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Working the Math Right

I would be underweight on sectors which are a little interest rate sensitive

R Rajagopal is a connoisseur of Carnatic music and if not a fund manager, would have been a research scientist. A science graduate, he pursued his MBA from Nagpur University. Starting his career with Stock Holding Corporation of India in 1993, Rajagopal had a short stint with Kotak Securities. Subsequently he joined IDBI Asset Management Company in October 1995 as an equity fund manager. After IDBI Asset Management sold its stake to Principal Mutual, he moved to IDBI Capital Markets. Rajgopal joined DBS Chola Asset Management as head of equity in December 2006 where he manages eight equity schemes

How did you land up in investments management, after doing your graduation in science?
I did have interest in stock markets even during my college days despite the fact that there was not much of an equity cult in a small city like Nagpur. So after completing my masters, I took the opportunity and got initiated into capital markets. I would say that my career has evolved along with the Indian capital markets. Stock Holding Corporation was basically handling the post-trading activities, and when I joined them, Indian markets had not yet moved to the dematerialized format. So I got the opportunity to handle a lot of instruments and understand them better. Moreover, I also had the opportunity to manage the debt schemes for nearly two years at IDBI Mutual Fund. So my experience of working with all these institutions has helped me develop a holistic approach towards investments.

Do markets look scary today?
I have been hooked to the Indian equity markets for the last 14 years. But I don't think I have ever got scared of the markets. Otherwise, I would have been far from them. What's important to understand is that volatility will be here to stay for a long time. And there are certain aspects that contribute to that. On one hand, you have foreign institutional investors. On the other, you have futures and options segment which has picked up very well, with more than twice the volumes recorded in the cash markets. And then, you have the retail investor. When these three come together, there is a view differential. Many a times, its sentiments versus fundamentals. Because of this, you will see a lot of volatility and turbulence in the market.

As a fundamental analyst I believe that the India story is there to stay. We are at an inflexion point where we have seen Indian GDP grow at 6 per cent for the last couple of decades. From that we are entering into a decadal GDP growth rate of 8 per cent plus. This augers well. Moreover, with the economy moving towards full capital account convertibility step-by-step, the capital markets should only gather more strength. But volatility would remain. If you see from the retail investors' perspective, time and again volatility has caused them to be out of the markets. In the process, they have lost out on the gains that the markets ultimately had to offer. Therefore, if people are getting scared of it, they need to employ tools to mitigate volatility rather than not being in the markets. They can participate through a mutual fund.

Through these 14 years, you would have seen so many ups and downs and even some of the good companies perish. Does that scare you?
I will give you a different perspective. If you look at the major indices, the amount of changes that they themselves have undergone would reflect what you have said. The companies which were part of the Sensex many years back are no longer are a part of it. That itself shows that many of the top companies of the past no longer enjoy that position today.

What has brought these changes are the fundamental aspects- the obsolescence of certain kind of industries, some technological changes and the new sunrise industries that have emerged in the last couple of years. This is the market reality today.

Suppose the markets tanks, do you have defensive strategies in place that you can immediately deploy?
I bring in a lot of statistical parameters into my fund management. DBS has also contributed a lot on risk management techniques.

We look at parameters like beta, the standard deviation, the R-squared and a couple of other statistical tools which helps us to analyse our portfolios in a risk-return matrix. We believe that we need to bring more objectivity using these numbers. To give an example, one needs to look at the returns in two different phases-a bear phase and a bull phase. The standard deviation of returns of any portfolio should be higher in a bull phase and lower in a bear phase. Only then will there be an objective out-performance in both types of scenarios. How do you go about doing it? One way is to manage the beta of your overall portfolio. When you are at a lower end of the curve, you try to build a portfolio of high beta, or high PE multiple stocks, which will give you higher returns in the bull phase. Moreover, instead of trying to time the market, we need to employ risk management strategies. SEBI now allows us to use derivatives which can be used for hedging strategies.

So at this point of time what would be your strategy, would you still be in high beta stocks? What stance would you take today?
One needs to have a moderate view and have a mix of both. This is precisely what all our portfolios reflect.

Benchmark also plays a very important role in managing a portfolio. You need to take a view on the sectors vis-à-vis the benchmark. By that I mean that you need to be underweight, overweight or neutral in sectors that you feel would probably do not so well, very well, or just normal going forward. I would employ these relative measures to construct a portfolio rather than omit a sector totally just because the PE multiples are high.

Mutual funds these days generally do not seem to be closely aligned with their benchmarks. Do you actually construct your portfolios and allocate assets to different sectors based upon their weights in the benchmark?
Well, this is a time-proven international practice. Construction of any portfolio is typically vis-à-vis the benchmark. The fund manager takes either an overweight, underweight or a neutral position on a sector. We, at DBS Chola, employ both top-down and bottom-up approaches. Top-down typically helps you take a relative perspective vis-à-vis the benchmark. It is also relevant from the risk perspective. If you construct a portfolio whose correlation with the benchmark is not very high, then statistically speaking, you are taking higher risk than the stated benchmark. Yes, you can do that but in the process you should be able to deliver superior returns .

Do you believe in using cash as a defensive strategy?
I don't personally believe in holding cash as a defensive strategy because once you do that, you are trying to time the market. As fund managers, we are long-term investors and we have a long-term perspective. And in the long-term, the cash component will actually not matter. I believe that opportunities exist in the market place at all points in time. There are always under-valued stocks available to construct a portfolio.

Also, if you look at the stated objectives of most of the diversified equity schemes today, they anyways cannot go more than 20-25 per cent into cash. Rather than cash, its better to use hedging techniques to manage the volatility in the portfolio. And that's what we are trying to do through derivatives.

Which are the sectors which you are very bullish upon right now, and the ones which you would like to avoid completely?
The sectors in which I would like to be underweight will be the ones which are a little interest rate sensitive. I would never like to avoid a sector in totality because bottom-up approach will still give you certain opportunities in that sector. To take the example of IT sector, the concern is the appreciating rupee. But not all IT companies are susceptible equally to the appreciating rupee. There are companies whose businesses are geographically quite widely spread, and hence have inflows in multiple currencies. They are little less susceptible to one component of the rupee appreciation. Similarly in other sectors, there will be a couple of stocks which will follow a different business model and will not directly get affected by all factors that would affect that particular sector. So broadly speaking, the sectors where one can remain under-weight to neutral are the automobiles, banking to an extent, and IT because of the rupee appreciation. One has to closely watch the interest rates in the economy to reverse the stand as well.

And the sectors where one can remain over-weight are capital goods, hotels, tourism- both domestic and international. Also a couple of commodities, because they are more dependent upon the global commodity cycle rather than the domestic interest rates. Therefore, both ferrous and non-ferrous metals are looking attractive.

Tell us about your investment style. How do you select your stocks?
We have a universe of stocks for each scheme. We employ both top-down and bottom-up approach. The team of investment analysts will evaluate stocks on the basis of certain parameters and ratios. For example, for sectors like telecom and FMCG, the top-line growth will be a very important parameter whereas for IT companies, EBITDA margins are important. Banking has to be looked at a little differently. Even though we have a neutral view on it because of interest rate sensitivity, but in the overall perspective of the 8 per cent growth of the economy, banking will have a role to play. Talking about valuations in that space, you have to differentiate between public sector and private sector banks. Private sector banks have enjoyed higher valuations, the reason being the difference in the kind of revenue stream that they have. Increasingly, fee-based activities are playing a major role. So the banks which have such higher fee-based income will not be so susceptible to the increase in interest rates.

You are managing nine funds- eight equity funds and one MIP. Isn't it a challenge looking after so many funds with diverse objectives?
It is definitely a challenge in the sense that all of them are different funds. I see to it that the stock picking is not the same across all schemes unless it fits into the investment criteria of the respective fund. You would also find that they are benchmarked to different indices and hence the sector weightages are also managed differently for each one of them. However, we are in the process of expanding our team.

Isn't there a clutter among your schemes? An investor can get confused as to which scheme to select.
Well, as far as the mutual fund industry is concerned there is a lot of clutter among the schemes. But as far as our stable of products is concerned, we offer very distinct products which are clearly segmented. To run you through, we have the Growth Fund, which is a large-cap fund, we have a Mid-cap Fund, we have a Multi-Cap Fund which has no capitalization bias. Then we have an Opportunities Fund which is positioned as a high-risk high-return concentrated fund focusing on few sectors of the economy. Apart from that, we have a contra fund where we put all the contra themes to play out and during certain kinds of market conditions it has actually delivered much superior returns than the other products.

The recent addition to our stable is the DBS Chola Hedged Equity, which tries to handle market volatility. So I don't think any cannibalisation is happening in our stable. Even the future products like a small-cap fund, an infrastructure fund and a capital protection fund, all of them are not existent in our current product range.

What has been your worst call on the hindsight?
What I have learnt in the last 14 years is that one should not get carried away by the news that suddenly starts doing the rounds about a particular sector. At the end of the day, fundamentals do override the sentiments. For example, in December, we were very over-weight on cement. The cement companies were operating at 100 per cent capacity, third quarter results were very good and fourth quarter results were expected to be good.

Things looked good. What we didn't consider was any government measures that could negatively affect the sector. So the decision of being too overweight actually eroded a lot of returns for a lot of us in the process. In January, I had to reverse my sector view and mellow down a bit. So what it teaches me going forward is that some sectors may have an inherent advantage because of which they might be doing well currently, but we need to have a balance.

Since you joined in December 2006, there has been a distinct shift in majority of the portfolios towards large-caps. What are the reasons and will this be a norm going forward?
Yes, your observation is quite right. What I observed was that the mid-caps were not performing too well and that we were taking excessive risk by not being closer to the benchmark. So I had to align my risk-return matrix and be in line with the stated investment objectives. Since our Growth Fund is a large-cap fund, it had to have large-caps in it. For the Contra Fund, I wanted it to be in line with what its name suggested. So in December, I increased exposure to oil and gas. So the portfolio changes have been done keeping in mind the objectives of the schemes.

This interview appeared in July 2007 Issue of Mutual Fund Insight.