fund manager: Macros a source of random risks, not an opportunity to add alpha, says $5 bn fund manager

NEW DELHI: In 1985, a young boy, then 13, captivated a 100 percent rally in stocks onto Dalal Street. Being in the financial capital of Mumbai and then Bombay, all his family savings were in stocks

The opportunity for wealth creation was huge, he recalls, as he has remained hooked to domestic stocks ever since.

As fate had it, he became CIO at Goldman Sachs, later starting his own firm, WhiteOak Capital Management. We are talking about Prashant Khemka.

Khemka, whose five-year WhiteOak manages $5 billion in assets, says macros are just a source of random risk rather than any opportunity to add alpha.

Every market cycle shows that the market does not wait for the economy to recover, it does not even have to determine with any degree of precision when or how low the bottom for the real economy might be.

Khemka says his belief that predicting future returns is futile is only strengthened with each passing crisis.

For example, during the global financial crisis (GFC), markets began to bounce back sharply from March 2009, even when the world was still in the throes of utter chaos in the real economy. Moreover, during the Covid crisis, the market “reached the bottom on March 23, 2020, when the number of daily Covid cases in India was only 75, the total number of cases was only 471 and the number of victims in single digits!”

Extraordinary returns are earned over time by investing in great companies at attractive values. If either one goes wrong, it’s time to sell, Khemka says.

Professional life
Khemka’s professional investment career began at State Street Global Advisors,

in 1998, which is currently the third largest asset manager.

After working there for a few years, Khemka joined the US Growth Equity team at Goldman Sachs Asset Management (GSAM), at the height of the dotcom bubble. “It was a high performing team where I learned a lot about investing and team building under the mentorship of Herbert Ehlers, the original founder of Liberty Asset Management which was acquired by GSAM,” he recalls.

With this expertise, Khemka returned to India in 2006 to launch GSAM’s India business as CIO and Lead PM for over ten years. His tenure at GSAM ended in 2017. By this time, Khemka had also assumed the role of CIO and Lead PM of Global Emerging Markets (GEM) Equity, which he has managed for nearly four years since 2013, in addition to GS India strategy.

Investment philosophy
Khemka says he relies on the stock-selection-based approach to investing in companies rather than betting on macros. The two critical elements here are business and valuation.

“We want to invest in companies that offer the most compelling combinations of these two elements. To be considered great, a company must possess three key characteristics: (a) superior returns on incremental capital, (b) scalable, (c) well managed in terms of execution and governance,” he said.

These characteristics, Khemka said, are rooted in the fundamental value equation: The value of any company is the present value of its future cash flows.

“Superior return on incremental capital is a prerequisite for sustainable free cash flow generation. Scalability is about growing the business over time compared to its current size relative to the industry, which in turn results in a stronger growth of its cash flows With such potential for free cash flows and growth you need the right management that can perform with a focus on long-term value creation Last but most importantly, the company’s governance DNA must be robust be,” he explained.

Khemka said that if there is no good governance, owning a company can be great, but only for the controlling shareholders or management and not for the minority shareholders. “The best way to make money from such poorly run companies is to stay away from them,” he said.

The right time to sell
Khemka says the philosophy that applies to buying decisions is the same that applies to selling decisions.

“When the combination of business and valuation is no longer compelling enough to own the company in the portfolio, the team sells it out and redeploys capital towards better opportunities,” he said.

Khemka says he doesn’t come from the mindset that one should buy and hold onto forever, no matter what.

Rather than being ostrich-like in the name of “buy-and-hold,” one should be open to the impact of such developments on existing portfolio companies, he stressed.

He recalled investing in the US market in the late 1990s and 2000s. At the time, many fund managers and famous investors regarded newspapers as a great company, as its business model flourished and remained untouched for more than a century through various economic cycles.

“Several fund managers who have owned newspaper stocks for decades chose to ignore the risks of the advent of the Internet to the newspaper business and destroy vast amounts of their client assets. This is a perfect example where blind, cult-like followers of clichés like “ buy and hold” without adequate ongoing reassessment of business fundamentals can do far more harm than good to customers’ portfolios,” he said.

Defining Valuations
At WhiteOak Capital Management, Khemka says his team is committed to buying the great companies when they are available at a significant discount to their NAV. For this he uses a proprietary analytical framework ‘OpcoFincoTM’ that provides him with insight into economic cash flow generation characteristics and quantifies the value of excess ROIC in a company.

“The team shuns the use of PE or EV/Ebitda multiples because such statistics can be very misleading and lead to wrong decisions,” he said.

Khemka believes that the money is made through stock selection rather than betting on sectors or themes. He said the sector weights in his portfolios are the result of bottom-up stock-specific opportunities rather than top-down biases across any sector.

“For us, top-down macro betting is just a source of risk that needs to be managed well. The team always strives for a balanced portfolio to mitigate such risks relative to the market,” he said.

Biggest Investor Mistake
Khemka said his faith is further strengthened during crises and that it is “useless to predict future returns”.

Investors in general, whether retail or institutional, tend to extrapolate today’s economic environment to equity market returns in the coming years. If the current economic climate is weak and gloom and doom pervades all over, investors assume that stock markets will fall until the economy recovers. And if the stock markets have already fallen, their belief is only reinforced that the markets will continue to fall until the economy or the macro environment improves noticeably.

“The best thing about investing is that learning never stops. You learn every day, but you can never be taught enough. For an observant student of investing, crises such as the global financial crisis (GFC) and Covid-19 are rare instances of accelerated learning within a There are countless lessons, and in fact one can continue to gain incremental insights over many years if one continues to look back on those times of crisis,” he said.

Khemka says that by the time investors and economists can predict a bottom for the economy in the distant future, they are almost always heavily influenced by the rise of the market itself.

For example, at the end of March 2020, even as investors panicked about the impact of nationwide lockdowns around the world, the market may have had a vague suspicion that the virus death rate was not high enough to withstand prolonged and widespread lockdowns of such, no matter when. a drug or vaccine is found. Such a hunch in and of itself might have been more than enough for the market to recover.

“The above illustrates that even perfect foreknowledge of macro events and the impact they can have in the real world can be grossly inadequate in assessing their implications for the stock markets. Clearly, it is not the first time that actual market returns during and the next major macro events turned out to be far from good compared to what could have logically been expected even with perfect foreknowledge of those macro events.The market is always looking and reflecting on what is far beyond the horizon as it present value of his companies’ estimated future cash flows into perpetuity, not just the current year or two’s earnings,” he said.

Born and raised in Mumbai, Khemka graduated with a bachelor’s degree in mechanical engineering from Sardar Patel College of the University of Mumbai in 1993. He later received a scholarship to Vanderbilt University in the US to complete his MBA in 1998.

Macros are random risks
Khemka said he believes macros are just a source of random risk rather than any opportunity to add alpha.

“To prevent such arbitrary risks from hijacking the team’s skills-based alpha, we maintain a balanced approach to portfolio construction at all times, while consciously avoiding macro bets such as market timing or sector rotation or other such top-down setbacks. is not that such top-down bets are always wrong, we just believe that they are right as often as wrong, not unlike a game of coin flips,” he said.

Even if the fundamentals remain intact, one must remember that there is an appropriate price for every business, he said.

“We always try to stay disciplined on valuations, as dictated by our proprietary Opco-Finco framework. If the stock price rises significantly without a commensurate rise in the underlying value of the company, and as a result, the stock’s upside potential is greatly reduced or eliminated, there can be a good case for taking some or all of the money out of that company and rearranging it into other ideas that deliver a more compelling combination of business and value,” he said.

(Disclaimer: The experts’ recommendations, suggestions, views and opinions are their own. They do not represent the views of Economic Times)

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