Why are Axis Mutual Fund’s Equity Schemes Over performing?

 Axis Mutual Funds

Axis Mutual Fund is one of India's top 10 Asset Management Companies. Established in 2009, it is a joint venture between India's 3rd largest private bank, Axis Bank and Schroder Singapore Holdings Private Limited (SSHPL). It is one of the fastest-growing mutual fund companies in India.

Highlights of Axis Mutual Funds

• The fund house has over Rs. 1.02 lakh crore in assets under management (as on July 31, 2019)
• The equity investment team is headed by Mr. Jinesh Gopani, who also manages its biggest fund - Axis Long Term Equity
• Has 29 funds across equity, debt, commodities, and hybrid categories

Why are Axis Mutual Fund’s Equity Schemes Overperforming?

We all love to see our investments do well. And one fund house that has been able to deliver outstanding returns consistently over the last few years is Axis Mutual Fund. But what is the secret sauce behind there in success?

In this blog, we will look at the reasons that make the equity schemes of Axis Mutual Fund one of the best-performing ones.

Axis Long Term Equity Fund: A Consistent Top Performer 

To understand the investment philosophy of Axis Mutual Fund, we will look at the workings of the Axis Long Term Equity Fund.

This fund manages over Rs. 22,000 crores of investor money and is not only the largest scheme for Axis Mutual Fund but is the largest fund in the ELSS or tax saving category. The Axis Long Term Equity Fund is a very successful fund. It has been around for more than 10 years and has delivered over 18% annual returns since its inception. Remarkably, the fund’s performance has been high and consistent. For this reason, it has been ranked within the top 3 performers in the ELSS category in 6 of the last 11 years.

To put that into perspective, if you had invested 10,000 rupees on 1st January 2010 in the Axis Long Term Equity Fund – your corpus at the end of October 2020 would have been 53,300 rupees. The next best performing fund over this entire period is the Invesco India Tax Plan, which would have delivered a lot lower returns with an accumulation of just 38,300 rupees. That’s a difference of 3.5% of returns every year for over 10 years.

Now, let’s look at the reasons behind this amazing performance.

Investment Strategy Behind Axis’ Overperformance

We have identified 5 extremely visible strategies that the Axis Mutual Fund team employs to deliver superior performance. Each of these 5 strategies supports the growth style of investing that Axis prefers to employ. 

Let’s dive into the first of the 5 strategies:

1. Avoid Regulated Companies

Most schemes of Axis Mutual Fund almost never have any public sector enterprises.

This might be on account of corporate governance issues with these companies their non-compliance with SEBI regulations, or the mere allocation or misallocation of shareholder capital towards more social projects rather than building shareholder value.

The flip side of this stance is that the Axis Long Term Equity Fund misses out on many commodity plays in the mining, oil, gas, metals, and refining sector as most companies in that space have heavy government shareholding. Nevertheless, this strategy has played out really well for the fund house over the last few years and stresses the importance of setting up boundaries within which you are most comfortable investing.

2. Go for Compounders

More often than not, if a business is growing in the right direction. The stock price complements that growth and responds positively. Now the question is: what growth are we referring to?

There are three primary growth metrics:

First is Growth in Revenue, which explains if the company is progressing and capturing greater market share. The second one is Growth in EBITDA or operating profits, which explains if the revenue or sales of the company are meaningful and are converting into earnings from operations the third growth metric is Growth in Earnings Per Share or EPS, which indicates if there is progress in the amount of profit that is being earned for every unit of ownership.

So, revenue, operating profit, and earnings per share are our growth metrics. In fact, there’s a loosely defined word called “compounders,” which is used to describe such types of companies that exhibit consistent and steady growth, which happens on account of high-quality operations, recurring revenue, and strong franchise.

3. Pay for Quality

There are 3 main quality metrics. Let’s look at how the Axis team is using them while selecting companies for the portfolio.

PE Ratio:

The Price Earning Ratio or the PE Ratio is one of the most commonly used valuation tools by everyday investors. Simply speaking, the PE Ratio explains how much you need to pay for 1 rupee of profit. This means, that the higher the PE ratio, the more expensive, or if you choose to look at it differently, the more valuable that business is to you. 

Net Profit Margin: In addition to the PE Ratio, another quality metric is the Net Profit Margin.

The average Indian company in the NIFTY 500 has a net profit margin of 7%-8%, but the Axis Long Term Equity portfolio companies average a net profit margin of around 15%. The net profit margin is a strong determinant of quality and a great proxy for formidable companies with a recognizable brand name, a quality product, and pricing power.

Free Cash Flow: The final quality metric, and perhaps the least discussed one, is the free cash flow generated by the business.
Free cash flow refers to the surplus cash generated by a business after paying off all operating and capital expenses. 
Let us explain the concept with a simple example. Suppose you own a furniture shop. So you bought some machines, employed some workers, got them the raw materials, and you are able to sell the finished products at a monthly profit of Rs. 10,000.
That’s a positive operating cash flow of Rs. 10,000 for your business. However, since wood cutting machines and tools tend to break or require frequent repairs, you end up paying Rs. 12,000 rupees a month to replace them. So technically, your capital expenditure is swallowing your entire cash from your operations, and you end up with a negative cash flow of Rs. 2,000 rupees. This is not a good business to be in because while you are making profits on paper but, you are losing real money.

So, when we compiled the free cash flow data for the companies Axis Long Term Equity Fund has invested in, it came as no surprise to find that the fund managers were heavily favoring businesses that have strong free cash flows.

4. Identity Shareholder Value Creators 

The shareholders of the company are the owners of that business, and it is the management team’s responsibility to make the best decisions on behalf of the shareholders.

Shareholder value can be looked at from two perspectives.

Quality of Management:
The quality of management includes understanding the governance practices, past record of the senior management team, executive compensation, stock options, and other policies drawn by the management from time to time.  This is not something that can be ignored as there have been many instances where executives or promoters have destroyed crores of shareholder wealth by making harmful decisions or indecisions which serve their needs more than that of the investors. The portfolio construct of the Axis Long Term Equity fund shows that they earmark a high weightage to the quality of the management team when choosing to invest in a business. 
Return on Equity (ROE) and Return on Capital Employed (ROCE): 
These are quantitative metrics around returns that explain the efficiency at which the business is generating returns for the shareholders. Return on Equity or ROE is the amount of profit generated for every one unit of shareholder’s money. So if the ROE is on the higher side, then the business generates a lot more cash internally, which is great from a valuation standpoint.

Return on Capital Employed or ROCE measures the efficiency with which a business uses its capital. The ROCE is measured using the EBITDA as a percentage of the total capital employed, which includes equity and debt.

5. Invest with Conviction

The final component is the importance of focused diversification.  Unlike many other funds in the ELSS category, the Axis Long Term Equity does not over-diversify by investing in 50 or 60 companies.  The fund averages just around 30 companies at any given time, which provides enough diversification and risk management. 

This also means that the fund management team has a lot more conviction in these businesses.

Bottom Line:

Axis Mutual Fund has been delivering consistent performance over the last few years. So this strategy is clearly working for them. But that is in no way a guarantee that this overperformance will continue in the future. So the key is to be aware of how the fund houses are investing and take an informed decision. 

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