.

    Once we have done that, we begin 360 degree research process to understand the intricacies of these companies and what makes these companies superior to others within the same sector. A total combination of 15 to 20 companies from different sectors would make the portfolio. We would typically dedicate 45 to 60 days to evaluate a single investment idea.  
  4. While talking about stock picks is always popular, few people actually discuss how they exit their holdings. Under what circumstances do you rearrange your portfolio and how does that tie up with your buy and hold philosophy?

    As we have a complete bottom up approach to investing, we would be very comfortable in holding the stock for a longer period of time unless
    • There is a material change in our investment hypothesis or
    • The management misallocates capital or
    • The environment has changed which adversely impacts the business model of the company or
    • The markets become extremely euphoric making the stock extremely overvalued
    Moreover, per se we do not invest in illiquid companies; hence there is sufficient liquidity available in case our investors do look to redeem out. We regularly run liquidity analysis on our portfolio in order to minimise any potential illiquidity risks arising out of the same.  
  5. Your fund has delivered outstanding performance during 2014, with one year rolling returns of 69.7%. Why do you think Indian equities performed so well during this period? Given that the average Indian hedge fund has a high correlation to the underlying equity markets, how do you assure your investors that they are paying for alpha rather than beta?

    Firstly, India is one amongst very few large economies in the world that is growing at 5% to 6% in real terms and 11% to 12% percent in nominal terms. Secondly, after 30 years India has a full majority government headed by Mr. Narendra Modi at the federal level .This government can unleash tough reforms and undo bureaucratic bottlenecks to catapult the economy to a faster growth rate. Third, cost of capital in India would come down in not so distant future, bringing down the risk premiums.

    Indian markets have delivered 15% CAGR returns over long periods of time i.e. doubling of money every five years. If we construct a portfolio of stocks where companies achieve 18% to 24% or more CAGR growth in earnings and with an ROE in excess of 15% .i.e. doubling profits every three to four years and with an efficiency of capital usage more than the cost of capital, the portfolio would beat market returns.

    Our portfolio’s correlation to the CNX MidCap Index is 0.75 while our beta is 0.51. This shows that our returns are coming on account of superior stock selection, which in turn ensures that our investors are paying for alpha rather than beta.
  6. Your fund prides itself on holding investments for the long term, with an average turnover of less than 15%. Aside from minimising transaction costs, how has this improved the performance of your portfolio?

    Having selected individual stocks, our approach towards managing a portfolio is as follows:

    Buy and Hold: We want to buy companies which offer secular and profitable growth opportunities over long periods of time. I.E. for the next 10 to 15 years, thus are churn rates are lower and our decision to remain invested in a stock is driven by fundamentals, rather than by valuations.

    Concentrated portfolio: We believe in maintaining a high conviction portfolio with a maximum of 15-20 stocks. We believe that this provides us with optimal diversification from individual security risk and exogenous systemic level risk.

    We believe that markets are generally erroneous about evaluating longevity of growth, that is, markets are agnostic to growth beyond 1.5 to 2 years. We believe that the aforementioned portfolio approach helps us in optimising this phenomenon and this also keeping the operational costs minimal.

    Comparatively, we do pass on benefit of lower operating costs to our investors – as our fees are on 1.5/15 structure rather than the 2/20 model as offered by our peers.  
  7. Could you give a rough breakdown of your asset allocation across the various industry sectors? How concentrated is your portfolio and are there limits on the maximum exposure you carry to a particular industry or stock name? Do you employ any leverage?

    As things stand today, the portfolio has an allocation of 28.30% in automobiles, 26.37% in banking, 20.91% in consumer staples, 4.26% in pharmaceuticals, 6.60% in capital goods, 4.54% in oil and gas, and 9.02% in other diversified sectors.

    We do run a concentrated portfolio as we firmly believe too much diversification dilutes returns but does not dilute risks. In order to minimise risk we have a cap of 10% allocation to a new stock idea. We trim allocations when allocation moves beyond 20% in a particular stock due to price appreciation. We have a cap of 35 percent in a particular sector at any given point in time.

    As a firm policy we do not make use of any kind of leverage or any such derivative instruments.   
  8. How is the liquidity in the India stock markets like for a fund of your size, in particular for mid-cap counters? Have you ever had to scale down an investment from your ideal size or become trapped in a position because of insufficient liquidity? The fund’s redemption period (quarterly) is unusually high for a fund that invests in listed equities. Is liquidity a factor in determining the fund’s redemption terms?

    In the last 11 years, we never had to trim allocations on any stock due to insufficient liquidity. We are a long term investor in Indian equities and we stick to our buy-hold philosophy. There is no illiquidity risk running on our portfolio.

    As mentioned earlier, we do carry out regular liquidity analysis on our portfolio and therefore are very comfortable in offering redemptions to our investors.

    We place great emphasis on the long term value creation for our investors, and hence would like to minimise any redemption events – therefore we are offering a quarterly redemption window.
  9. With regards to investor allocations, how warm has the reception been to the India Zen fund? Do you foresee a growth in investor appetite for hedge fund products in India, especially given the relatively strong inflows into ETF and mutual funds recently?

    The fund’s superior performance in absolute terms and relative performance compared to the benchmark have been the primary reason for the fund attracting decent levels of investor interest. We are currently in selective strategic discussions with few highly pedigreed investor groups, who are looking to seed our offshore platform.

    Our fund is targeted towards global institutional investors like pension funds, endowments, family offices, et al that are looking for steady returns over a longer period of time in order to preserve and create wealth consistently for their end investors. We believe these large investors have an obligation to end the plague of short-termism. 

    Logically, real investing (as opposed to trading) is inherently wealth creating and long-term in nature. However, powerful short-term forces stand in the way of this kind of investing.

    Our seven year track record and investment philosophy provides evidence that when these short-term forces are neutralised, executing long-term investment strategies to generate positive multi-decade excess returns becomes a realistic possibility.

    We believe that during the course of the investors carrying out their due-diligence on our team, they would come to realise that we follow a well thought-out & documented philosophy followed by a stringent investment process that we do not deviate from regardless of market conditions. I personally believe this is one of our greatest strengths, which makes investors comfortable in investing with us. We have seen plenty of instances wherein they have increased allocations to our fund over a period of time.

    Bulk of the corpus has come from Indian high net worth individuals and various Indian corporate houses.
  10. How has creation and regulation of a new class of investors known as ‘Foreign Portfolio Investors’ affected non-resident Indians and foreign hedge fund investors who wish to participate in the India growth story? Has capital flow from overseas been affected as a result of this new development?

    We believe the new norms are expected to make it much easier for the foreign investors to enter the country and make investment decisions.

    The new FPI guidelines put a lot of onus on the FPI issuers for ensuring compliance & governance and hence we believe it would have a positive impact in the long term.

    In order to ring-fence the new regulations from possible misuse, the FPIs would need to be from countries that are member of global bodies such as Financial Action Task Force (FATF), IOSCO (International Organisation of Securities Commissions).

    Besides, the entities from any country against which bodies like FATF have issued a warning for AML/CFT (Anti-Money Laundering and Combating the Financing of Terrorism) deficiencies would not be allowed to register as FPIs.

    We haven’t yet seen any negative impact of the new regulations; on the contrary we have been told that the number of applications under the new regulations has increased.
  11. Finally, please share with our readers some of your high conviction themes in the near future vis a vis sectoral allocations in the Indian equity markets.

    We are bullish on themes that are related to an increase in the discretionary spending ability of the Indian consumer and sectors which would benefit from the pro-reformist approach of the current government. Sectors such as banking and financial services and automobiles would be plays on the aforementioned themes.



Contact Details
Ankit Bengani
Director, Business Development
India Zen Fund
+91 98 2019 6123