The Overseas Conundrum of PPFAS explained – Raj Mehta, Fund Manager, PPFAS

Radhakrishnan Chonat: Good day, everyone. Once again, welcome to our insights show. We have a very special guest. I keep saying we have a very special guest, but this time around he’s really special. He is Raj Mehta from the famed fundhouse PPFAS. Raj, thanks for joining on a busy day like today when the election results are out.

Raj Mehta: Thank you so much for having me here.

Radhakrishnan Chonat: Great. Raj, as usual we have read your profile. You are a career veteran at PPFAS. You started as an analyst, now you’re a fund manager. So tell us about your journey? How you got interested into finance and how you ended up in PPFAS and your journey so far in brief.

Raj Mehta: Sure. So my dad is a Chartered Accountant. So from my school days I wanted to become a Chartered Accountant first. So after my Chartered Accountancy days I thought that stock markets or something which interested me because during my articleship I used to invest my stipend into equity markets, though it was very low, but still that was a good starting point to have. And since then I thought that I wanted to enter into equity research field where every day is a new day for the analyst where something or the other is happening around the world and that impacts the stock prices. So that’s where I started off. So when I decided that I wanted to enter into Equity Research, I looked for other courses which I could enroll into so that I could get knowledge into the research part. So then I enrolled for CFA and after completing two levels I thought I have a good financial base with a CA degree plus two levels of CFA. So that’s when I was looking for a job. 2012 was a very, very tough year in terms of getting new jobs. So then I approached PPFAS Mr. Rajeev Thakkar, who is the CIO, currently at that time also he was the CIO. So then I — when I initially approached, he said that there are no vacancies right now. And so then I thought that let’s start off as an intern without any stipend as such, without any salary. And then as and when I learned the tricks of the trade and then I can move to other roles as and when possible. So I started off as an intern here. After about 10 to 11 months we started our mutual fund here, before that we were a PMS. So when we started off as a mutual fund I was recruited here itself as an analyst. And then from analyst role I moved onto the fund management role sometime in 2016. So that’s how the career progression has been. I have always been curious to know why stock prices move and that’s what got me here.

Radhakrishnan Chonat: Interesting journey from an analyst to a fund manager. Exciting to hear that Raj. Now PFFAS needs no introduction but there are still listeners that we have who probably have not come across the fund. So give us a little bit history. What does PPFAS stand for? Who was Mr. Parikh and what is it that you guys are doing unique? And you also mentioned that you were a PMS fund. I think if I’m not wrong, I think you were one of the first PMS funds that converted itself into a mutual fund house, right? So give us a brief history of your founder and what your fund is and what you stand out for?

Raj Mehta: Sure. So, for those who don’t know PPFAS stands for Parag Parikh Financial Advisory Services. So it’s named after our founder, Mr. Parag Parikh. He was a very well known value investor and he was the one who actually started Equity Research in India sometime in early ’90s, when foreign investors were allowed to invest in India. So that’s when — so just to give you a background of our firm, it started off sometime in 1979 and we started off as a stockbroking firm. Since then, we moved on to becoming a Portfolio Management Services or a PMS firm. So we were the first ones to get a PMS license in ’95, ’96 and since then we have moved on to the mutual fund business sometime in 2013. So the reasons for moving from a PMS business to mutual fund business was that we wanted to serve retail investors, also the limit or the minimum investment limit which we had was increased from INR25 lakhs to INR50 lakhs, sorry INR5 lakhs to INR25 lakhs at that point in time. And then we thought that taxation wise also for retail investors, mutual fund was a much more efficient structure compared to a PMS. So, that’s when we started our steps towards launching our own mutual fund. Another thing, which prompted us to launch a mutual fund was that post the Global Financial Crisis we thought the stocks in U.S. were really attractive and to invest in them under the PMS structure was not possible so we used to advice clients on where to invest in foreign markets, but we couldn’t do it ourselves under the PMS structure. So under the mutual fund structure, we built our product in such a way that we could invest in both Indian as well as foreign stocks together and that’s how our flagship scheme, which is the Parag Parikh Long-Term Equity Scheme, which is now called the Parag Parikh Flexi Cap Fund. That’s how it came into being. So basically how this fund is structured is that 65% invested in Indian equities and the balance is invested in Foreign Securities. We wanted this to be a fund where it can do everything. We can stay in cash if we want to. We can invest in foreign equities. If we find that foreign equities are expensive we can be 100% in Indian equities also. Basically it was Swiss Army Knife which we called it, it could do anything that the investor wanted and basic aim of the fund was to earn reasonable returns and that has been the aim that we have had since the PMS days. So we don’t want to add ourselves to a benchmark. We want to earn absolute returns which are reasonable for the investor. So that’s how we started off. After the initial fund we came out with three other funds, Parag Parikh Liquid Fund was the second fund, which we launched and that was at the behest of our investors who wanted to invest in the liquid fund and then do STPs or switches into the flagship scheme. So that was one. The other scheme which we launched was the Tax Saver or the ELSS fund. So again this was at the behest of our distributor partners and the end investors. So they wanted a product, which would give them benefits under 80C and a pure equity fund as well, Indian equity fund as well. So that’s when we launched our Parag Parikh Tax Saver Fund in 2019. And last year we launched our Conservative Hybrid Fund, which we like to call a debt fund from our fund house, which basically just like the Flexi Cap which can do anything on the equity side. This can do anything on the debt side. So we don’t want to take any major credit risk, but we are willing to take interest rate risk as long as you know the end investor is willing to wait it out for the longer term. So that’s how our fund structure is currently.

Radhakrishnan Chonat: Great. So let’s talk more about your flagship fund here. As you rightly said, now the name or the scheme has been changed to a flexi cap, right, thanks to the SEBI regulation that came in last year. And now again one more regulation that came in recently, where you know you are now restricted to take any new other than SIBs, I believe any new fresh funding into that because there is a cap on foreign remittance. How has that impacted you? Last two years if you see there’s lot of scheme level changes has happened. You still have invested, continuing to invest in U.S. and other outside funds. But now with this restriction by posed by SEBI, do you see it changing anytime soon or how have you adapted to this new situation?

Raj Mehta: So what has happened is that there is an industrial limit, which has been set by RBI to invest overseas. So this limit was set sometime in 2008 and the industrial limit is $7 billion. SEBI has set up for AMC or a per fundhouse limit of $1 billion within the $7 billion limit. So what happened was that in the last couple of years we have seen the foreign markets doing really well. And most of the fundhouses have come out with NFOs of funds which invest overseas. So this limit got exhausted very quickly and sometime in January end MP and SEBI realized that we are very close to getting that limit. So then they suggested to stop remitting any more dollars from 2nd of February onwards. And that’s when — so we stopped inflows into our flexi cap schemes. So the existing SIPs and STPs would continue but any new SIP, STP registration as well as lump sum investments were restricted. So as of now what is happening is that whatever SIP, STP inflows that we received during the month are invested in only in Indian Securities because we are restricted from investing abroad. Going forward, we don’t know how long will it take for the RBI to increase the limit, but we are hopeful that they will increase the limit soon. They have taken a little longer than what we had expected. But we don’t know the timing or the limit that they will increase or where they will increase it by $2 billion, $4 billion, $6 billion, we don’t know the limit also. So we’ll wait and watch till then. As and when we feel that it’s taking very long, we may start inflows into the flexi cap and invest only in India as well. So that’s an option we already have, but let’s see, we’ll wait and watch how it goes.

Radhakrishnan Chonat: Okay. Related to this, I had told the community that we have at AlphaStreet and other social media that I’m going to interview you so related to this there’s a question that a community member asked. So his concern is with the restrictions in growing your AUM and the immediate restriction right, you are known for your value picks, value investing picks, you are known for that. Would you be forced to compromise on your stock picks now with all these restrictions? So, any thoughts on that? In other words, are they going to abandon their value investing principles? So, any thoughts?

Raj Mehta: The philosophy, the approach remains the same irrespective of the situation that we are in. So we are not willing to bend our morals or bend our principles to any extent. We’ll stay put our investment approach and that will remain the same always not today, next year, a year after that, but always it will remain the same. So the inflows which have been restricted do not impact us in any way because whatever SIP inflows we are receiving we are finding opportunities in India. So that’s not a problem. On the other side, I would also like to say that the valuations in foreign markets have become even more attractive. So if the RBI and SEBI increase the limit we will be very happy to take the inflows and invest abroad also so yeah.

Radhakrishnan Chonat: Good, good. Good to reassure your investors that you know you will stick to your principles, excellent. Another question that came in, I think it’s got to do with recent performance of Facebook, right? You have a significant stake in Facebook. Why is Facebook still part of flexi cap portfolio? What’s the reasoning behind investing in Facebook? Another question from an investor.

Raj Mehta: So Facebook as we all know is a very, very big player in the digital advertising market. And at the same time they have some other platforms, which have not been monetized fully, so something like WhatsApp hasn’t been monetized fully. Instagram is something which they have been expanding very rapidly. And the reason for the fall in recent times is because of the major investments they have done on the Metaverse side. So whether that will work or not is a question mark. We don’t have an opinion either way. We’ll also wait and watch but the investors are worried about the major investments that they have done in the last year or so on the Metaverse side. So if that works out well, it’s very good. If that doesn’t work out well then we’ll see how it goes. So these kind of investments have been made by other companies like Alphabet and Amazon also and some of them work, some of them don’t work, so you need to use the cash flows of the cash cow that you have very judiciously, so that is what we’ll be looking for.

Radhakrishnan Chonat: Great, great. Shifting gears a little bit to the — your latest hybrid fund that you had launched so another, again, I’m taking questions from investors. PPFAS has mentioned their conservative hybrid fund us a one-stop debt fund option for long-term debt front, right? How should people plan to use this fund as they near the goal? So do you have any strategies that investors should use, staggered approach or STP, our SWP or whatever?

Raj Mehta: So as you reach towards your goal one option for you to withdraw money is SWP. So after three years, if you do it taxation-wise also it’s more efficient and we would recommend say half a percent per month kind of a SWP something which any investor should be looking for. So I think that should be good enough to take care of your monthly needs and based on that you need to have a sufficient purpose in the fund.

Radhakrishnan Chonat: You also mentioned that, your fundhouse has limited number of funds, which is good — from an investors’ point of view, he can pick and choose. Now you have a tax saver fund and it’s marched — most of youngsters are now looking at which fund to invest in. So briefly tell us about you know your tax saver fund and how is it different from others?

Raj Mehta: Sure. So the tax saver fund, if you see the portfolio of both flexi cap as well as the tax saver fund most of these stocks are same, weightages may differ here and there mainly because we are not allowed to invest in foreign securities in the tax saver fund by regulation, not by choice. Other restriction that we have is that we cannot use derivatives in the tax saver category so any cash to features, arbitrage or covered call options or anything we cannot do that on the tax saver side. But on the other side if you look at the portfolio of the tax saver fund we have tried to substitute the foreign holdings that we have with the Indian substitute so for Amazons, Alphabets of the world, you have TCS and Wipro, which have been added to the tax saver fund. Instead of Suzuki, we have Maruti Suzuki, otherwise more or less the portfolio remains the same. One or two illiquid names may be there because of the size of the fund also. So tax saver fund is hardly INR500 crores. So that helps us in investing in some of these illiquid small- and mid-cap companies. So overall we now are looking to position this product as an Indian-centric fund rather than a Tax Saver Fund. So, tax saving benefit is something which comes additionally with it, but primarily it’s an India-centric fund. And since we recommend the investors to invest in Indian equities or equity funds for five years plus, three years lock-in should not really hurt them. So, we can actually position this as an India-centric one rather than launching a new fund just for the sake of it.

Radhakrishnan Chonat: Excellent. So now coming back to you briefly, Raj. Tell us about sort of the mental models that you follow while analyzing a company or a security, what are the checklist you have that probably can help an investor, at least do a primary filtering.

Raj Mehta: Sure. So, there are three or four main points that we try and cover during our equity research process or analyzing a company. First and foremost is the promoter quality. So given the conservative nature that we have of our philosophy as well as the fund, we feel that promoter quality is paramount, and we do not want to compromise even a little bit on the promoter quality side. So, we may pay up on the valuation if the promoter is good, but we don’t want to compromise on the promoter side. So, first and foremost, is that. If that is good, then only we go to the next step. If that isn’t good, then we don’t go further. So, after that we look at the company or in the industry, how big is the market size, how big the company can become, whether it can take market share from others, whether the market size itself is growing or not. If the market itself is growing, plus the company’s market share is growing, very good. So, both the things are working on your favor. Even if one of it is working, but the valuations are really good, then also good. But if both are working, that’s like a ideal kind of a scenario for us where our growth run rate ahead would be really good for the company. So second would be that. Third would be on the balance sheet side, so more than the P&L statement, we study the balance sheet. So, we like to have companies with very low debt or borrowings. We like companies which earn a return on capital which is sustainably over a cycle more than say 13%, 14%, 15%. So those are the basic, I would say, quantitative criteria that we have in terms of the financials. There are many other checklist points that we have, but these would be the primary ones. Other than that, last comes the valuation. So, valuation is something which we look at last. We do not have any DCF models as such, but we try and see what the company would be in the next three to five years, so what growth the company would be able to achieve, and based on that, we come out with a valuation.

Radhakrishnan Chonat: Interesting choices. You mentioned management quality as one of the first criterias for filtering, right? From an investor’s perspective or from a retail investor’s perspective, what should be some of the red flags that he should be looking for just from his point of? What are some of the red flags where immediately he should not consider investing? So, what are some of the red flags that you’d recommend when it comes to analyzing the management quality?

Raj Mehta: Sure. Sure. So, for our retail investors, it may be a little difficult to analyze this because a lot of the data is not in the public domain. A lot of it is when you speak to a lot of people around the promoters. So, if you speak to the vendors, the distributors, the customers sometimes deal directly with the promoter, so you get a lot of data. Apart from that, on the annual reports and financial data what you can do is you can look at the historical capital allocation policy of the company, whether they have done any capital misallocations in the past. If they have done that, then definitely that’s a red flag, and you should be very careful that he or she may do that in the future as well. Secondly, you can also look at the earning transcripts of the company and see what the management is telling, try to match that with what is happening in the company, whether what the management has told is actually happening with the company or not. That is also something which you can see. And on the guidance front, if the management doesn’t give guidance, very good. If the management gives guidance, then you should check whether the management is conservative or aggressive in terms of the guidance that it gives and whether it is able to actually meet the guidance or not in the next year. So, all these are points which you can easily get from the public sources. Apart from that, you can obviously do a lot of scuttlebutt talking to a lot of people and get information about the promoters.

Radhakrishnan Chonat: Nice pointers. And for those listeners who probably don’t know, shameless plug, you can go to alphastreet.com/india and read all earnings transcripts available for free. So that’s one source that Raj mentioned. Coming back to Raj, so I ask this to all my guests. You as a person pre-COVID and post-COVID, what have been some of the biggest learnings that you have?

Raj Mehta: Sure. So pre-COVID, post-COVID nothing much has changed. A couple of changes. So, I have tried and started focusing more on my health now given that I had a lot of time on my hand sitting at home because before COVID I used to travel for 2-3 hours a day, so saving 2-3 hours a day, and even half of it if you can focus on your health, that would be really good. So that is something which I have started focusing on. Apart from that, saving yourself from some screen time is also something which I am looking forward to, because during the COVID or lockdown, we were all glued to our screens be it mobiles, laptops, iPad, and we were all on Zoom meetings throughout the day. So post-COVID, I hope we are post-COVID right now, and we’ll start physical meetings, because physical meetings is something which I missed terribly during the lockdowns. Meeting people and discussing something is completely different from a Zoom meeting and meeting them online. So that is something which I look forward to.

Radhakrishnan Chonat: Interesting that you mentioned that we all hope it’s post-COVID, so probably I preempted the question in the midst of COVID. So yeah, it’s still pre-COVID. So, Raj, I know you like to read a lot. So as usual, any book recommendations? I always ask my guests, can you give us top three books, your favorite books, or top-of-the-mind books for our listeners?

Raj Mehta: Sure. So, I am a big fan of Peter Lynch. So, the two books written by him, Beating the Street and One Up on Wall Street. These two are the books which any new investor, retail investor, existing investor, experienced investor can read. I reread them a lot. So, these two are the books which I would strongly recommend. And then, obviously, the Warren Buffett, Charlie Munger books are something which everybody reads. So, yeah, these would be the recommendations that I give.

Radhakrishnan Chonat: Nice. Thanks for those recommendations, Raj. Now PPFAS is a small and unique core team, right? You all have been career veterans. I’m sure my listeners are interested in knowing the work culture there, how close a team you are, some insights that we can get that is not already available. Probably I can put it as an exclusive. Tell us more about your team.

Raj Mehta: Sure. So just about two years back, we were a staff of about 50 people. Right now, we are a staff of about 150 people. So, we have grown quite a lot in terms of staff strength in the last couple of years. But the culture has remained quite the same. So, when I joined in 2012, we were all provided learning resources and told to learn, to read, to spend some time of the day on reading so that you can improve yourself. On our academics also, we have been told that if you want to do any course and if you actually pass that course, the company will reimburse the fees. So that is something where we encourage the employees to take on the academic courses, improve their own knowledge base, and hence in turn benefit the company. So that is something which we look forward to. Apart from that, the structure over here is not hierarchical. So, what happens in most of the firms is that you have to go through many layers before your word actually reaches the CEO, CIO, or the top management. So here it’s a very flat structure. And if your work is good, you may be handed some responsibility very soon, and you may grow up the rank. So, taking my example forward, so I started off as an intern to analyst to a fund manager now. And again, managing Rs. 300 crores to Rs. 20,000, Rs. 25,000 crores now. So, yeah, that is something which we look forward to. And going forward, as our organization grows, we hope that we’ll be able to retain our culture despite the growing staff strength that we have.

Radhakrishnan Chonat: Excellent. Great to hear that. Now the million-dollar question, the most requested question that I got is when is PPFAS launching a new fund, or are you planning to come out with a index fund offering, because that looks like the flavor of the season. So, when are you planning a new fund offering?

Raj Mehta: Sure. So, answering your second question first, never. So, we are never launching an index fund. Index fund is something which is a scale game. We don’t have the scale. At the expense ratio at which some of these index funds and the ETFs run, we don’t think that we would be able to provide something different. So, our philosophy has always been to launch a scheme only when we ourselves would be interested in investing in them and something different which we can do for the investors. So, in index funds or ETFs we cannot do that. It’s replicating the index. So, there’s nothing that we can do. On the new fund offering, at least in the near future, I don’t see any new fund offering from our side. Post the inflow stopping in the Flexicap Fund, we had received requests to launch only an India-centric fund, and that’s when we changed our stance on the Tax Saver Fund where we thought that we have a credible three-year track record of the Tax Saver Fund, which is an India-centric fund, the only constraint that most of the investors have is that it has a lock-in period. But since most of the investor base that we have is very familiar with the philosophy that we have, and we want investors to stay in for the longer term of five years plus, at least three years plus, so the lock-in period is something which shouldn’t matter to us. So, Tax Saver Fund is something which you can call it an India-centric fund and you can call it an old fund offering instead of a new fund offering.

Radhakrishnan Chonat: Old fund offering, that’s interesting to hear. Last question. Talking about the geopolitics, right, there are a lot of new investors that came in, in the last two to three years, and this probably looking at the, kind of, chatter that I see on our platform, this probably is the first time they’re seeing most of their portfolio in red, and they haven’t seen a cycle, right? What advice do you have for them? They’re worried about, okay, is this going to end up in a Third World War? Is my investment going to go absolute zero? Did I do a mistake? My parents or my uncles told me never to invest in markets. Now I did it. So, to, kind of, give them that reassurance, what is your outlook on the geopolitical issues that you’re seeing right now and, sort of, crystal ball gazing, where do you see this headed.

Raj Mehta: Sure. So, keeping aside my views on the geopolitical issues, first I would like to tell the investors that those who have come in the last couple of years haven’t seen a meaningful correction as such. So, a 10% to 15% or 20% correction is something which happens very regularly in equity markets, and you should be used to it. If you cannot take a 20% hit on your portfolio, then you are not meant for the equity markets, because equity markets are volatile, and the returns go up and down. It’s not a straight line. So that is something you should have. Secondly, all the investors should have a investment allocation in place where they put certain money in equity and certain money in debt. Whatever funds the investor requires in the next couple of years should be in debt funds and not in equity funds. Equity funds are meant for longer-term goals and goals which can be flexible in terms of timelines. So that is something which I would recommend. On the geopolitical issues, I don’t have a strong view as such. We’ll see what happens, but more or less as long as your portfolio companies are not exposed to those countries or are not exposed to commodities mainly or even if you have exposure to companies which are dependent on those commodities, if they have pricing power and if they are able to increase the prices based on the commodity price increases, you are good enough. So, over a longer period of time, these cycles play out, and you should be good.

Radhakrishnan Chonat: Great. So, it was wonderful catching up with you, Raj. I look forward to more interactions in the future and wishing you all the best.

Raj Mehta: Sure. Nice to meet you, too. And thanks for having me.

Radhakrishnan Chonat: Thank you.