Investment Strategy
IDFC Imperial Equity is a diversified large-cap Indian equity fund, launched in February 2006. The fund adopts top-down investment approach and focuses on top-70 stocks by market capitalization.
The fund invests in companies, which could benefit from emerging trends within the economy, strong growth in demand and potential value unlocking, led by subsidiary listing. We believe though subsidiary listing was a popular phenomenon during 2006 when this fund was launched, it may not be able to cash on it now as not many companies would be interested to list their subsidiaries in the current market scenario.
The fund employs a top-down investment approach whereby the fund manager looks at industries, which can generate high incremental cash flows. Within the industry, the manager looks at companies, which could benefit from these cash flows.
The fund management team also conducts quarterly meetings with government ministry officials to understand policy initiatives. The quarterly meeting helps to identify companies that are likely to benefit from government policy.
While selecting stocks within the industry, the manager prefers to invest in companies where he believes that growth predictability is higher even if the stock price might be marginally higher. In line with its investment strategy, the energy sector accounted for the fund’s highest allocation as of March 2009.
Within the energy sector, the fund manager increased exposure to the oil and gas industry, which he believes can generate higher cash flows over the long term, driven by an increase in oil prices amid strong global demand.
The portfolio’s risk is controlled through position size and valuation discipline. For example, the fund does not invest more than 8% of its assets in a single stock. The fund follows the BSE 200 Index as its benchmark. The fund manager strives to add value by increasing exposure to high conviction stocks within the benchmark index.
Management Profile
Kenneth Andrade, with around 15 years of experience in the investment management field, manages the IDFC Imperial Equity since its inception in February 2006. Kenneth manages two equity funds, including IDFC Sterling Equity.
The manager is confident of the fund's investment strategy and possesses adequate knowledge of the portfolio positioning. The fund manager ramped up the fund’s allocation to cash between July 2008 and February. The fund manager admitted his mistake of maintaining higher cash allocation as the fund’s performance suffered in March when it missed strong equity rally. The fund manager is supported by three equity research analysts, each covering three sectors, comprising of 10 stocks in each sector.
Investment research ideas are generated at the analyst level and discussed with fund managers. Being a small investment research team, investment ideas are discussed through formal as well as informal channels. The sound ideas are discussed with the investment management committee including the chief executive officer.
Finally, the portfolio manager is responsible for buy and sells decisions for the fund. The fund also relies on external analysts’ for about a third of its research. The team evaluates the quality of outside research through internal cross referencing and due diligence.
Performance Analysis
The fund has delivered strong relative performance since its February 2006 inception through the end of March 2009. The fund ranked in the top decile of the Morningstar Large-Cap equity category over the past three calendar years. And its three-year trailing return through March 31, 2009 was better than 96% of its category peers. The fund was also rated five stars by Morningstar in March. The fund was rated at “High” in terms of return rating over the three-year period by Morningstar.
As for the absolute performance, the fund posted an 0.8% return during the three-year period, as an economic slowdown and financial markets turmoil impacted equities sharply in 2008. In comparison, the large-cap category posted a 6.1% loss over that time periord.
Thanks to its tactical cash positioning and selective large-cap bias, the fund outperformed its peers during tough times and dipped 25.5% during the one-year period as of March. In comparison, the large cap category posted a 37% loss. The fund benefited from higher cash positioning during 2008 and early 2009.
On the risk front, the fund performed well too. For the three-year period, the fund’s Morningstar risk rating was “Low.”
It’s heartening that the fund has gotten off to a good start; however, its track record is limited and it’s too short to provide much information about how it might perform over a full market cycle and in a variety of market conditions. This fund has shown that it can perform well in brutal bear markets, but we’d like to see how it fares when the market rallies.
Portfolio Analysis
The fund manager significantly increased the fund’s allocation to the energy sector to high double digit levels in 2008 and early 2009. Reliance Industries is a good example of value unlocking as the company might consider listing its retail business once market conditions rebound.
The company generates high incremental cash flows and therefore it is a top holding in the fund’s portfolio. Though an increase in crude oil and natural gas prices could benefit the fund, we believe, the fund is exposed to high risk in the event of a sharp decline in oil and gas prices. The fund manager has also moved in and out of the materials sector very frequently, owing to dynamic global market conditions and change in materials prices.
He reduced the fund’s exposure to the materials sector from high double digit levels in 2006 to low single digit levels in early 2007. The manager then increased exposure in mid 2007 and reduced it again early 2008. These frequent changes illustrate the manager’s high-turnover style.
The fund's exposure to the industrial sector was reduced in mid-2008 from high double digit levels, which the fund manager had maintained since the fund’s inception. The industrial sector benefited from the strong surge in domestic economic growth between 2004 and 2008 and that enabled these companies to generate higher cash flows.
However, expectations of slowing economic growth caused the fund manager to cut exposure to the sector in mid-2008. Within this sector, the fund cut exposure to the Larsen & Toubro, owing to fundamental concerns amid the economic slowdown.
As of the March 2009, the energy, materials and telecommunication sectors accounted for 58% of the fund’s assets. The manager runs a concentrated portfolio of just 18 holdings, compared to the typical large-cap fund which holds 35 stocks. That exposes the fund to more risks than more broadly diversified funds; however, the fund’s high cash stake has helped moderate volatility recently.
The fund’s assets size was Rs 1570 million at the end of the March. Because of the dynamic stock selection approach, the fund’s turnover ratio was higher at 150% for the one-year period as of March 2009.
The fund’s total expense ratio was at 2.43% as of March end, higher than the category average of 2.01%. We’d like this fund better if it were cheaper. Its high expense ratio can dampen the fund’s performance in the long-run and may put the fund at a disadvantage, compared to peers with lower costs.