Checkmate Moves

UTI Dividend Yield was launched in May 2005. Current fund manager Swati Kulkarni took over the reins in December that year. And since then has done a brilliant job. Currently, there are six dividend yield funds available. But the star has been UTI Dividend Yield. We decided to get Kulkarni's views on what makes this fund a success and also gain an understanding as to how she goes about picking her stocks. To sum it up, she also expressed her views on the current stock market scenario.

Your fund UTI Dividend Yield is the best in its category. The mandate of your fund is to buy stocks whose dividend yield is greater than the dividend of the Nifty last released. Can you throw some light on how you go about picking these stocks?
It's certainly not about arranging the stocks in descending order and picking up those from the top whose dividend yield is higher than the Nifty. First and foremost, UTI Dividend Yield Fund is a diversified equity fund. Thus, capital appreciation potential is the most important aspect while selecting a stock along with the expected dividend income. Hence, we look at sustainability of cash flows and growth opportunities. For example, in pharmaceuticals we may see some stocks with a very high dividend yield but sustainability of growth may be missing - due to one off profit opportunities. Certain companies with high cash generation but lower incremental ROCE growth opportunities may prefer giving high dividends. The allocation to such companies is decided depending on the market phases.

We also look at the scalability of the businesses and management quality. Then of course we have to consider valuations to ensure that we buy stocks that have capital appreciation potential in the long term. Thus we take a complete view.

Our investment processes make it mandatory to meet the management of the company and maintain contact on a quarterly basis. So, certain small cap ideas, where we may not be able to have any regular contact with the management, will not be able to figure in our portfolio.

In past, this fund was able to benefit from the exposure to certain mid cap stocks in various sectors like sugar, auto ancillaries, cement, capital goods, metals and cement. The dividend yield is a criteria used to sharpen the focus by narrowing the investable universe to leave out certain opportunities which are risky at this point in time or not very attractive from a valuations perspective. The fund is essentially a bottom-up fund and it cannot really have a predominant top-down approach.

But in 2007, you bought Reliance Industries and reentered Tata Power when the energy sector was doing well. And your energy allocation has risen. So the top-down approach did have a place here.
IPCL was a high dividend yield stock which got converted into Reliance Industries Ltd. Most of the power sector players in the Transmission and Distribution space (T&D) and equipment manufacturers did not qualify for a high dividend. But since the growth visibility for the sector was good we stayed overweight in such utilities that had clear growth strategies and a project execution track record. And also, they were available at relatively fair valuations.

The oil and gas sector has high dividend yield stocks especially oil marketing companies and pure refiners. We stayed underweight on such companies on account of lack of clarity on retail product prices and subsidy sharing policies even though valuations were attractive. Now with the fall in crude oil prices we are looking at such stocks. So, there is a predominance of the bottom-up approach to investing.

You mentioned earlier how you picked up mid caps from various sectors. Are there any sectors which you view favourably or not for high dividend yield stocks?
Generally, companies in the pharmaceuticals, FMCG, banking, oil and gas, and metals space tend to be high dividend yield companies. Infotech too falls under this as they are basically cash generators, as long as they do not use the cash for costly and earnings dilutive acquisitions. In capital goods too you may find high dividend yield companies but they are mainly mid caps. Construction is a working capital intensive business so cash generation may take place after a prolonged period of growth.

Your take on these sectors right now?
After staying underweight for the last three years, this fund has started increasing exposure to FMCG and pharmaceuticals. It is underweight on technology right now due to the concerns on the volume growth and impact of cross currency movements. At lower levels, we would look at power utilities and banking. The valuations are turning attractive for high dividend yield stocks in the cement sector.

What is your take on the quarterly earnings? Do you see the situation improving anytime soon?
Yes, we have been conservative for a while. In terms of large-cap exposure, there has been a conscious shift, given the risk aversion and rising impact costs, especially with respect to mid-cap stocks.

But in terms of number of stocks, it is not a deliberate move. It is just that there are more opportunities being created in the market.

Where cash is concerned, we had given dividends in May. That would explain the increase in liquidity in June because we had to book profits. That month the price of crude shot up to $140 per barrel from less than $100/barrel in February 2008. Commodity prices too showed a sharp rise. The global crisis too was looming. The macro picture was worsening. In such a scenario, we turned a bit more cautious. We had reduced our metals exposure considerably and there was no hurry to re-invest.

What is your take on the quarterly earnings?
The earnings growth is moderating to 12 per cent to 15 per cent from 30 per cent plus seen two to three years ago. Though the sales and order book momentum remains in excess of 20 per cent, the pressure on margins is evident.

The silver lining is that commodity prices and crude has fallen off; though, it may take a while to get the benefit reflected in the numbers. Corporate India is still to see softening in interest rates, which has just begun. So, in next two quarters margins may improve.

Liquidity has shrunk as de-leveraging process is underway. Repercussions are being felt across the asset classes and markets, India being no exception.

Do you see the situation improving anytime soon?
I do believe that value is emerging at current levels. The BSE Sensex one-year forward PE multiple at 9700 levels, is close to a single digit. The lowest one-year forward PE multiple in last 15 years was 8½x, observed in 2003.

I believe, now we do not have to put in the efforts which we had in 2002-03 to convince foreigners that India is worth looking at. Today our relative strengths of domestic demand and the infrastructure focus, irrespective of political leadership are well known. Looking at valuations, I don't see anyone gaining by being bearish at these levels from a long-term perspective. One has to be opportunistic to cash in on the event risks in the short term.

From all the sectors which rallied in the last bull run, which one do you think will not make a comeback? And why?
I think leveraged companies in commodities, real estate, and capital goods and engineering will take a while to make a comeback. These sectors have seen the best times in terms of demand, realisation and operating performances.

Commodities have had a dream run on account of zooming prices backed by buoyant demand and funds activity earlier. But as developed countries and China, the main demand drivers, are slowing down, the prices have come off. Falling volume and prices will put pressure on operational performance. Real estate companies are yet to show a meaningful correction in the price and supply of houses. Once that reflects in the reported numbers of these sectors, we could expect some buying interest.

Capital goods and engineering companies could get affected due to project delays and slowing of investment spending in the short term. But they are likely to gain on account of benign commodity prices and falling interest rates in the long run.

Which sectors do you believe will begin to rally when the market picks up?
As long as the volatility persists, I believe cash generating companies with reasonable growth prospects would outperform. Typically FMCG, utilities and financials should outperform. With falling inflation, interest rates are expected to come down. So rate sensitive sectors may also evince investors' interest. However, for a short period, it is possible that the most beaten up stocks may rally initially as market picks up.

What would be a catalyst for the next rally?
Rural disposable income has been good on account of firm food grain prices and improving yields. While this will support the domestic consumption in the near term, a significant investment will be needed for improving agriculture yields and improving rural infrastructure so that the dependence on monsoon is reduced. Increasing private participation through additional reforms could also be one of the catalysts post central elections, as the government refocuses on achieving fiscal targets.