White Oak Capital's founder, Prashant Khemka, shares his insights with BQ Prime's Niraj Shah on where the big opportunities in the market lie and strategies to create alpha.
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00:00 Thanks for tuning into Alpha Mughals, a show where we speak to some of the finest investing
00:12 minds about how is it that they are constructing the portfolio to generate alpha over the next
00:17 12 to 24 months.
00:18 Our guest today is Prashant Khimka of Ytalk.
00:21 Prashant, great having you.
00:22 It's been a while.
00:23 Thanks for taking the time out.
00:24 My pleasure, Neeraj.
00:25 Always a pleasure talking to you.
00:26 Thanks for having me.
00:27 Thank you so much, the feeling is entirely mutual and more so.
00:31 So Prashant, seldom do all time highs get accompanied by mouthwatering valuations or
00:40 normal valuations.
00:41 So I'm trying to understand when you are thinking of the portfolio construct in order to generate
00:45 alpha over the next 24, 12 to 24 months, how do you think about this?
00:51 Certainly, so Neeraj, we take market as a given, we assume, our assumption always is
00:58 that market is fairly valued or better for worse.
01:01 What we are looking for is relatively attractively valued businesses.
01:07 So market can be high or low, we would only know with hindsight in our view.
01:14 But regardless of where it is, there are always going to be within that market, some names
01:19 that are overvalued, relatively overvalued and some names that are relatively undervalued.
01:24 So it is the relative framework with which we proceed to identify investment opportunities.
01:30 Okay, let me try and ask it another way as well.
01:36 Let's say over the course of the next 12 months, and if 12 months is slightly shorter time
01:40 frame than 18 to 24 months, do you reckon generation of alpha over the benchmark would
01:49 mean just about performing at par or do you reckon the markets themselves from where we
01:55 are looking at earnings growth, looking at geopolitics, looking at everything at the
01:58 technical factors, that the markets could be higher than where we are currently.
02:02 And therefore, the alpha generation would be a particular number, which portfolio managers
02:08 like yourself or teams such as yours will have to deliver.
02:11 Just trying to understand what is your basic construct about what happens over the next
02:16 24 months?
02:17 A very interesting question.
02:21 Something that I do get asked oftentimes by clients as well, whether in effect what we
02:27 are asking, if I interpret it correctly, is whether the alpha portion is particularly
02:31 higher or lower at this time.
02:35 See, the answer I've always given is what I believe is that the alpha opportunity is
02:42 more or less the same through time, meaning that the mispriced opportunities to the relative
02:50 overvaluation or undervaluation that I spoke about, that does not change compared to the
02:58 market level.
02:59 Because we are talking again, relative valuations.
03:03 Let's assume for a minute, in hindsight, we can all agree that 2007 or year 2000 was a
03:11 high point in the market valuations.
03:14 Still at that time, at that point in time, there were many names which were way overvalued
03:21 compared to that market level, which in subsequent years were decimated.
03:26 The same time, there were other companies which obviously went up as well as many of
03:31 them which went down, but didn't go down as much.
03:34 So that is relative outperformance.
03:36 If the market goes down 16% and certain names go down only 20%, that's massive relative
03:44 outperformance.
03:45 So, and on the other hand, same way, if you take 2003 or to a lesser degree, 2013, when
03:53 the markets were at cyclical lows, at those points in time, after that, yes, most stocks,
04:01 a lot of companies, vast majority of the companies have a sharp move upwards.
04:06 But within that, some go up multifold and again, outperform the market by many times,
04:13 whereas others can't keep up with the market.
04:16 So that's again, relative outperformance based on a variety of factors and that outperformance
04:25 or alpha, unfortunately, I haven't at least found a way of distinguishing in different
04:31 market environments, the alpha to be different.
04:35 Okay.
04:36 Yeah, well, a lot of these things are probably known in hindsight, but let me still try and
04:39 understand one more aspect from you.
04:42 And in hindsight, one would argue that March 2020, if you had the guts, was a market that
04:48 was teeming with opportunities.
04:51 And maybe 2007 was a market fraught with risks, even though the sentiments were completely
04:56 polar opposites at those times.
04:58 Currently, do you feel that the market is full of opportunities because of this whole
05:05 India positioning in the geopolitical world and the Shainoja of all eyes, so on so forth,
05:10 or is it a market that is teeming with risk because there is just too much of money chasing
05:16 very few global assets, if you will?
05:20 So those five points in time, as you pointed out, 2020, and the other one was 2007.
05:27 As you can see, those points come far and few in between, almost once a cycle.
05:33 Do I think whether we are at such a point in the cycle one way or the other?
05:39 Certainly not at a low point.
05:41 And I also don't, because that's just, you can see the historically where we've come
05:45 from.
05:46 But remember about 20 months ago or 18, 19 months ago, in October 21, the market was
05:55 just slightly lower than where we are.
05:57 Yes, we've climbed an all-time high, no doubt, but it's not an all-time high after rising
06:03 50 to 100% or, you know, multifold over the last couple of years, or like it was in 2007.
06:11 So we've had certain time consolidation over the last 18, 20 months.
06:17 And so at this time, not that I'm good at picking these tops or bottoms, and nor have
06:23 I found anyone else to be good at picking these tops and bottoms with any degree of
06:29 consistency other than what can be associated with luck.
06:33 So my view is at this time, we are in one of those normal times, which is neither at
06:40 one extreme or the other.
06:42 And somewhere around the...
06:44 Got it.
06:45 Now, viewers, the reason I don't ask Prashant about macro is because in the past he's told
06:49 me that trying to second-guess macro is like flipping a coin.
06:53 And therefore we're not getting there only because why waste these, anything out of these
06:57 next 20 minutes or 15 minutes with Prashant.
07:00 Would love to understand again from a portfolio perspective, Prashant, therefore, is the construct
07:06 of the portfolio currently, and whether you put in new money or you keep existing money,
07:12 both of them are vindication of the opportunity that exists.
07:15 So is the construction of the portfolio currently geared more towards high growth opportunities,
07:23 even if they might be priced at a premium to your own framework that you have, which
07:29 is Opco and Finco?
07:30 But even from that metric, is the opportunity more geared towards high growth, even if it
07:35 comes at a premium?
07:36 Or are you very, very conscious of the average multiple of the portfolio, even if it means
07:43 that you're settling for slightly lower growth?
07:46 So, perfect.
07:48 And first, I'd just like to make a comment on the previous comment you made, Neeraj,
07:53 it's not that the macro is unpredictable.
07:56 It's the implications of the macro on the market, which is completely unpredictable.
08:03 Right now, it may be, for example, predictable to a certain degree, what the Fed is going
08:08 to do.
08:09 They've orchestrated it so well.
08:12 It's also maybe to some degree, one can argue predictable what the US and the global economy
08:17 would do, what the Indian economy would do.
08:20 But what those implications of those macro outcomes are on the market, are they any different
08:27 than what the market is already priced in, is what is unpredictable, just to be clear,
08:32 Neeraj.
08:33 Now, coming to your point on the growth, see, growth is valuable only as an element in the
08:42 value equation.
08:44 So if, after factoring in a certain projected growth, if you don't see any material upside
08:53 in a company, then you're better off not investing, staying on the sidelines.
08:57 And we have so many companies in the market, which are amongst the fastest growing companies,
09:02 but our team has not invested in them.
09:06 Some of them have turned out to be not so prudent to not invest, because even despite
09:14 their valuations, they continue to sustain and grow higher.
09:19 But valuation is of crucial importance, whether you're looking at companies which are in their
09:26 hyper growth phase or high growth phase or moderate growth phase.
09:30 What I would say is our team looks for opportunities in those segments of the market.
09:37 Because remember, there are hundreds, I mean, 500 to 700 names in the market.
09:42 So not all come and assume for a minute, half of them are above average growth and half
09:48 of them are below average growth.
09:50 So there would still be 250 to 350 companies, call it 300 companies which are above average.
09:58 So it's highly, highly unlikely, I haven't seen a market environment where all these
10:01 names would be relatively overvalued.
10:05 So we look for opportunities first and foremost, where there is a strong business model, where
10:11 we expect the company, growth in and of itself is of no use unless it's accompanied by superior
10:16 returns on incremental capital.
10:18 In fact, a company that is growing very rapidly, but not generating and not expected to generate
10:24 cost of capital is going to lose you money at an accelerated pace.
10:28 A lot of wireless and telecom companies did that at the turn of the century globally and
10:33 in India afterwards.
10:35 So first and foremost, superior returns on incremental capital, and then companies that
10:40 are growing faster with superior returns on incremental capital, growing faster because
10:46 they're gaining market share on the back of strong management execution.
10:54 And when such companies are available with good governance, adequate governance, all
11:01 these are the attributes that we look for.
11:03 And then finally, or alongside, I shouldn't say that in terms of sequencing, but alongside,
11:10 we also look for something that's attractively valued.
11:12 Otherwise, it would just be a great business and for which we can, you know, stay on the
11:18 sidelines till we get the right opportunity.
11:21 So are you getting opportunities that satisfy most, if not all of the reasons currently
11:26 at these current valuations?
11:28 Yeah, definitely.
11:29 So obviously, we have a live portfolio and new inflows we are investing.
11:36 So there are companies that we find in current environment as well, which relatively rest
11:40 of the market are on these parameters that I just talked about, the team finds to be
11:44 very attractively poised to deliver alpha.
11:50 So before I probe that answer a bit, just one more question around this, Prashant.
11:54 One way in which I have heard enough people now segregate, where is it that they're looking
11:59 for opportunities is talking about companies which are domestic focused, and which will
12:05 gain out of the growth in India over the course of the next three, four years, because the
12:10 globe may be a shaky place.
12:12 And then there's a set of people who are looking at global opportunities because they are playing
12:15 the slightly longer game and saying that valuations in a bunch of these pockets are quote unquote
12:20 bombed out.
12:22 And they are factoring in the worst and the worst may not come.
12:26 Just trying to understand, are you looking at both?
12:30 Or are you favouring one over the other?
12:33 How is it?
12:34 No, very much looking at both and pretty much at all times.
12:38 I can't recollect a time in the past when the team is not looking at opportunities in
12:44 both these segments.
12:45 Because if you look over time, over long periods of time through the cycles, both these segments
12:53 have created tremendous wealth for investors.
12:56 If I just give you two examples, banking, which is as domestic as can get, that's created
13:02 we all know, tremendous wealth.
13:05 And let's look at IT services, cash machines that have created tremendous amount of wealth
13:10 over the years, over decades.
13:13 So now the second question could be that can you from time to time, enter and exit one
13:22 or the other depending on where you see faster growth in the near to medium term or whatever
13:31 extent period of time.
13:33 That element we believe is inherently unpredictable.
13:37 That is the macro that is inherently unpredictable, beyond what is already priced in the market.
13:43 So as an example, right now, it is already evident in the market to market participants
13:50 that demand globally for IT services is a bit of a struggle.
13:57 Demand environment has slowed down compared to a couple of years ago.
14:01 Demand environment domestically because of robust GDP growth is favorable to many of
14:08 the capital goods and domestic cyclical companies.
14:11 So these are well anticipated and well factored in our view in the market from an aggregate
14:17 perspective.
14:18 So there isn't like a lot of undiscovered value or performance to be gained by moving
14:28 from one segment to another from time to time.
14:32 Sometimes you can get lucky because even a point flip half the time would come in your
14:37 favor.
14:38 But it is about half the time that in market we believe by making such macro calls, you
14:45 can make money, the other half you lose.
14:46 So we generally tend to be invested and look for opportunities at all time in both segments
14:52 of this point.
14:54 There are multiple ways you can slice and dice the market.
14:57 This is one way, domestic focus versus a global oriented and we at all times in the portfolio
15:03 have good representation, balanced representation from both segments.
15:08 Where are you most constructive on Prashant, whether for the existing money or comfort
15:13 of putting in even new money to work?
15:16 So see we are most constructive and these are again structurally true.
15:21 Neeraj, you won't find us.
15:24 Now if there are structural changes in the market then there would be change in this
15:27 as well and that it happens because of technological changes and other changes in the society,
15:35 there can be structural changes.
15:36 But otherwise for a long period of time, we have found attractive opportunities in the
15:43 market.
15:44 These are some of the things that are representative of segments of the market that we find a lot
15:52 of opportunities, which is that governance, you can find a large number of companies,
15:59 large mid and small, entrepreneurially driven companies as against let's say primarily government
16:05 owned companies or so.
16:06 A lot of companies with good governance and you know segments.
16:17 So let me give you more examples, private sector financials are a segment of the market
16:22 where as long as I can remember, we've been able to find a lot many attractive investment
16:28 opportunities and these are not talking about just private sector banks, but private sector
16:33 and BFCs and private sector non-lending institutions.
16:36 There are obviously amongst non-lenders, there are insurers and capital market intermediaries
16:42 and so on.
16:44 And then we've always found opportunities and there are some very well-governed companies
16:49 in this segment growing not only well ahead of the industry, economic growth, but well
16:58 ahead of peer group on back of strong execution.
17:01 Similarly, IT services, the two sectors that we're talking about domestic and global oriented
17:08 in IT services also, there are companies which on the back of strong execution are able to
17:13 maintain a very wide margin compared to the industry average growth over a very sustained
17:19 period of time.
17:20 And IT services, most companies unless they are doing something non-kosher, if you will,
17:29 they tend to generate very strong cash flows and tend to have very superior returns on
17:35 incremental capital.
17:36 So these are segments where the team has routinely found and there are other segments as well
17:40 including consumption, both discretionary, consumer discretionary as well as consumer
17:45 staples, healthcare and allied sectors, we see chemicals, the team has been very successful
17:55 in finding opportunities that pass the hurdle from an investment approach perspective.
18:03 So Prashant, the past performances of some of your portfolios, chemical companies for
18:12 example have been exemplary.
18:14 The recent one month has shown number of global chemical companies sounding of the bugle of
18:23 low growth, no growth, de-growth as the case may be across segments and it's probably true
18:30 for both spec chem and commodity chemicals as well.
18:34 Is that exporting opportunity a bit of a no-go currency or even within there, there are pockets
18:42 of opportunity available?
18:44 Within there are pockets of opportunities, Neeraj.
18:48 And see, over time, if you look at the banking sector, just as something that everyone's
18:56 lot more familiar with, we had demonetization, we had COVID, we had global financial crisis,
19:04 we had other crisis in between that we both might not be able to remember.
19:08 Obviously, fair increasing rates, decreasing rates and all those are usual inflation rising,
19:13 inflation declining, RBI raising rates.
19:19 Can anyone really make more money than, let's say, identifying the right banks, say 20 years
19:31 ago and staying invested or identifying new opportunities along the way?
19:37 I'm not saying that if they go to any valuation, you stay invested, but would anyone have made
19:41 a lot of money by getting in and out of banks at each of these crisis times or in each of
19:48 these macro inflection points?
19:52 I don't think so.
19:53 A lot of people probably have lost a lot of money by exiting right after global financial
19:57 crisis or exiting after COVID struck because all these banks, when any crisis happens,
20:04 the banks seem to be the first one going under the bus because their leverage, one is to
20:08 eight, one is to 10.
20:10 So moratoriums, when the regulator announced moratoriums, there was a lot of concern.
20:16 So when, you know, in those environments, it would seem very prescient to get out of
20:22 these names or unload these names from the portfolio.
20:25 But then in hindsight, they're all the very wrong time periods and the wrong reason to
20:30 exit.
20:31 Similarly, in IT services also, there have been a number of times, including GFC and
20:35 COVID and all when initially you remember COVID, when it hit, IT services business was
20:41 expected to collapse because all the demand from globally would stop and then they turned
20:47 out to be big beneficiaries.
20:49 So it is not possible to predict these macro factors to any greater degree than what the
21:01 stock prices are already factoring in at the time.
21:04 So the money we seek to make is through identifying companies in these industries, let's say chemical
21:11 which have a certain right to win either due to strong technology, strong process know-how,
21:20 strong chemical or chemistry skills.
21:23 And they would weather the ups and downs like others do as well, but do a lot better than
21:28 others and over time end up gaining market share in a very profitable manner.
21:33 The other thing is, Prashant, a lot of newer opportunities or maybe opportunities or companies
21:41 or businesses that are always existing, but have found a new lease of life, maybe due
21:46 to the government focus or otherwise.
21:48 So, you know, the whole defence railway pack which has come or when you because you run
21:54 global portfolios, and you might be looking at what's happening in other emerging markets,
21:58 whether it's due to the per capita moving per capita per GDP moving up or GDP itself
22:02 moving up in India, then opportunities of a similar nature back home in India, which
22:07 might do well because it's happened in the world.
22:09 And it's a replica.
22:10 How are you thinking about these would love to understand what goes in your mind when
22:15 you think about such things?
22:16 These are very important ones.
22:19 And these are macro of a different kind, which are important from stock selection perspective
22:24 as well.
22:25 And with the advent of internet, you know, some 25 years ago, it has completely changed
22:33 the way we live.
22:34 A lot of opportunities to a lot of sectors, new sectors that were born, existing sectors
22:40 which benefited and other sectors that got demolished, like, you know, some of the media
22:45 sectors that we all very well know in print and on.
22:49 So those are things that we have to as a team continually stay on top of technological threats,
22:56 technological obsolescence, which provide opportunities as well as risks.
23:03 Those are things that we may not have all the answers at any point in time, as many
23:07 times nobody has the answer.
23:08 For example, generating AI, there's a lot of debate.
23:15 Everyone agrees that it's a very big thing.
23:18 We have compared it to as big as the internet.
23:21 What is at this time, not clear.
23:24 So when internet came, it was supposed to demolish a lot of various industries.
23:30 It did demolish a few, but others that it was expected to destroy, actually ended up
23:34 leveraging it and benefiting a lot.
23:37 Just two, three years ago, if you remember, BNPL, Buy Now, Pay Later, was supposed to
23:42 be a big threat to traditional financial companies, both banks as well as non-banks.
23:47 Today, hardly anyone mentions BNPL and to the extent it is played out, probably the
23:53 existing companies have benefited from it.
23:56 Maybe not under the same acronym, they may call it differently.
24:00 So there would be opportunities from generating AI.
24:03 It is not clear to us right now how much of a threat, how much of an opportunity it is.
24:09 We continuously as a team try to stay on top of the developments.
24:14 To some companies, we believe it would end up being a big opportunity, which are well
24:18 prepared for this and have the necessary skill sets or develop the skill sets in a timely
24:24 manner.
24:25 To others who are slow movers can be left behind.
24:29 So again, execution capability becomes of primary importance.
24:32 Similarly, the other big change that's been going on for longer than generating AI is
24:37 this whole energy transformation.
24:39 It's going to many countries, it's accelerated.
24:44 It has been accelerating and post-COVID it's accelerated further.
24:47 In Norway, I was reading in Norway, 80% of new vehicles sold are electric vehicles and
24:54 other countries are riding the same curve.
25:01 And it has implications for very large segments of the fossil fuel chain and overall society.
25:11 So those things also the team continues to evaluate, not necessarily that at present
25:16 time you may have opportunities in India that are listed and appropriately valued to benefit
25:25 from these, the most direct opportunities, but there are second or third effects, positive
25:31 and negative.
25:32 So you can make money by avoiding those that are impacted by negative effects.
25:37 So that's what the team is on top of, but these are certainly risks, you can call them
25:42 macro risks.
25:44 I would say these are macro risks of the kind of technological obsolescence or technological
25:50 opportunities that every now and then present a lot of opportunities as well as pose risks
25:59 to existing players.
26:01 So that's my final question.
26:02 So the construct is wonderfully laid out.
26:04 Where does your team find there to be opportunities, Prashant, in any of these newer landscapes,
26:11 which you may have already invested in because some of these might be private in nature,
26:15 but defence, PLI, whatever, a bunch of opportunities are public in nature as well.
26:21 So where is it that you find favour?
26:23 Yes, absolutely.
26:24 So one of the things that so I talked about only technological phenomena, but one of the
26:28 things that is evolving, has been evolving and gaining momentum is the whole diversification
26:34 away from China.
26:36 It's imperative for global corporations of what's their need.
26:42 The board members are asking management, the investors are asking management, what is your
26:48 risk mitigation strategy if China were to face, you know, disruptions that we saw during
26:57 COVID or let's say Russia-Ukraine war, cause disruption.
27:00 So there are those opportunities already right now that the team has in the portfolio and
27:08 has had for some time.
27:11 They are in manufacturing sector and defence is not directly related to China plus one.
27:18 But yes, it is also several of the defence names also that the team has identified are,
27:27 you know, beneficiaries of the indigenisation of defence equipment that's been underway
27:32 over the last two, three years.
27:33 So these two, if I were to say somewhat distinct, the China plus one, which also has helped
27:39 PLI is one of the elements that is helping it, but there's a major overarching force,
27:45 if you will, tie that is helping that and PLI is one aspect that is helping and on defence
27:52 in particular, it is the indigenisation effort that is helping.
27:56 And there are opportunities in both which the team and more opportunities that the team
28:01 looks for and already identified opportunities that we've invested in.
28:04 Got it.
28:05 My final question, Prashant, on this, what are the risks to be in the current form?
28:12 I mean, there are always risks and some standard risks would be there, but what are the risks
28:15 to having a good run over the course of the next 12 months, maybe market wide risks, or
28:24 maybe something that portfolio managers will need to carefully weigh?
28:29 So then see one of the risks in the India context is, you know, central elections are
28:33 less than 12 months from now.
28:36 The market is expecting a certain outcome.
28:39 Like every election, the market expects a certain outcome.
28:42 The market is more comfortable with that outcome, which it is expecting, which is, you know,
28:50 maintains continuity.
28:53 We have seen in the past that sometimes these can spring surprises.
29:00 While right now, that does seem a very low probability event, but it is a high, a low
29:08 probability, very low probability, I would agree, very low probability, but a high consequences
29:12 event.
29:14 So that is one of the risks that is more India specific that one has to look out for.
29:20 Obviously, there are those other risks like El Nino and inflation and GDP growth slowing
29:26 down and all those which are of the very well known and well discussed variety.
29:30 Obviously, I'm not saying elections are not well discussed, but I think as we move closer
29:36 to the event, this would start occupying more of the investor mindshare.
29:44 This risk would start occupying it because there are certain state elections along the
29:47 way as well, those outcomes would have a bearing on what market expectations are for the central
29:52 election.
29:53 So that's something to be mindful of.
29:56 Got it.
29:57 Okay.
29:58 Prashant, this was lovely.
29:59 Thank you for giving us an overarching view and some nitty gritties as well.
30:03 Much appreciate your time.
30:05 And thanks for joining in on yet another episode of Alpha Muggles.
30:08 Thank you much, Neeraj.
30:09 Always a pleasure to be with you.
30:10 The pleasure is ours.
30:12 And viewers, thanks for tuning in.
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