You took over Magnum Emerging Businesses a few months ago. Could you give us a perspective on why the fund fell so dramatically from January to July?
Sector exposure could be one reason since the fund had 60 per cent of its portfolio into construction and industrial equipment segment. The cash component was low with 98 per cent of the fund invested. These two factors could be the contributors to the fall.
Could the fund tilt towards mid- and small-caps also be a contributing factor?
Maybe. But let me clarify that there are no market cap restrictions in this fund, since it refers to emerging businesses. Instead, it is more of a business focus — what is an emerging business for a company or the country as a whole. So let’s say that according to estimates in next 3-4 years, 30-40 per cent of L&T’s profits will come from emerging businesses like ship building, defence and power equipment which have a zero contribution to the company’s profits today. Then in that case, L&T will find a place in portfolio. Gas, for instance, is a new business for Reliance Industries and a significant opportunity for the company and for the country.
So why the tilt towards a particular sector?
By and large, this fund will have a concentrated portfolio with around 20 stocks with the top 5 cornering 30-35 per cent. The past few years, many businesses and opportunities emerged in the capital goods/construction space given the infrastructure development opportunity in India. We had invested in businesses which were seen as emerging and we are monitoring the ongoing execution and awaiting the fruitfulness of these investments. Take transmission tower businesses, for instance. We recognised the business a few years ago but execution of those is what we have now begun to witness. So it might look like we have invested in a sector, which is no longer emerging, but we are staying invested to see the result of such an investment. We are holding for the execution phase.
When you took over, what changes did you make? I lowered the capital goods/construction exposure from around 60 to 40 per cent and the divested amount was held in cash. Creating cash was more from tactical reason, to take benefit of falling market conditions and invest in newer emerging businesses available at attractive valuations or add to already existing ideas.
As a fund manager, I was not put here to take an asset call by diverting money into cash. An investor would make his own asset allocation and the money he has put into this fund is for an investment into the theme. So I have to buy equity, expecting the portfolio would probably fall less or rise more than the broad market in the long run.
Did the slump catch you by surprise? Yes, in terms of the steepness of decline, specifically with regards to the capital goods sector. It was anyone’s guess when a broad market correction would take place, but certain sectors were very badly hit, not what was expected at all.
What do you think will change the fortunes of the market? Equity markets are function of liquidity, valuations/yields and sentiments. It’s unproven if flows lead to fall or rise in the markets. This year, sentiments have corrected, rather than liquidity issues. Sentiments could turn positive, if commodity prices, including oil, start correcting. However, it is not necessary that something good for sentiments will necessarily mean good fundamentally, because commodity prices may come down due to demand destruction caused by slow global economic growth.
In terms of valuations, this is going to be a year of slow corporate profit growth. The quarterly results were better than expected but I have my doubts for the full year. Capacity expansion — leading to higher depreciation and interest burden and higher input costs are ensuring that operating leverage and financial leverage are working against Corporate India. Businesses will have to adjust to this current scenario.
This time it is not a correction like the one in 2004 or 2006. This time it is deeper with slow growth and higher inflation.
What are you buying in such a scenario? This year, from January to June, on a monthly basis, there has been volatility of 7 to 20 per cent. If you take the Sensex low and high in any month, you could get a variation of 10-20 per cent. We are of the opinion that this will continue. In such a scenario it is difficult for someone to convincingly buy anything.
But to look at the positive side of market volatility, it’s also giving an opportunity to invest into selected businesses at attractive valuations. It’s time to evaluate and differentiate good businesses from bad ones and be ready with price points that one wants to invest. Market volatility will give opportunity to participate and that’s what we are doing.