Why Negen’s Neil Bahal swears by special situations strategy

Bahal, founder and CEO of Negen Capital, follows the ‘special situations’ style of investing, which was championed by legendary investor Warren Buffett and American academic and hedge fund manager Joel Greenblatt. Bahal shared his portfolio details, investment strategy and financial journey for the specialMintseries—Guru portfolio.Edited excerpts from an interview:

What brought you to the stock markets?

It was by chance, actually. I’m probably the first person in my family to get into the stock markets. When I was in school, I was watching a business channel one day, and I just got hooked. It was love at first sight. At the age of 15 years, I started investing and my first stock pick was Infosys in 2002. My father set up ademataccount for me. Initially, I was investing with very limited knowledge, and without any kind of guidance or mentorship. It was more like buying one share and then selling it.

Were you investing out of your own pocket money?

My father gave me a little money. My real investment journey started with the IPOs (initial public offers) of Yes Bank andPetronetLNG. These were my first two big wins. As a young kid, I ended up making decent money. Of course, the returns were on a very small base, but when you start making decent money in percentage terms, you get even more hooked.

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What was your initial investment strategy?

I was a very typical retail investor and there was no real strategy as such. It was whatever you like, you buy. For example, if there was something good for a particular sector in the union budget, I bought a stock. Since India has been a great story, whatever I bought went up. I stumbled upon winners, but largely due to luck.

 

Take us through your early professional life.

Right from my seventhgrade ,I was selling old stamps and posters. At that time,Sportstarmagazine used to carrycentrespread pictures of cricketers and other sportspersons. I would try to sell these posters to myclas​smatesfor ₹20-30. So, I never thought of doing any job. I wanted to be a full-time investor but that was not easy, because I needed money for that. So, I started my own business during the last year of my degree at SP Jain Institute of Management and Research, and Negen Capital was born as a sub-broker in 2007.

Did you burn your fingers in the market crash of 2008?

Well, 2008 was not very kind to anyone. I, too, saw my portfolio go down by a huge margin of around 70%. But one important lesson from that period was that even if my portfolio went down, the period after that was good for me, especially in 2014. The lesson was that as long as you own decent companies, and do systematic investing, you’re going to be fine because India is a very good story. The 2008 crash was a big event because it took away my fear completely.

How did your investing strategy evolve?

Around 2014-2015, I was introduced to a new way of investing, which is a kind of an extension to value investing, called special situations investing. That really changed the trajectory of my life.

Did serious investing start happen with this strategy?

Yes, that’s correct. My brother, who worked at a hedge fund in London, introduced me to the special situations strategy after he came across Joel Greenblatt and his story. Today, my brother manages his own alternative investment fund.

How does this strategy work?

So, special situation is basically an advanced way of doing value investing. In value investing, you buy a business at a discount, a strategy that Warren Buffett made famous. Then the internet came, and everybody started getting information about a business. So, your good businesses started trading at a very high valuation, and whichever business was available at a cheap price, it was largely because of a reason, which could be a corporate governance issue or an industry going through a bad period.

Special situation is a kind of corporate action, something like a delisting, demerger or a change in promoter altogether, which changes the DNA of a business completely. This gives an investor enough time to kind of figure out before the market does how the DNA change of the business is going to change the valuation of the business.

For example, the biggest special situation in the world is the US-based Berkshire Hathaway. Before Warren Buffett took over the company, it was a failing textile business and it was cheap.

When Buffett came and took over the business at $14 per share, it changed the DNA of the company. They got into chocolates, furniture and even insurance. The business changed direction completely and this is what you call the special situation where some event happens, which changes the DNA.

If you can become an expert in special situations, and do it consistently, you can create a huge amount of alpha. Both Buffett and Greenblatt focused on special situations. There’s no dearth of special situations in the market. In India, there could be 200-300 examples of such opportunities.

What would be the average holding period under this strategy?

In special situations, our target is not to compound money. The target is for the undervaluation to go away, and look for the re-rating. Once the re-rating happens, you’re better off finding the next special situation. In my opinion, two to three years is a good holding period under this strategy.

What is the quantum of assets you’re currently managing?

So, one fund is PMS, where our current assets under management is close to ₹450 crore, and then we have an AIF, which is approaching ₹100 crore in AUM.

Can you take us through the schemes that you offer?

We are very clear that in the PMS, for example, we don’t want to confuse our clients. So, we only have one scheme which is a special situations scheme. We also have an AIF where we invest in startups.

What is the current asset mix in your personal portfolio?

I’m fully invested in the capital markets -on the equity side and in startups. I have nothing in real estate, gold or debt. I have a house, but I don’t count that as an investment. My overall portfolio would be 70% in equity and 30% in startups.

Would you look to rejig this allocation?

I would not look to take my startup exposure to beyond 30% because equity and India are in a very special place. Equity offers you growth and liquidity. Startups also offer you good growth, but the liquidity is a little bit less. At the same time, I would not be averse to taking a little bit of risk if something good comes up.

Do you invest in international stocks?

A little bit, just to wet my feet, but nothing in a serious way. We don’t have the bandwidth for doing the research that you require to make money in the mid-caps and small-caps in the US. Of course, I can buy Google or Apple, but we won’t be creating alpha doing that.

How has your portfolio performed over the years?

In my PMS, the two-year CAGR (compounded annual growth rate) has been around 59%, while the three-year CAGR is 39%. On the equity front, my personal portfolio would be somewhere in the same region.

A strategy that worked for your portfolio and the one that didn’t.

The strategy that has worked for me is believing in India. The other thing that has worked for me is betting on special situations strategy.

On the other hand, trading has not worked well for me in the past, so I stopped trading altogether. I focus just on investing now.

What are the sectors that you are either bullish or negative on?

I’m bullish across the board. As late Rakesh Jhunjhunwala said, “it’s a buffet, eat whatever you want but don’t overeat". This has shaped my thinking that everything is an opportunity in India for all, from entrepreneurs to investors. I’m most bullish on quick service restaurants (QSR). I think this space will grow 20%, over the next many years. I am not bearish on any stocks or sectors as such.

Which stocks have contributed most to your portfolio?

There is Max Healthcare, where the demerger played very well for us. Also,GreenpanelIndustries and CG power did well for us. Earlier, YES bank did amazingly well for me in percentage terms, but it was on a very small base.

How many stocks do you hold in your portfolio?

We like to own between 20 and 25 stocks. We’ve done the math around this. Let’s say, you have a two-stock portfolio. Here you will have a 96% risk, where if something goes wrong with that one business, your portfolio can totally melt. Now, when you reach the number 16, your non-market risk reduces by 96%. Now, the diversification bit is done at 16 stocks. As per our math, 16 stocksisthe sweet number, but we typically own 20 stocks in the portfolio.

How many months of emergency fund do you provision for?

We have a small lump sum which is sufficient for five-six months. This emergency fund is kept as simple bank fixed deposits.

Do you involve your wife in your financial matters?

Yes, I do. I just keep on blabbering about any particular company or some opportunity that I like. She is qualified to be a fund manager herself. The best part is that she gives me a lot of advice, and I think having her perspective has really improved my thinking process.

What does wealth mean to you?

I’m perfectly happy with whatever we have. More wealth is not going to change me, as I still drive a 13-year-old car and I don’t have any fancy watch. So, wealth is a byproduct of what you are busy doing.

How do you identify yourself as an investor?

I would think that I’m a little bit too fearless. That may not be a good thing, but I’m just not bothered if the market would hit a lower circuit or not. I would say I’m an eternal India believer.

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