VR Logo

Growing Principle

With 18 years of experience in fund management, Rajat Jain is one of the most respected people in the industry. We talk to him about the fund he manages & his vision for his fund house...

Rajat Jain is an old hand at fund management. In his 18 years of experience, he has worked in various capacities including fund manager and head of research. Currently he holds charge of two funds-Principal Global Opportunities and Principal Resurgent India Equity. A mechanical engineer by education, he knows the nuts and bolts of the markets well.

How does Principal Global Opportunities Fund work?
The fund was launched in April 2004. It was the first fund to offer an opportunity to Indian investors to invest outside India. At that time the regulations permitted a very restricted investment universe. So our list was very limiting. But that changed in August 2006 when the regulations were liberalised. Then we repositioned the fund as a feeder fund that feeds into Principal's Emerging Markets Fund. Principal manages over $6 billion in emerging market equity assets.

What is the Emerging Markets Fund investing strategy?
Principal group uses a mix of qualitative and quantitative analysis in its stock picking. They are bottom-up stock selectors. The fund takes no cash calls.

The benchmark is MSCI Emerging Markets. Principal Global Investors, which is managing the emerging markets fund, do not take major calls on either a sector or a country. They are bottom up stock selectors. As part of risk control, they take controlled exposures to individual stocks, countries and sectors vis-à-vis the benchmark. They will have limited divergence vis-à-vis the benchmark. But within that, they will go for the best stocks in respective countries or sectors. They will pick the best stocks in a sector across countries.

So despite controlled sector and country calls, the coverage ratio of the fund is 35-40 per cent. This translates into around 60 per cent of the stocks adding alpha. So it is a very stock specific strategy. No country or sector call, but rather stock calls. So, in a manner of speaking, they may not hit many home runs, but hit multiple singles i.e. they take multiple small bets rather than few big bets.

Does it have any India allocation?
No. It is an offshore fund, i.e. the fund is fully invested in the Principal Emerging Markets Fund.

Other than your tax saving fund which has done very well recently, why have your equity funds not done too well?
Our equity funds have done well. In the last two years the performance of our equity funds has been very strong and they are among top quartile in different categories.

What happened in the past two years that you have come back on track?
Our performance was somewhat impacted on account of omissions rather than mistakes of commission i.e. its not that we made wrong calls, but that we did not make all the right stock calls. What makes a good fund manager is diligent back end work in quick turnaround time. We have been meeting more companies, doing our due diligence and including more names into our portfolios in meaningful exposures. We gained by taking aggressive - meaningful - exposures in our high conviction picks in the mid-cap space. In the large-cap fund we got our stock calls spot on. This fund has been a top quartile performer since inception, which was October 2005.

Principal Growth Fund and Principal Resurgent India Fund have not been impressive performers. Why?
We found that Principal Growth Fund was over diversified with multiple large- and mid-cap stocks and numerous positions. We made it a more concentrated portfolio of 40-odd stocks, down from the 60 odd stocks in the portfolio. It was too diversified in the mid-cap space. The performance has improved. From lower quartile, Principal Growth has become a second quartile performer in the peer set we track. Besides, many of our stock picks, including those that we had held for quite some time, did well. These included KEC International, L&T, Balaji Telefilms, Axis Bank and Tata Power. Till September 2007, Principal Resurgent India Fund was a top quartile performer amongst diversified equity funds that we track. In was only in the last quarter of the year that it has not done as well. We believe that it is a very competitive fund in the diversified equity category.

Many smaller fund houses do not get quick and immediate access to broker reports. Do you feel that is a problem?
Broker research is available to everyone. It is not that we will get a preference over it. Brokers may service bigger players first. We rely a lot more on in-house research. Some of our best calls are the result of internal research. Some of our mid-cap picks which turned out to be multi baggers were the result of in-house research. We were ahead of the curve in many of our picks.

So how do you go about analysing a stock?
We look at the business franchise. Can the company continue to do what it has been doing in a competitive environment? Does it have a leading market share in this business? Is it a price taker? Then we look at management - both transparency and capability. Finally, we consider the relative valuation of the business. We are not value investors, but look at valuations in comparison with other companies in the sector and to the broad market. We do not take large cash calls in our portfolio so to that extent, absolute valuations are somewhat less important. However, absolute valuations are important because they help you check your assumptions, and they keep you grounded.

How big is your team?
We have a team of 12 including me. There are four on the fixed income desk and seven on the equity team. We are also adding to our team.

You invested in Phoenix Mills. Does that mean you are bullish on the real estate sector?
No, we are underweight in that sector. And that hurt our performance in the last few months of 2007 as post August, this sector has had a tremendous run. We were concerned about execution risks in the business, as companies who have delivered x million square feet are looking at multiples of x in terms of delivery. The commercial space has been looking good but we had concerns on the retail and residential space. Retail rentals have shot up and it would impact the viability of the tenants. So based on scalability and execution capabilities, we have remained underweight on this sector. Now the sector has been looking good in this correction.

Aviation is another new sector. What is your stance on it?
We have been underweight and plan to stay that way. The industry is in a better position now than it was a few years ago. There have been no new entrants. Consolidation has taken place. Pricing has improved. So things have improved. But against that, fuel prices are having an impact. When we look at the cash flows and the entire business metrics, we prefer being underweight.

What about IT?
We are underweight in technology. The US is clearly seeing a slowdown and the BSFI space - the biggest customer for Indian IT companies - is facing a lot of issues. In such a scenario, price hikes is not a possibility. In fact, prices will be under pressure. We are awaiting the last quarter numbers to see the guidance these companies give before we decide to change our call.

Would you take a contrarian bet in automobiles?
The medium and heavy commercial vehicles have been showing negative volume growth for the past few months. The two-wheelers volume numbers have been mixed. Passenger cars have done well, but the environment remains challenging given rising input costs, increased competitive intensity and cost of finance.

So you are underweight in real estate, aviation, technology and automobiles. Which are the sectors you are bullish on?
Infrastructure plays - not real estate but construction oriented players. We also like capital goods and banks. We have an exposure to metals and mining companies. We believe the steel cycle is still holding firm. We believe this will continue. It is difficult for me to speak on sectors I am bullish on or avoiding. We are mainly bottom-up stock pickers. So if we like a stock, it appears in our portfolio even if it is a sector that is not favoured.

You say you are bullish on banks. But you also invested in JM Financial. What is your take on brokerage stocks? They had a great run a while back.
We have a scenario where the financial services industry is going to increase in importance for a large segment of our population. It will hence bring many more individuals in its network. This is great for the long run. There is banking, distribution companies, insurance companies and brokerages in this space. They will all gain from the financial inclusion of a large population of India. We did feel towards the end of last year that the market was somewhat frothy. And in the near term there could be an impact on brokerage stocks as their performance is linked to that of volumes in the equity market.

In the current market slump, what did you pick up?
I cannot comment on individual stocks. Frankly, we just increased our position in stocks we already owned. We did not add new ideas. We stuck to those companies we had already met and done our due diligence on. Since we were more comfortable with the valuations during the market slump, we added to our positions.

When you say you increased your position to a stock, what is the maximum exposure you take?
Generally we hold a stock up to a maximum of around 7 per cent in our portfolio. We usually have around 30-40 stocks in each portfolio.

Do you think the bull run has run out of steam? What are the threats you see in the market - corporate earnings, FII inflows, slowdown in the US?
I think the long term bull market in emerging market equities remains. There are long term trends that favour this - the increasing competitiveness of emerging market economies, increasing strength of the middle class, improving corporate governance, companies attaining global sizes and better risk-reward characteristics than most developed markets. In the case of India, the relative dependence on the U.S. is lesser, which is a positive in the current scenario. Corporate earnings are seeing a slowdown, but there will always be stocks that have been punished unusually hard in the current volatility and the risk reward would look attractive there. Markets are never perfect, and in such volatile times, investors can find good picks.

What advice would you give to investors at this point in time?
I think this is a good time to add equities. Investors can look at both diversified equity and mid-cap funds for their portfolio. The markets are catching up to over four years of high returns. I cannot predict the returns that investors will get this year, but my sense is that the current turmoil is a good opportunity to add equity. Two or three years down the line, returns from this should be better than almost any other asset class.

This interview appeared in February 2008 Issue of Mutual Fund Insight.