Different Strokes | Value Research When we met up with Patwardhan, our first question pertained to the proposed smaller companies fund. Unfortunately, their compliance officer stopped us from reproducing the information saying that it still awaits SEBI clearance. So we proceed with the rest.
Interview

Different Strokes

When we met up with Patwardhan, our first question pertained to the proposed smaller companies fund. Unfortunately, their compliance officer stopped us from reproducing the information saying that it still awaits SEBI clearance. So we proceed with the rest.

14-Nov-2007

When we met up with Patwardhan, our first question pertained to the proposed smaller companies fund. Unfortunately, their compliance officer stopped us from reproducing the information saying that it still awaits SEBI clearance. So we proceed with the rest.

Your equity fund is not market cap specific, yet it has a large-cap tilt.
True. Although nothing stops us from moving into various market caps, our main concern is that the fund should be fairly liquid as we believe our portfolio composition to be sacrosanct. This liquidity is very relevant when market corrections take place. And we all know that when it happens, redemptions are inevitable. At such times, the fund manager is forced to sell to pay out the redemption proceeds. But often what a fund manager can sell is not necessarily what he wants to. We try to make sure that when we sell, the composition of our portfolio is not disturbed since at that time, liquidity tends to dry up in many of the mid and small cap stocks. This is what happened during the May-June period of 2006 when a number of funds were invested in small and mid caps. So, the composition of the portfolio going into the correction and emerging out of the correction can be materially different. Which is why we wanted to avoid a concentration in mid and small caps in this fund. The way we see it: why should the interests of an investor who wants to stick with us through the correction be compromised? We want to ensure that the portfolio composition of our fund is dictated by the fund manager and not the market. And that can only happen if the portfolio has adequate liquidity.

Do your funds have a liquidity measure?
Yes. To arrive at the liquidity measure of our portfolio, we look at the stocks we own and the trading volumes on BSE and NSE. The liquidity measure is calculated on the basis of the number of days it would take to exit from stocks in the JPMorgan India Equity Fund. We assume, typically, 30 to 40 per cent of the average daily traded volume for each stock on the NSE or BSE can be transacted without severely impacting the price.

On the basis of this assumption, we calculated how long it would take us to exit from a position in a stock without affecting the price. According to our last liquidity measure displayed in the August fact sheet, 60 per cent of our portfolio can be liquidated within a day and close to a further 30 per cent within one or two days.

Do you feel a portfolio should have an ideal number of stocks?
As per our August factsheet outlines, we had 50 stocks at the end of that month. We believe in a focused style of investing with minimal stocks. Sometimes, we could have 35 stocks, sometimes 50 or even more. But we have no ideal number.

Do you believe in holding cash as a defensive measure?
No. When an investor puts his money in our fund, he has done so after taking an asset allocation decision. We believe he has invested in our fund because he has decided to allocate that money to equities. And that is our responsibility. He has not invested in our fund for us to hold, say, 20 per cent in cash. If he wants to stay in cash, he is free to redeem his investment.

It is very difficult to take a call on the market or time the market. One cannot say that the market is going to tank next week or go up next week so my cash position must accordingly change. That is not even our business. Our job is to identify relevant businesses which have good growth prospects and are valued appropriately.

What sectors are you bullish and bearish on right now?
When looked at in the context of the benchmark, we are underweight on the auto industry. We are bullish on industrials and infrastructure capex, as a theme. We believe this will be a multi-year theme and is not just cyclical.

Financials seems to be a sector you are bullish on, yet ICICI Bank and SBI do not feature in your top holdings.
We have only disclosed our top 15 holdings. Obviously, those are the ones we find most attractive.

You seem to be middle-of-the-road where IT is concerned. What is your view on the sector?
If you look at the BSE-200 Index, then we are underweight on IT services. We believe that the appreciating rupee is not good news for the sector. Within this sector, however, the larger companies are more likely to be able to tackle the rupee appreciation effectively through levers such as shifting to fixed price contracts and increasing productivity. In the previous quarter, we saw a steep rupee appreciation but we believe that those were extreme circumstances. The RBI has indicated that it would like to smoothen the rupee's appreciation in the future.

Most IT stocks have severely underperformed over the last quarter. However, one should not forget what is driving the demand for these services and recognise that neither has the competitiveness of these companies diminished.

No aviation stocks in your portfolio. What is your take on that sector?
The sector went through a rough patch a few years ago. Competition shot up and fuel costs went through the roof. So the economics of the sector was adversely impacted. But it appears that things are changing on the competition side, not on the fuel side. We are watching to see how it pans out.

You don't have a company that has a real estate exposure, like Bombay Dyeing, and no real estate stocks. Why?
Real estate will be a big sector in India. We have seen how it has played out in other markets like China. A year ago, there were barely any listed stocks available. Now, we have a much wider choice. Despite it being a great opportunity, we were not comfortable with the disclosure level of real estate companies, which have now improved thanks to SEBI intervention. Neither were we comfortable with how valuations were done, especially where land bank holdings were concerned. But clarity is emerging on this front with more IPOs coming in.

Is your approach top-down?
We tend not to take too many sector related bets. Take the auto industry. It will have a few sub-sectors - four-wheelers, two-wheelers, commercial vehicles - and each of these will have very different economic characteristics. Or take the case of pharma which is such a diverse sector. We take a bottom-up approach but we are also aware of the macro fundamentals when we do so. Ultimately, we invest in stocks, not sectors.

If that is your approach, how closely do you adhere to your benchmark?
Not closely at all. That is why in our fact sheet we mention what we call "active positive bets". Let me explain this with an example. If stock A has a 5 per cent weightage in the index but we own 8 per cent of that stock in our portfolio, then we have a 3 per cent active positive bet on that stock. We are active fund managers. We don't try to mimic the benchmark.

The benchmark is used by us to evaluate our performance. But investors or distributors may even use the Sensex to make a comparison.

You say you are an active fund manager. Does that mean you churn your portfolio often?
This fund is just a few months old so we cannot talk of portfolio churn here. But let's look at our group's overseas funds since the basic underlying philosophy, strategy and style of the two sets remains the same. Over the past few years, our fund statistics show that we tend to hold on to a stock for an average of three years. We do not have any internal targets on portfolio churn. But we typically tend to be buy-and-hold investors.

Tell us something about the JPMorgan's style of investing.
Globally, we have three different equity styles of investing. The first is quant-oriented with algorithms which dictate the asset allocation. The second is a behavioural finance approach that is followed by some of our European funds. And the last one, a research-based, bottom-up approach, is what we follow in India.

How do you benefit from JP Morgan's global expertise?
We have three people in Hong Kong who run the India offshore fund. In India, there are four of us. Often, we do company meetings and conference calls together. There is a lot of idea sharing. The kind of regional perspective my colleagues have gives us insights which we leverage off when investing in India. We have a very strong China team. And since China is ahead of India in terms of the development of many sectors, the experience my colleagues have in dealing with companies there directly benefits us. For instance, we know how issues panned out in the Chinese cellular industry and some of those lessons can be directly applied to India.

We also have a formalised process of sharing ideas and information. So, every Monday we have what is called a PRG (Pacific Regional Group) call. On this call fund managers from all over Asia log in to discuss and debate ideas and share perspectives since JP Morgan manages $55 billion in Asia. The debate could centre around a global or country specific event.

We have a global emerging markets team that works out of London. If one of them meets the management of an Indian company abroad, the kind of perspective he/she can offer on that particular sector or company is invaluable. This information is shared on our internal portal for fund managers called JFirst.portal. This helps every fund manager in the group leverage off the discussions or insights that another member of the group had or gained.

Do you rely only on in-house research?
No. We also utilise the research of various brokerage houses. We are a team of four and we research around 175 to 200 stocks, the number of which is expanding. Last year, we managed around 600 exclusive company contacts; this year we expect this number to exceed 750 to 800.

Do you feel valuations are stretched?
There is no doubt that Indian GDP will grow by at least 8 per cent over the next three to five years. If inflation stays at around 5.5 to 6 per cent, nominal GDP growth will be in the region of 13-14 per cent. This provides a great macro environment and corporate India can grow at around 17 to 18 per cent. We believe that it is possible to identify companies and build a portfolio which should be able to deliver about 20 per cent growth over the next three to five years. We do not believe valuations are stretched at this level though they may not be as cheap as they used to. Ultimately, valuations are a function of growth and return on equity.

What is your view on the liquidity front?
On the liquidity front, we believe India to be very strongly positioned.

In our opinion, domestic demand for equities will grow. Household exposure to equity is very low since people invest mostly in gold, bank deposits and property. But, over the next few years, this will change dramatically. To take just one example, we expect insurance companies to have a huge exposure to equities.

Additionally, we do not see a fall in foreign inflows into equities over the next three to four years. In fact, such inflows could go up to $20-25 billion dollars per annum from the current level of $8-10 billion.

The final factor that causes us to be long-term bullish on India's prospects has to do with the change in global perceptions on its growth. Until recently, India used to be clubbed with other emerging markets. But now, investors abroad talk of China and India as a separate category compared with the rest of the emerging markets. The visibility and focus of India as an investment destination has changed. So international liquidity is likely to be tremendous going forward.

Having said that, despite the growth in foreign flows we genuinely believe that domestic liquidity will eclipse international flows. And despite the levels of the Index and investor fears of a correction, we believe that the long-term equity party has just begun.

This interview appeared in October 2007 Issue of Wealth Insight.



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