At one time, when we had to mention the best performing funds, your funds were top-of-the mind recall. Now, others have taken that spot. Any comment?
In the past two years, some of our funds have not done as well when compared to their peer groups. The reasons differ for each of the funds and it is due to a combination of factors. One could be that our style of investing has not worked well in the past few years for some of our funds. On the risk spectrum, we are more conservative. Take the case of Unitech. Others were giving a lot of value to the land bank. We too knew the story but we held back. Our portfolio managers and analysts wanted to be very sure of the legal rights and other issues. Others might have been willing to take a risk and jump in but we wanted to be very sure and not go by just hearsay.
So we missed the opportunity because our process was more conservative. And in a bull market, you tend to miss more such opportunities than in a steady market. But our focus is delivering superior risk-adjusted returns over the medium- to long-term. We would like our performance to be better. But we need to work on things in a right manner rather than a knee-jerk reaction. We will maintain our style and integrity but will improve on execution and we are doing several things on that front.
We have to look at whether there are any structural issues with the team. We do believe that there is room to improve our performance by increasing the depth of the team. What I am trying to do as CIO is to improve the bandwidth of the team further. We have 10 in our investment team, not including the traders. If you depend on one person contributing to the entire alpha of the fund, then you have a problem because he will have good and bad patches. The analysts, portfolio manager, everyone should bring in some alpha and the process should be supportive of that. The success of an investment team depends a lot on the collaboration and the team efforts.
Seniority is no longer measured in terms of whether or not you become a portfolio manager on even a CIO but on your ability to create alpha. We have put processes in place to measure the alpha of each member. Since all our compensation is based on the amount of alpha created, an analyst can get paid even more than a portfolio manager. When the market gets bigger, there must be delegation. We need the diverse bandwidth and the ability to pick stocks. Earlier I used to visit every company. Now that is not possible. Our analysts must be of a certain level so that they can add value and do not have to make a second guess on every call. If I spent the same time picking stocks I might have contributed more alpha but I have to make sure we are gearing up for a bigger market and the future. So it might have a short-term negative impact but we need to look at these aspects.
In the case of the Prima - some of the top holdings had a very good run in 2003-04, like Goodlass Nerolac and MICO. We did not exit because the long-term story looked good. We did not take any exposure to the real estate sector as we could not understand the business model of the some of the companies. Many do not even furnish proof of ownership of property for which investors attribute value. Also, we were uncomfortable getting into some of the cyclicals like sugar. A combination of these factors contributed to underperformance. It was not what we had in the portfolio but what we did not. We missed out on some of the smaller engineering companies. As I said earlier, we had no meaningful exposure to real estate during the boom time. Even now, it is not much. We avoided trading in the sugar sector. From a long-term perspective, there were no meaningful opportunities but in these sectors in the short term there were trading opportunities. In the last one year, some of the big holdings lost steam. Maybe some reduction in weightage would have helped. But hindsight is always 20:20. But of course, there are reasons within our control where we could have done better. The last year has not been the best. But we have seen such cycles over the last 12 years and believe in sticking to fundamentals.
What are you betting on this year?
In the large-cap portfolios like Bluechip and Prima Plus, we had the usual bets on Bharti and Infosys but also had some off-beat bets like Kotak Bank. In the mid-cap area, we took bets in media on TV18 and NDTV and India Infoline.
What is your view on real estate?
There are two issues here. The first is how much real estate prices will fall. The second is how much the share prices of the companies will fall because the valuations themselves are faulty.
There definitely is room for real estate prices to collapse but going by historical market trends, it will be a slow death not a sudden, drastic collapse. Prices have peaked and they will slowly decline before they resurrect after a full cycle. In terms of companies, there are three areas of concern. One is the claimed land bank against the actual real estate holdings. The second is the ability to convert that land bank into real estate at the current market price within a reasonable time frame. The third is blowing up the value that is there currently in the company into something new - buying land back at high prices which they will not be able to sell.
I am a bit apprehensive about the sector. The entry barriers are very low. Anyone with a few crore can borrow money and get into the business and create problems for the current players. I don't see that changing currently. But there is some differentiation between the established players and the new ones and opportunities are going to increase. It could be mind boggling. Apart from growth in the domestic sector, international players will approach Indian airline companies over a period of time. For example, Lufthansa and British Airways are middle-men operating between the US and India. While an Indian airline company can directly fly from the US to India. Today we have aircraft capable of such long flights. A passenger cuts down the travel time and it is more convenient. So I do see a shift in volume from traffic to the Indian airline players and a growth in this volume thanks to rising affluent income levels.
We expect margins to compress over a period of time. You cannot have such margins in the long run. They will go down for the entire sector. But I believe the poorer companies will get hit first. Companies like Infosys will weather it for a longer time. But margins will fall. The best years in terms of growth in the infotech sector are behind us. In the next couple of years, volume growth can still be good. Infosys will no longer be the best growth story in the country.
Why does Templeton have so many funds?
We have got a comprehensive product range. Look at the entire stable of funds. We have funds for various categories - diversified equity, hybrid and sector funds. Our latest was the High Growth Companies Fund, which is pure growth. We also have an opportunities fund which takes aggressive bets. We are trying to build better synergy between the various funds. So stock picking can be more focused depending on the fund's strategy where a person can play a particular strategy and improve the synergy.
Does the Opportunities Fund not clash with the High Growth Fund?
Let me explain the rationale behind the High Growth Fund. If you look at our existing funds, the best performance has come from growth companies. There are other stocks too that have beaten the market but they have not been powerful enough to impact the long-term performance of the fund. But the fund yet has to maintain the balance because the volatility in growth stocks is high. So we could not make any product purely growth oriented because it would be a risky product and diverge from our blend style of investing. So we decided to come out with a multi-cap, growth fund that adopts a combination of top-down and bottom up approaches. The Opportunities Fund is an aggressively managed fund. The target stock could be a turn-around story, a takeover target, a potential M and A or a special situation. We can even take a very short-term view on the company. We needed something in the high-risk space which will deliver value over a period of time.
Tell us something about fund differentiation and strategy.
Our equity funds are positioned both on market cap and investment styles. I would say I am into blend investing with a growth bias.
The Templeton range of funds follow a value style of investing, while the Franklin equity funds adopt a blend style. Value investing is done by Mobius' group. Right now they have three people in India and they handle Templeton India Growth and Templeton India Equity Income.
This positioning provides investors with an insight into the fund's investment emphasis and, to some degree, the risks that it assumes.
What scares you in today's market? Valuations?
Yes and no. Take the case of Infosys. We invested in 1995 and the current price is 300 times the price it was at that point of time. At 20 times, people thought it was expensive. It could have been at 50 times, but if you really discount the current price, the PE multiple would have been in excess of 1,000 times. So you could have bought it at a 1,000 PE multiple and still made a 15 per cent compounded annual return on that stock. So your entry point into a company may not be very good. But if you buy the right company, you will make money at the end of the day.
Some of the bets we had taken have performed big time. We figured the market would move from traditional savings banking to financial products. We wanted to bet on someone strong on financial products - Kotak Mahindra Bank was the number one choice. The ones that followed were India Infoline and Geojit. We made money on all of them. Look at China, there are 5 lakh broking accounts being opened every day and this will definitely happen in India. These are growth businesses and if companies remain leaders or have a strong position in such a market, they will still create value even if you pay a higher price. So they may not look cheap but I will not exit if I see tremendous growth potential.
This interview appeared in August 2007 Issue of Wealth Insight.