Value investing works, and so does growth investing. Quality investing works and so does chor-bane-mor (improving governance). Start-up investing works, and so do turnarounds. Even sectoral/trend following works.

A fund dedicated to new-age internet business models will likely have exposure to many such businesses, ranging from InfoEdge (Naukri), Zomato, PolicyBazaar, to Firstcry, PayTM & Nykaa.

It is impossible to pinpoint exactly which will be successful and which will fail. However, at a basket level, even a few winners tend to more than compensate for the laggards.

Similarly, a turnaround strategy could have an exposure to a host of businesses that struggled through the last decade. Some, like Vodafone, continue to struggle, while others, like CG Power or Suzlon, have turned around with mega gains. Again, at a basket level, it works because even a few outlier winners take care of returns for the entire portfolio.

Funds focused on mega trends buy high-growth companies, irrespective of their valuation, whether it is 50 PE or 100 PE. The underlying assumption is that they will continue to grow at a supernormal rate for the foreseeable future, creating big value even from those elevated valuations. The ones that fail to execute could swiftly loose even 50% of the value, but again, the winners take care of it all. Currently, most stocks from solar, electronic manufacturing, defence, and capital goods would fit the bill here.

PPFAS, which manages over Rs 1,00,000 Crore, follows a value investing strategy, which has worked well for them.

ValueQuest, which manages over Rs 25,000 Crore, follows mega-trends investing, which is diametrically opposite of PPFAS’ value investing strategy, and yet has outperformed the benchmark well.

Then the million-dollar question is, ‘If all the strategies work, why do most portfolios struggle? The reasons are twofold:

1. Style drift: If we buy every stock that sounds interesting despite being in different strategies above, our portfolio would become a khichdi of diverse styles, which will pull the results back to a mediocre average (equivalent to index returns or even lower).
   
   Imagine buying:
   1. Coal India at 7 PE (value), because PPFAS owns it. 
   2. TBO Tek at 70 PE (growth), because ValueQuest owns it.
   3. UPL (turnaround), because Old Bridge owns it.
   4. Raymond Lifestyle (potential change in perception/governance), because Equity Intelligence owns it.
      
      5-10-20 years data shows their respective strategies have worked out well for them, but would these specific stock picks work for you? Coat-tailing has a better chance of working out when one replicates someone’s entire portfolio (even as a small basket within one’s portfolio). If someone coat-tailed the iconic Mr Rakesh Jhunjhunwala but missed just one stock (Titan), his/her returns would be dismal compared to RJ’s.
      
      Pick a style that suits your a). temperament, b). intended horizon & c). risk appetite. Then make sure you stick to it. Most stock picks in your portfolio should be aligned with this. Also, there should be sufficient allocation to each position so that if they turn out to be a winner, they end up lifting the entire portfolio. We can’t expect that from a 50-stock portfolio with an average allocation of 2% to each stock. An outlier may not be able to move the needle in this case.

2. Time horizon: The second reason is often our inability to give the desired time for a particular strategy to play out. Keep in mind that the sugarcane crop grows in one year, but an avocado tree takes five.
   

In the 2019-2021 phase, many investors got lured towards the buy-at-any-price (BAAP) strategy for high-quality businesses like Asian Paints, HUL, Nestle, 3M & Whirlpool, etc. To many people’s shock, this high-quality portfolio of stocks has delivered a low single-digit annualised return despite a roaring bull market in the last five years, materially underperforming the index/market returns.

Does it mean quality investing doesn’t work any more? No, it does! But it probably takes a 7-10 year cycle for this to play out; BAAP is like planting an avocado in the investing world. But how many people have that much patience? Interestingly, even the fund that propagated this strategy had to shift gears, given that it ran an open-ended fund where end investors ran out of patience.

At Stalwart, what strategy do we follow & how do we manage the two challenges of style drift & time horizon?

Our primary strategy is mean-reversion (MR), which is a subset of value-investing and, second strategy is growth-at-reasonable-price (GARP).

MR could be in sales growth, profit margins, valuation and/or in capital allocation (management actions). We are essentially playing 3-5 year business cycles by entering businesses facing temporarily low profit margins & low RoEs and exiting once the pendulum goes back to high margins & high RoE. Valuation (re-rating) often contributes a good chunk to our returns.

Stalwart’s entire portfolio consists of stock opportunities based on MR & GARP. Since our inception in 2014,  we have stayed true to our style with negligible style drift.

With respect to time horizon, we have had the patience of even holding stocks for 5-8 years to give our avocado trees sufficient time to harvest. Some worked out pretty well, like Sanghvi Movers (5x), others couldn’t deliver due to both external & internal reasons, like Wonderla Holidays (65% return in 8 years – impacted by COVID and park delays), but at least we don’t have any regrets about any untimely/premature exits.

If you are sowing an avocado tree, it would be unwise to expect returns in one year (like sugarcane). If you keep an investment horizon that is aligned with your investment style, you are more likely to have the desired outcomes.

The flip side?

By sticking to just one or two strategies, wouldn’t one miss great stocks from other strategies? Sure! But that’s part of the game. If a girl has to choose a suitable groom among 100 boys by either talking to each for 10 minutes or talking to a shortlist of 10 boys for an hour each, it will invariably be better to go with the second option, offering depth. 

There are 4,000+ actively traded stocks, and we cannot track all of them. Given the desired depth, we at Stalwart track about 100 companies in the core basket and about another 100 (peers/value chain), with perhaps lesser depth. This implies our universe is 5%* of all the listed companies shortlisted based on a plethora of quantitative and qualitative filters based on our circle of competence & preferences. Just 5% – despite being full-time in this profession with a five-member research team. The commensurate number for a full-time individual investor who is doing this as a one-man army drops much lower. If we talk about a hobby investor who devotes a few hours every weekend, managing the width vs depth becomes even a bigger challenge. But it’s absolutely fine; we can’t be at all the parties, learn to enjoy the one you are at. Coming to peace with this reality is the key.

Further Resources:

1. If one is interested in understanding business cycles (fragmentation & consolidation), a good book to pick is Capital Returns: Investing Through the Capital Cycle, by Edward Chancellor.
2. One can also listen to long-form YouTube interviews of Mr Kenneth Andrade of Oldbridge MF, he is an avid practitioner of this strategy and has thoroughly articulated the same in his interviews.

*Stock Universe

We published a blog post in 2019 that laid out a framework to create a shortlist of stocks. This has, of course, evolved for us in the last six years, however, this step-by-step guide remains a handy resource for anyone trying to do a similar exercise: 

Only 2.5% of 8,000 Listed Indian Stocks Are Investable; Here’s The List

Only 2.5% of 8,000 Listed Indian Stocks Are Investable; Here’s The List