Look for margin of safety in price

Vinay Paharia, chief investment officer at Union Asset Management Company, is responsible for overseeing the entire investment function. He has around 15 years experience in fund management.

In his earlier role, he worked with Invesco Asset Management as fund manager–equity. He has also worked as an equity research analyst at DBS Cholamandalam AMC, KR Choksey Shares & Securities and First Global Stockbroking. Vinay has done his MMS in finance and is a certified financial analyst.

Investment strategy

Paharia’s investment strategy is divided into stock selection and portfolio construction. In selecting stocks, He strongly believes in fundamental analysis and the core premise is that stock prices track intrinsic values over time. Hence, the focus is on the margin of safety in purchase price and (b) the growth in intrinsic value. “When we are constructing a portfolio from such selected stocks, we believe in strict adherence to portfolio objectives, in both letter and spirit,” says Vinay.

The stock selection process at Union AMC--which has assets under management of Rs. 4,163 crore as of April with Rs.1,723 in equity-oriented schemes--starts with a universe of stocks that have a market capitalisation of more than a defined threshold. After which several filters are applied, such as the Business, Management and Valuation to arrive at the ‘fund house equity universe’. Fund managers can only buy stocks for the portfolio from this universe.

In the business filter, Paharia and his team looks for companies (a) that can generate a sustainable return on invested capital greater than their cost of capital and (b) have a reasonable and sustainable growth outlook. In the Management filter, objective factors like capital allocation track record and business plan execution track record are seen and subjective factors like integrity, transparency, communication are also studied.

In the Valuation filter, companies are valued based on their cash flows. In addition, the peer relative values and risk-reward payoff matrix are seen to judge a stock’s attractiveness.

Once a stock is included in the fund house equity universe, it is segmented into either of the two segments—Growth Stock or Bargain Stock. “In Growth stocks, intrinsic value grows faster than our country’s nominal gross domestic product (GDP), but they may be available at a price higher than current intrinsic value. Bargain stocks, on the other hand, are available at a significant discount to current intrinsic value, though the intrinsic value may be growing at a slower pace than our country’s nominal GDP,” says Paharia.

“Such selected stocks are then chosen by respective fund managers to construct a portfolio. In doing this, they are guided by ‘portfolio construction guidelines’, which in turn depends on five factors. These are stock selection (Growth stocks or Bargain stocks), sector allocation (restriction or freedom on sector allocation), Capitalisation (large, mid or small cap allocation), asset allocation (equity, fixed income, gold) and concentration (focused or diversified). The portfolio so constructed should then be true to the mandate.”