Changes to the Fidelity India Fund

Medha

Good day, all right, thank you for joining us today for this webinar, my name is Maita Salman. I'm an investment director for Fidelity based in Hong Kong joining us today is Amit goal, the portfolio manager of the Fidelity Fund, thank you. Amit for being here today.

Amit

Thanks Medha, nice to be here.

Medha:

The purpose of this webinar is to really talk about the team changes and have a conversation with Amit Goel. So before we start, I just like to highlight a couple of points in terms of what is happening.

After almost 18 years at Fidelity Sandeep Kothari who was the portfolio advisor to the Fidelity India Fund has decided to leave the company. He will be with the firm until the 31st of March 2020 in order to make sure that there is a smooth transition starting 28th of February 2020. Amit Goel will assume sole management responsibility of the Fund and the key implication here is that the current manager advisor structure will discontinue.

Amit who is based in Singapore will continue to be based there. He will travel extensively to India to interact with Fidelity’s Mumbai-based analyst team, as well as conduct research and meet companies.

The change is effective from the 28th of February 2020, and just to highlight there's no change in the quality and growth bias, they is still that focus on valuation when it comes to investment, just that the Fund will become more concentrated and have and higher active share.

So Amit, can you go through your previous work experience, you know, when you started off as an analyst progressed on to become a portfolio manager and really talk about your journey of investing across the Asian equities and Indian equity spectrum.

Amit:

Thanks Medha. Thanks everyone for listening to this presentation.

I have been working with Fidelity for 12 years now. I started as a research specialist in Fidelity’s Delhi office where I was working alongside portfolio managers and analysts, and I was looking at global healthcare sector. In 2008, I moved to Mumbai and this team, within the Fidelity office, and for the next five years from 2008 to 2013.

I was looking at a variety of sectors in India as an analyst. I looked at small caps consumer staples and discretionary, IT services, healthcare sector. In 2013, I moved to Fidelity Singapore in the emerging markets team, and I started managing the Asia sleeve of the emerging market franchise.

Within the last five years, India has been an integral part of my investment process and my Fund’s construction. I have spent a lot of time in India whilst being based in Singapore. I usually travel to India every quarter, sitting alongside the investment team and India has always been an overweight in our emerging market franchise.

So combined with these 7-8 years’ experience, plus the last six years in Singapore, I would say that India has always been a very critical component of my investment philosophy and my investment process. This is underpinned by a very deep understanding of a large number of businesses in India. Whether as an analyst, or the last six years as a portfolio manager. I have worked very closely with the India team and our outgoing Portfolio Managers Sandeep Kothari. So I believe I'm very well judged into the team.

Medha

Okay, thank you. So, we have the largest on the ground India analyst team on the buy side, which is based in Mumbai. How do you plan to leverage this research team going forward?

Amit:

I think we have a very strong team in India. We have roughly nine early in India now, and one analyst in Singapore who looks at Indian equities. He covers the healthcare sector in India along with the regional healthcare sector. I have worked with all these analysts over the last 10 years. Some of them have been analysts which have worked with as a colleague in the India office. Some of them have joined in the last five years and I have worked very closely with them, understanding the stocks they have covered, and have owned some of the stocks. So I believe that I have a very strong personal and professional relationship with the analyst team in India, and I believe I can leverage that completely to help our clients in the Fund.

The analyst team actively looks at 170-180 stocks in India and we are trying to enhance this coverage to roughly 200 stocks, which will almost cover 90% of the benchmark. So, we have 90% of the benchmark which is actively covered by the analyst team the analyst team speaks with these companies on a daily basis. We have a very deep understanding of the whole benchmark, driven by our strong presence on the ground.

I plan to travel very frequently to India, as I said earlier that I have been travelling to India every quarter. But with the expended responsibilities of the India Fund, I plan to travel to India every month over the next one year the actively improve my engagement with the team further with face to face connections and there has been continuous discussion with the team almost on a daily basis. So I have discussed most of our large holdings with the team in great detail, we have done management called together and I am encouraging them to be closer to the portfolio.

As I will explain later, we are trying to concentrate the portfolio, having high conviction larger positions. I think that should help the analyst team a lot. That should take them closer to the portfolio, they should think about the impact of their their last position on the Fund and on the client performance. I think that's a very good process in which we can mentor and improve the conviction level and understanding of the analysts about the businesses which we want to own. So I do believe that the resources that we have on the ground, the team, the experience of the team and and my relationship of the team is very strong and that should that should present in a very good outcome for our funds and our clients.

Medha:

So moving to portfolio transition, how long do you expect this to take, you know what are some of the key changes that clients can see.

Amit:

So the portfolio transition I think we'll take three to six months. But we have a very strong fundamental principle about this transition that we want to minimize any impact on the client performance and the Fund performance. I will explain the changes which I'm going to implement, but again what I want to stress a point here is that anything which will we do to change the portfolio construction and the portfolio characteristics we will always think that what is the kind of impact it can have on fund performance. So we are not going to do anything in a hurry. We are always talking to the analyst team, deciding on what prices we need to sell the stocks or we need to buy incrementally. We're talking to traders to make sure that there's no liquidity impact on stock performances.

Now I'll  take you through key porfolio changes which we can expect from the change in portfolio manager. The core philosophy of the fund will remain the same, and I think this this is very important to continue for our clients. The Fund will continue to focus on identifying and owning the best quality and structural growth businesses in India.  I follow a bottom up stock selection approach, where we intent to create a portfolio, after doing very deep fundamental research on every stock and hence look to own it, only after we understand it in great detail. This is also very similar to the existing portfolio construction. The beta of the portfolio should remain below one as we intend to own high quality and less volatile companies. On liquidity the Fund will focus more on mid-to-large caps and has a lower proportion of illiquid names, and this is this is slightly different from the earlier portfolio where we had a long tail of some small illiquid names. The tracking error of the fund should be similar at three to six percent.

So, I believe in the in terms of philosophy, in terms of the kind of stocks we want to own there is a there is a continuity in in the portfolio. While the core philosophy of the Fund should look similar, we should expect considerable changes in the portfolio construction characteristics.

I believe the Fund will get more focussed and concentrated, with number of holdings reducing from fifty to seventy currently, to twenty five to thirty five. As a result, we should expect active share to increase from the 40 percent, to seventy percent. The active sector and stock weight should also be higher than the previous portfolio. I believe this should all result in better alpha for our clients, and I don't think that we are taking unnecessary risks to achieve these outcomes. So overall, I believe the core philosophy remains the same, the portfolio will get more focus and concentrated, and I don't think the risk profile of the Fund will increase.

Medha

So can you talk about how you identify stocks to be included in the portfolio, and also what are the triggers to sell them?

Amit:

I’ll take you through my investment processing detail here. My investment process is based on the investment philosophy of buying the best quality businesses, which are driven by very detailed understanding and keeping a valuation discipline to capture the upside. The process aims to filter our investment universe that satisfies our key parameters of quality, business understanding, good management, ESG characteristics and reasonable valuations. I believe our overall universes roughly three to four hundred stocks if we think about the size and liquidity of the names which we can own. Within that universe, we aim to identify structural growth segments within India. These are segments which can grow at a strong double-digit rate, and this growth is driven by under penetration, this is driven by improving industry structure, this is driven by India's Demographics. Some of these sectors are consumers, financials, industrials, technology and healthcare. And as I said, we have a very strong team on the ground, we actively covered 200 stocks. At any point in time we are looking at 250 to 300 stocks. So, this is a universe which is very very covered and, and we look to identify structural growth stocks out of this universe.

After that, what we are looking for are looking real market leaders within those structural growth segments. These are companies which are number one, number two, number three in the respective segments. These are companies with strong brands, with strong technology, with cost leaderships. These are market leaders of today, or these are companies which we believe can be market leaders in future. Again, all these identification of market leaders is underpinned by our strong research platform and our understanding of these businesses.

After identifying these market leaders, I am looking for companies which have got very strong management teams, with a good historical track record, which have got a very good capital allocation track record, and more importantly, good and improving ESG characteristics. I believe at any point in time we can have 50 to 70 companies in that range.

And my last step in my process is to buy some of these high-quality businesses at reasonable prices. That would eventually lead us to a portfolio of 25 to 35 stocks where I believe that we can really own high quality businesses at reasonable prices.

So, if I want to take you in a bit of detail on how we look for identifying some of these great businesses, and what is our process to understand them. We are looking for some key attributes when we talk about quality businesses. These key attributes are as I said strong brands, strong technology, good scale and cost leadership. We are looking for good industry structure and reinvestment opportunities, we are looking for sustainable high returns on capital, we are looking for trustworthy management teams and very good capital allocation track record and we are looking for all of these characteristics in one business. Because I believe if you if you have a good structural growth segment but the management team is not good, we are not probably going to have a profitable growth. So we are not looking of looking at one or two attributes, we are looking at all these attributes when we identify quality businesses to own.

Then the most important part in our process is to identify and understand these businesses. I believe we spend most of our time, 80 to 90% of our time, in understanding these businesses. We engage with management teams to understand their business, their culture, what are their competitive advantages, how this strategy strategise to gain market share. We understand the complete value chain, we talk to clients, we talk to consumers, we talk to their competitors. All this is again driven by our strong presence on the ground. Spending time with management teams in their offices, spending time in their factories and I believe this is the only way to ensure that we can create a high conviction portfolio. And the last part in this process is to challenge our thesis all the time. As an analyst, as a portfolio manager we all have our biases. So I want to make sure that that we clear our biases as much as possible so we are always looking for business changes, we are always looking for competitors which can gain market share versus our companies. So we are continuously challenging our thesis, and we will be very productive in in selling our premium stocks where we think the investment thesis is changing.

And lastly in this stock selection process, I would say that we would normally avoid any low quality cyclical names, as I believe that low quality cyclical names typically don't add any value over a period of time.

You talked about our selling discipline. Our selling discipline comes from our valuation framework. To me, valuation is the last step in my process because I believe that if we cannot understand the business it is very hard to value any business. After our understanding of a business we are trying to project the long-term reasonable earning power of that business. We assign a reasonable multiple depending on the kind of business we are we have we try to own, and we look for strong double digit compounding in every stock we want to own in the portfolio.

The position size of the stock, and our buy and sell decisions is based on our target price approach. So we assign a very clear two year and a five-year target price, to every stock in the portfolio. And we buy when we see more upside than downside, and we sell when the stock approaches our target price without any change in investment thesis. I believe this is a very diligent process of buying and selling stocks and it helps us in capturing all the alpha and double digit compounding that we try to achieve.

Medha

You talk about having a more concentrated portfolio. Can you go through the implications of concentration for your clients?

Amit:

So to me, all my portfolio characteristics, whether this is, concentration, focus, high active share, these are all outcomes of our process. What we are trying to achieve is very simple. We are trying to buy very high-quality businesses, which can compound over medium to long term and we are trying to buy them at reasonable prices. Which mean that at any point in time we are not going to have many, many businesses with these characteristics, trading at reasonable valuations. So that results in an outcome which means that we have to learn a focus and concentrated portfolio. I believe if we follow a very diligent valuation approach, if we if we follow our process of identifying and owning high quality businesses, even with concentration of 25 to 35 names the portfolio is diversified enough, and it will it comes as a low risk portfolio.

So I will take you through my portfolio construction matrix. Typically see 25 to 35 names. The portfolio is benchmark agnostic, but we always understand the risk of not owning large benchmark names. So while we are benchmark agnostic, at the same time, we are benchmark aware. We will have high active money of 50 70%, and a low turnover of 20 to 40%, which means our time horizon is roughly 2 to 4 years.  Within a portfolio of 25 to 35 holdings we will have top 5-6 holdings which are either large benchmark stocks, or stocks which are decently liquid, with very high conviction and low downside risk. These top 5-6 holdings will be roughly 30 to 40 percent of the portfolio, with the typical position size of 5 to 8 percent. Then ee will have a very strong core of the portfolio, which is roughly 15 to 20 stocks. And this will comprise 40 to 60 percent of portfolio, with roughly 2 to 4 percent position size. I believe this core is very important in the portfolio these are stocks which are mid and large cap, which have strong double digit compounding which are underpinned by our process of identifying and understanding businesses, and I think this will add most of the alpha to the portfolio.

And then we will have a small tail in the portfolio these are either a illiquid names with high conviction, or some of the names which are entering or exiting the portfolio. We may see eight to ten holdings here, with a typical weight of ten to twenty percent in the portfolio, and a typical position size of one to two percent. All these combined will lead to a portfolio which I believe will be very focused, and concentrated in around thirty names. As I said earlier, I believe the beta of the portfolio will remain lower than one. I believe the portfolio volatility in general will be lower than the benchmark, with a similar or lower diversification ratio. So I think because the quality of the businesses which we own is very high and we are valuation conscious, this focus and concentration will not lead to any increase risk.

Medha:

Amit, how important is ESG in your process?

Amit:

ESG is now a key part of my investment thesis. As I said that we are looking to buy very high quality businesses, which are run by very competent and high integrity management teams. And I believe that now ESG characteristics have been added to that part in my investment process. I believe very strong eager characteristics are very important for sustainability of any business. ESG is a source of value, ESG will impact on how consumer and your clients will perceive your products and services in future, ESG will affect your cost of capital, it will affect the rate at which you can you can raise equity or debt. And ESG will also impact your investor sentiments and investor demand. So I believe ESG will touch every part of the value chain of any business in future and that's why we can't have it as a peripheral characteristics. So in my investment process I have made ESG as an integral part of my process, and the ESG characteristic is not just looking at the ESG rating for me. ESG is another topic of engagement with the management team, with the business, as we engage them on their brand on their products and on their services.

In past I have engaged with most of my companies on all parts of ESG. Whether it's environmental whether it's social or governance. There have been businesses where we have written letters to the board asking for better capital allocations and improving governance. There have been instances where we have sat with plant managers to discuss the environmental impact of their facilities. There have been cases where we have discussed how they are how their managing social aspects of their large work forces. So, this is a very continuous engagement process with the management team, and I believe the portfolio change and the portfolio transition, you will see improving ESG characteristics in the portfolio.

Medha:

So moving on to the Indian equity space, can you comment on the valuations that we are seeing with respect to Indian stocks versus their expected returns?

Amit:

If you look at very long history of Indian markets, say last 30 years, Indian markets have typically given a return of ten percent, plus or minus on any time horizon in last thirty years. Whether we talk about five-year, ten year, fifteen year returns. It's ten percent plus or minus in US dollars, and twenty to thirteen percent in nominal Indian currencies. And I do believe that India still has the potential to achieve that, over medium to long term in next 10 to 15 years. The GDP growth in India is roughly around mid to high single digit in real terms, and 10 to 12 percent in nominal terms. I believe with increasing GDP per capita, increasing evolution of markets, corporate earnings can grow faster than that. So we can we can grow corporate earnings at low to mid teens, and that is the kind of nominal return I expect for Indian markets in long term.

If you if you see in terms of valuations, Indian market which is MSCI India, it is roughly trading at 18-19 times one year forward price-to-earnings, and it is roughly trading at three-times price-to-book. This is very close to our long-term average, and I believe that India is currently going through a down cycle, so earnings are depressed. So, I don't think these multiples are expensive by any means. While I cannot call when we can see an up cycle in the short term. In the medium-to-long term we could see earnings compounding in India at 10 to 15 percent. I believe valuations are reasonable at this level, so I don't expect big multiple generating in the long-term, and hence I believe that we can still achieve good long term double digit compounding in India.

Medha:

What according to you is the impact of the recent corona virus situation on Indian equities?

Amit:

I believe the situation is still developing. For the first two months of this outbreak, in January and in February, we have seen very few cases coming out of India. In the last one week, we have started to see a couple of cases in India. These are people who have come from coronavirus affected areas, from the Middle East and Italy.

While I will hesitate to project whether India will have an outbreak or not, I do believe it will have a short term impact with respect to exports, with respect to travel, with respect to discretionary consumption in India. We have to understand that india is already going through a downcycle in terms of consumption, and in terms of GDP growth. And this corona virus impact may aggravate that situation a little bit. All said and done, I do believe that India still the least impacted area with respect to this coronavirus outbreak. And medium-to-long term structurally, we can benefit from this situation. We have already seen trade issues between US and China in last couple of years, and with this whole coronavirus issues I think businesses will keep on trying to diversify their manufacturing locations, their value chain, their ecosystem and India could be a very good counterpart to that diversification. The government is also recognising this opportunity, and in the last budget we the government talk about manufacturing ecosystems, technology ecosystem, and I do believe all these issues will lead to more manufacturing coming to India.

Just on the short-term impact, I believe that this will impact consumption slightly, this will this will impact industrial production slightly, which is already going through a down cycle. But I do see that this impact may be short term three to six months, and I do see positive impact in long term.

Medha:

So lastly, can you give us a quick outlook on India in terms of the economy and the markets.  And what areas are you finding the best opportunities?

Amit:

So, I will take you to my long-term view on India, as an economy and what do I think from a short term point of view as well.

So if you if you think very long term, India has been improving its structural growth rate. If you see last 50 years, first decades of sixties and seventies, India was primarily going through four five percent. Then in in eighties, nineties, India improved to six percent, and in last 10-15 years India has been growing seven percent. So I do believe that India has all the structural drivers of growth, which can keep its medium to long term growth at high single digit. Whether we talk about demographics, whether we talk about under penetration across categories, whether we talk about education level, whether we talk about institution infrastructure. I do believe that India has all the characteristics of continuing this high single digit growth. There is a very good level of entrepreneurship, skill level. Yes, we need some enhancement in ecosystems. In manufacturing ecosystems, streamlining of labour laws, streamlining of taxation, which I believe government is also focusing on. So I think we can continuously grow at this mid to high single digit GDP growth for long period of time.

India is exactly where China was 15 years back. I'm not saying here that India can repeat what China has done in last 15 years, but it has got all the characteristics of keeping a high single digit GDP growth, and within the emerging market space I believe India will remain the fastest growing economy.

Now talking about short term. If you think, in last four or five years, India has seen continuous decline in GDP growth. From seven, eight percent in 2016/2017, to roughly five percent now. And this has been driven by all parts of the economy. Whether you talk about agriculture, whether you talk about industrial, services or private consumption. Private consumption was one thing which was holding up the economy since last two, three years, but we have seen a continuous decline in last two, three quarters. So clearly we are going through a cyclical down cycle. India has always seen these financials and and cyclical down cycle in in last few years, in last few decades, and I believe that at some point of time we will be coming out of it.

So if you if you see all the characteristics of these down cycle, whether we talk about issues in the financial system, whether we talk about credit growth, whether we talk about interest rates. I believe we are at the bottom, in most of these characteristics. The asset cycle in the banking system went through a bad phase from 2013 to 2018, but it is now stabilizing. Credit growth is already having eight percent which I believe should improve from here. Interest rates have come down, the liquid in the market is reasonable, so I believe we are we are sitting at the bottom of the cycle. I don't know whether we can improve in next three months or next six months, but the government is now kind of talking about manufacturing, they're talking about job creation. They understand that all these economic parameters are very important for them to get re-elected as well. Yes, we have seen some disturbances in India, with respect to some religious issues, but I do believe that these are part and parcel of the Indian economy and culture, and we can keep on growing, we can keep on improving irrespective of these issues. The government in past has focused on some of the restructural reforms, which is demonetization, formalization of economy goods and services tax. And I believe all these factors, while they are very important long-term reforms, they have also impacted the economy, as India remained a highly informal economy. And all these factors have kind of disrupted that formal economy.

So, in a totality I believe that we have long very good long-term characteristics. We are now at a cyclical bottom and short term we should be improving in in next six to 12 months. Valuations are reasonable for Indian equities and all of this combined, I think pays a very good backdrop for India as a market.

Within the Indian space, we are most optimistic on the Indians financial space, and within the financial space, I believe private financial companies. Look the best asset class. So, if you see the breakup of Indian financial system, between private and public sector companies, the Indian financial system is still roughly 60 to 70 percent owned by the public sector financial companies, whether we talk about credit or deposit side. And we have seen a gradual shift in market share from public sector companies to private financial companies. I believe this this market share shift is very structural, this is driven by the incentive structure within these companies. This is driven by their products, their services, the way they reach their customers and I won't be surprised if in 10 to 15 years’ time we will see a complete flip of this market share, from 65 to 35, in favour of private companies. So our focus is to really identify the best private financial companies in India, because we are very sure of the growth profile of these companies.

So if you see the areas which we like a lot in Indian financial space, are areas where we see very high under penetration. These areas like mortgage, auto, credit cards, life insurance, general insurance. And, we tend to own the best quality companies within all these areas. So in terms of portfolio positioning you should expect us to be highly overweight in some of the best financial companies in India in the private space.

Medha:

So with this, we mark the end of the webinar. Thank you all for joining us, and thank you Amit for your insights. If you have any questions, please contact your Fidelity regional sales manager, or go to our website at Fidelity.com. Thank you.