We recently had the pleasure of interviewing value investment manager Parag Parikh of Mumbai, India-based PPFAS Asset Management recently. Born in 1954 in Mumbai, Parag obtained a Master’s degree from the University of Bombay and went on to buy a membership on the Bombay Stock Exchange in 1983. His firm, Parag Parikh Financial Advisory Services (PPFAS), is a research-driven value investment organization that embraces the principles of value investing.
Please tell us about the genesis of your firm. What operating principles have guided you since founding Parag Parikh Financial Advisory Services in the 1980s?
When I was a college student, I was consumed by the idea of entrepreneurship. However, I was not very keen on cutting through the thicket of “red-tapism” that the Indian system was beset with, in those days. However, I realized I could satiate my urge in a vicarious manner by investing in great companies which were listed on the stock market. I then extended this idea into stockbroking by securing my licence in 1983.
At every stage in my professional life, I have asked myself ‘Am I doing something different”? This led me to undertake certain activities which were considered ‘novel’ at that point in time.
One such striking instance was when my company emerged as one of the first Indian brokerage houses to set up a formal Equity Research Desk. At that time, order flow from the handful of active Indian institutions was based more on personal rapport and many of my peers complacently thought that this cozy arrangement would last forever. However, I foresaw that while the liberalization of the Indian economy would throw up immense opportunities for order flow from Foreign Institutional Investors, they would only empanel those stock brokers who possessed robust research capabilities.
Over the past three decades, my company has always embraced change whenever we felt that such change would be beneficial to our clients. Hence, while we started out as stockbrokers in 1983, we branched out into portfolio management in 1996 when we realized that clients were craving for a trusted money manager. We recently launched a mutual fund when it was apparent that the regulatory regime considered them as the ideal vehicle for small-ticket retail investors.
A few of the overarching principles which have guided me and my company over the years are:
- Merely doing things right is not enough… It is vital to do the right things too.
- Client-centricity should not be confined only to mission statements… It should reflect in all your actions.
- In financial services, the client’s trust in you is your greatest asset. Nurture it and enhance their confidence in you by treating your service as a profession and not as a business.
- Nothing is permanent in life. Change with the times… However, in doing so, do not forsake evergreen time-tested principles which have held you in good stead over the years.
- Being ethical, is not just an exercise in public-relations. It makes good business sense too, as it helps us to attract the right type of clientele.
- We are clear that being ‘professional’ in our approach does not mean being ‘impersonal’. We realize that we are dealing with human emotions & aspirations and that is why we take care not to come across as a faceless organisation.
How would you describe your underlying investment philosophy?
Our investment approach is grounded in the principles of value investing.
We follow a simple (though not simplistic) investment process. As we do not pay mere lip service to value investing, it may mean that often we will be purchasing businesses which are going through a painful phase and are therefore unloved. Each of them will blossom at different points and that is why, there may be extended periods when you may feel that ‘nothing is happening’. While some may regard us as boring, we are adamant that we will never sacrifice prudence for the sake of providing excitement.
Also, our fund managers attempt to profit from various cognitive and emotional biases displayed by companies and market participants. In other words, along with the dissection of financial statements, there will is an overlay of the study of human emotions.
You have stated that your aim is to “ensure that the bulk of the portfolio is made up of world class companies that operate in non-cyclical industries and can sustain above-market rates of earnings growth.” What is your process for identifying such businesses?
Firstly, I would like to clarify our approach. It is not captured exactly in the sentence above. We aim to buy businesses which are run by honest and competent managers, which are easy to understand, which generate high return on capital and which generally do not require too much of debt or capital expenditure.
We surely prefer non-cyclical and high growth companies. However this is not at the cost of investment returns. In cases where cyclical companies on an average generate high returns on capital and where they are available at very attractive valuations, we would not be averse to buying them. Similarly there could be a case that a high growth company is overvalued whereas some other quality company with low growth is available at a big discount to intrinsic value. In such a situation we would buy the low growth company.
The process of identifying such businesses has multiple dimensions, both quantitative and qualitative. Some of the parameters that we look at while identifying companies are:
- Average return on capital and return on equity in the past.
- Capital intensity.
- Whether any competitive advantage exists. This could be in the form of brand, patents, technology, scale efficiencies, network effect resulting in a monopoly / duopoly and so on. The number of competitors in the business.
- Biography of the key managers and business history.
- Media interviews of the key managers.
- Interaction with various stakeholders like ex-employees, suppliers, customers, competitors.
When it comes to equity analysis, how do you assess the quality and incentives of management, and what CEOs do you admire most?
When we evaluate the management of a company, we look for:
- Integrity in dealing with minority shareholders. Apart from this we also look at business practices of the management as regards dealing with other stakeholders like customers, employees and the government. Many times, evidence of malpractices in dealings with other stakeholders serves as an advance warning sign of shareholder un-friendly actions.
- Capital efficiency. We are looking for managers who are looking to generate wealth for shareholders rather than build an empire. Managers and companies who focus too much on size or market share generally turn out to be poor investments.
- Competence and passion for the business. Most managers we like do few things and do them well. It is difficult to find a manager having competence and passion across various different sectors. Hence the managers we like stick to their core competence and deliver in their chosen area.
Some of the CEOs that I admire are Aditya Puri, Rajiv Bajaj and Harsh Mariwala.
Would you outline the summary thesis behind one or two of your best ideas at this time?
Private Sector Banks in India: The Indian economy has been opened up to a large extent in the last two decades. In the financial sector, competition has been introduced in various areas like Insurance, Investment Management, Stock Brokerage, Investment Banking and so on. However the banking space is still a place where there is no ease of entry and this situation is expected to continue for quite some time.
We have a unique situation in India where the public sector banks have about 75% market share. These banks are run on social considerations apart from being run as a business. Hence many times we see loans being made to projects and corporations which are high risk ventures and where the bank is likely to lose money. Further, these banks are forced to participate in politically populist lending.
On the other side there are a host of private sector banks and foreign banks which operate in India. However the foreign banks have to operate under severe restrictions in terms of opening branches, directed lending and so on. These foreign banks are effectively restricted to being niche service providers mainly focusing on cross border transactions and so on.
The private sector banks are the only serious players focusing on asset quality and profitability. Among these private sector banks, there are a few banks who both have good business practices and the capability to scale without sacrificing margins and asset quality. Examples would be banks like HDFC Bank and Axis Bank. A lot of people opt for public sector banks as they trade at cheaper valuations. However, as Buffett has pointed out that in this business where there is a very high leverage and the balance sheet size may be 20 times the net worth it is better to go with quality banks at higher valuations than to buy low quality banks at low valuations.
How do you protect client portfolios from permanent loss of capital?
We pay a lot of attention as to when to enter a particular stock. In other words, purchasing at attractive valuations is one way of reducing the risk of permanent capital loss.
Also, while we are against closet indexing and thereby prefer to have a focused portfolio, as a matter of prudence we avoid overly concentrated ones too. This is because, we realize that however good our research and conviction may be, there is always the risk of some ‘unknown-unknown’ which may send the stock into a death-spiral.
Finally, we are not averse to selling our holdings and remaining in cash equivalents for extended periods of time whenever we observe that market / sector valuations are overly optimistic.
You have made the case for a focused portfolio. How many holdings do you view as optimal?
We generally have around 20-25 stocks in our portfolio. This gives us adequate diversification and at the same time does not dilute the returns from our best ideas.
How has market volatility over the past several years affected your investment process, and have you tweaked your approach in any way as a result?
Market volatility whenever it occurs, reinforces the wisdom of keeping cash whenever opportunities are not that attractive and to resist the temptation of being 100% invested at all points in time. Short term underperformance is a price to pay for longer term results. Hence we are not in a hurry to invest ever.
Also it is important to have clients who are not perturbed by volatility. If the clients fell tempted to withdraw investments when prices fall and want to add to their investments when prices go up it would be impossible to do sensible investing. Hence client communication and selection is as important as stock selection.
Can you recommend recent books that have given you new insights into the art of investing?
- Anti Fragile: How To Live In A World We Don’t Understand, by Nassim Taleb
- The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success, by William Thorndike
- The Honest Truth About Dishonesty, by Dan Ariely
The original article could be seen here.