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Investing in India - Honest Truth by Ajit Dayal
7 reasons why Quantum's equity fund has "high cash" A  A  A
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30 AUGUST 2014

The Economic Times carried a nice-sized and flattering article on the fact that Quantum Long Term Equity Fund "hoards cash as valuation sparks concern".

The article highlighted the unique value approach to investing adopted by the Quantum Long Term Equity Fund, including the risks of taking such an unusually large level of 32% cash (the average cash holding of most funds is 8%, according to the ET article) which could result in "under-performance" compared to the benchmark indices. The article also pointed out that, in the past, this cash level has helped The Fund outperform its peers - and the indices - as money was deployed at lower levels.

While the past performance is definitely no indicator of future performance, investors would do well to better understand the reasons why Quantum Long Term Equity Fund holds cash. I should point out that I am on the Board of Quantum Asset Management Company Private Limited and a member of the Investment Committee so am intimately familiar with the "research and investment process". Having said that, nothing written here is a state secret and many of these facts are known and discussed at public forums including the Path to Profit series of seminars that Quantum MF has been conducting since 2009.

On a high of expected expectations
Before we move on to the 7 Reasons Why QLTEF has high cash, let's look at a snapshot of the current "market environment".

Since February 2014 (around the time when Rahul Gandhi directed the already sinking Congress ship into temporary oblivion with his famous interview with Arnab Goswami), the stock markets had been expecting a Modi win. These raging sentiments were met, stride for stride, by rising earnings estimates (Table 1) written by research analysts who work for brokers and whose salaries and commissions thrive on rising markets. As stocks keep surging on "expected reforms", note how the cash levels of QLTEF keep rising. Obviously, the research team at QLTEF has a different view. Time will tell who was "right" and who was "wrong". But for now, the believers on the left column are facing off with the dis-believers on the right column!

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Table 1: The sell-side research raises estimated earnings, QLTEF sells and raises cash!
Reporting Period Earnings Estimate of S&P BSE Sensex for CY 2014 Earnings Estimate for CY 2015 S&P BSE Sensex Index Level % Change in S&P BSE Sensex in INR No of stocks in the portfolio, as stated in the fact sheets Level of Cash (after adding Net Receivables / deducting Payables)
14-Jan 1,345.7 1,576.3 20,513.9 -3.1% 27 15.7%
14-Feb 1,344.4 1,574.7 21,120.1 +3.0% 27 17.4%
14-Mar 1,571.2 1,817.90 22,386.3 +6.0% 27 17.2%
14-Apr 1,581.4 1,817.2 22,417.8 +0.1% 26 19.2%
14-May 1,576.0 1,831.4 24,217.3 +8.0% 23 32.3%
14-Jun 1,563.7 1,835.2 25,413.78 +4.9% 22 30.9%
14-Jul 1,553.4 1,860.2 25,894.97 +1.9% 20 32.3%
Source: Bloomberg, QLTEF fact sheets www.QuantumMF.com

The 7 Reasons
With that background, here are 7 reasons why the Quantum Long Term Equity Fund holds "high cash".

  1. QLTEF is a "value" investor"; they don't buy shares because buying shares is in fashion. A value investor assumes a certain macro-economic environment, contemplates how the management of various company will do in such an operating environment, and then estimates a "buy" price and a "sell" price for every stock that they research;

  2. They buy shares because they see "value"; when share prices reach "sell limits", they review their earnings estimates of the company, and - if there is no reason to "up" the estimates - they will sell shares, irrespective of what the "market thinks";

  3. When shares are sold outright or when positions are trimmed, cash levels rise

  4. This cash can either be deployed back in some existing stocks or in new stocks that may make it to the "buy limit";

  5. In a "bull market", chances are that it is difficult to deploy cash into new stocks or existing stocks that may be heading closer towards "sell limits" - things may look "expensive" for a "value buyer",

  6. As such, the rate of cash generation exceeds the rate of cash deployment (selling activity is more than buying activity),

  7. Therefore, levels of cash rise. It should be noted that "cash" does not mean that there are sacks of money lying under the mattresses of the Fund Managers - that is a domain of expertise best left to other elements of economic society! ☺; "cash" is actually "marketable instruments" that can be sold quickly and deployed back into stocks in case the opportunity arises.

As can be clearly seen from the above, cash is a residual of the investment process, it is not an objective. Neither Atul Kumar nor Nilesh Shetty - the fund management team of QLTEF - wake up every morning and say "the market is going up, let's sell and raise cash".
Nor do they say "the market is going down, let's buy".
Nope, they don't have the luxury of falling into such sentimental traps.

Think, don't feeeel...
"Think, don't feel" is a line from the cult movie, Enter the Dragon, starring Bruce Lee.
Sometimes feeling can be dangerous... and thinking does not always prove right!

Every action at QLTEF - good or bad - is guided by a deliberate research process that focuses on the long term and the resultant "buy" and "sell" limits which are based on:

  1. Long term macro views on the economy,
  2. Assumptions on how a sector will do in such an environment,
  3. Assumptions on how a company will do in such an environment,
  4. Assumptions on what a "value" investor should pay for that expected long term growth in earnings of a specific company. ,
  5. Assumptions on whether managements who run these businesses are fair to their minority shareholders,
  6. Assumptions on whether the founder shareholders are people of integrity or people whose driving skill set is gaming the system.

Clearly, all these assumptions can change. Hence, they are reviewed, pinched, and tested constantly.

Holding cash in a rising market will be a painful process in the near term if markets keep rising. Holding cash in a falling market may help (Table 2).

Table 2: What "cash" can mean in different market situations.
QLTEF portfolio Market Up by +10% Market down by -10%
70% in equity 70% invested portfolio may go up by +10% for a +7% return 70% invested portfolio may go down by -10% for a -7% loss
30% in "cash" No impact, no appreciation No impact, no depreciation
Overall portfolio Up +7% Down -7%
Conclusion "under-performed" "out-performed"
Note: Illustrative example, there is absolutely NO guarantee that the markets or the QLTEF portfolio may behave in the way illustrated in the table.
Before you make any investments, read all offering material in detail, be sensible, be cautious, and don't be taken for a ride by sweet-talking wealth advisors, intoxicated friends, or smooth-writing (or talking) fund managers on glib TV channels. And, yes, please do not make any judgment based
on this article! Figure out what you want/need and then evaluate carefully.

For now, the assumptions made by the teams at QLTEF don't seem to merit buying stocks.
How wrong - or right - they are will be known over time.
But their process is their process - not open to compromise.
Their stupidity or their genius will be there for all to see over the next few years.

And, come to think of it, that is why they get paid a management fee: to have a view.
And succeed - or fail - by their decisions and their views.
If they are wrong, they will need to find new careers: something which they are good at.
If they are right, they will be safe in their views and their jobs - till the next challenging environment that is thrown at them by the market.

No amount of net worth can make a fund manager - or an AMC - a good or bad AMC.
Or a "serious"AMC.
Ultimately, it is the stated research and investment process - and the outcome - by which a fund house will succeed. Or fail.
For now, QLTEF has made its views known.
The outcome will be known in some time: maybe in 1 month or maybe in 2 years.


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9 Responses to "7 reasons why Quantum's equity fund has "high cash""
Cleetus F
Sep 3, 2014
I do not want to comment on the strategy chosen because every strategy has its own merits and demerits. Under the current stock market scenario, it is safer to hold more cash. However, I have an important and interesting comment...if this fund is an open-ended funded, then this is the best time to invest in the fund bcoz they have 32% in cash at a time when the markets are ripe for a pretty good correction and hence, the cash would be used for better returns! Like (1)
hemal tanna
Sep 2, 2014
Ok, so QLTEF has now turned a balanced fund with flexibility to convert back to an equity fund when the time is right! It sure doesn't matter to me having made slow n steady gains in this mutual fund.

I just hope that the research team doesn't bite the bullet when the Nifty touches 10000 and invests the remaining cash! :)
Like (2)
rangnath
Sep 1, 2014
But isn't asset allocation the investor's job and the fund manager's job is to beat the index post costs? Do you believe adhering to high cash levels help your fund beat the market? Like (1)
Savio
Sep 1, 2014
Hi Ajit,

I am tempted to quote Warren Buffet to this interesting debate: We don't get paid for activity, just for being right.

I think most investors (especially retail) want to see their fund moving up incrementally every month. This is because most of them compare an equity investment with a bank FD. It hurts them no end if their fund is languishing or if it is not moving as fast as what their neighbor bought. They fail to realize that value investing is, as the gurus suggest, downright "boring."

It could be years before the real payoff comes. When it comes, it is BIG. The investors bravely holding their own at that point are handsomely rewarded.

For those wanting to know why your fund is 31% in debt, I suggest they go to valueresearch and check the P/E of the fund and the stocks you are holding. That will itself tell them if a value investing fund should be holding stocks at such high P/Es. So if you cannot totally exit a stock, all you can do to play safe is to trim your holdings.

For those reading, I have made good money with the Quantum Long Term Equity Fund already. So if you are willing to treat this as a marriage, hang on. If you are looking for the casual fling, look for other funds. But as relationships go, beware of the flings. You might get hurt. ;)

Best,
Savio
Like (1)
Ranjit
Sep 1, 2014
What Bruce Lee said is actually “Don't think. FEEL. It's like a finger pointing at the moon. Do not concentrate on the finger, or you will miss all of the heavenly glory.”
No arguments about thinking the way Quantum does, but it may also miss all the heavenly glory!! :-) which is still ok for a true value investor i guess!
But for a individual investor who invests in your funds, all that matters honestly is you should beat the index - that's what fund managers are paid for.
Like (1)
Yatin
Aug 31, 2014
Dear Ajit,
are you trying to say that your fund managers cannot seem to find any stocks worth buying in this rising market senario ? maybe they should take the help of Equitymaster !
Regards,
Yatin
Like (2)
G Darad
Aug 30, 2014
If you sincerely believe in, and do, what you profess, then it's really an admirable thinking and approach in todays' investment scenario full of hawks taking the gullible investors for a ride.The real culprit, however, is the conniving-rising upper-middle and upper class which is flush with a special colour of money(black!)which is not only sizzling but is also on the lookout for an opportunity to multiply itself overnight.How else can you explain the rise of mighty ponzi schemes in a country where potable water and power are still a luxury? While one half of the population looks at the stock market with greed, another half looks at it with disdain.The power of media mafia is also on the side of the first half. Who is then going to convince one and all that investment is a healthy art of wealth creation to be practised with patience and care and not a magic wand to be used on the bourses.Who is going to listen to you? Who cares? I have been trying to figure you out over the years and sometimes you appear to me like a holy cow which is yearning for life but can be sacrificed at will by the trading tribe.If the ignoble can mount an attack, why should the noble remain always on the defensive? Why not a pre-emptive strike for a nobler cause?Make yourself known. Like (12)
manish patel
Aug 30, 2014
then why not the same yardstick applied to quantum equity fund of funds where you had invested 97.70% as per july 2014 factsheet. Like (12)
bharat shah
Aug 30, 2014
thank you for the post.however i think , a little daring in holding good businesses in such time (i think, still not euphoric as December,2007 end) could do wonder to QLTE . I just happen to back testing of NI15 index equity shares between period 31122008 to now , and found appreciated to 400% without considering dividend.most of them are great businesses, i think. Like (1)
  
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