Why are you launching a Business Leaders Fund as your first offering?
To create an equity product, there are a number of parameters to consider: asset allocation, sector allocation, market capitalisation bias and stock selection. But we also have to look at where the economy is and where the market is currently placed. We wanted a longer-term, all-weather flagship fund. We wanted an equity fund that had a strong investment case, especially with reference to the current market environment.
In terms of asset allocation, it will be a fully invested fund, but will focus on companies, which are market leaders in their fields. In trying economic conditions, it is these leaders who are left standing simply because they have inherent strengths built into their business models. What will separate the men from the boys will be parameters like cost leadership, brand leadership, complete integration, strong underlying cash flows and access to capital.
When you say business leader, you don't mean emerging leader?
No. We mean companies that have demonstrated leadership capabi-lities. The investment premise is to pick the companies that have demonstrated their leadership in quantifiable terms rather than companies that might be tomorrow's leaders. They must show market leadership either in terms of market share or financial parameters relative to the industry peer group.
The most obvious factor of leadership is market share within their industry or relevant sub-segment within which they operate. But equally it is also a function of certain strategic advantages that they have in terms of a cost leadership position, industry leading margins, technology advantage or access to capital, which basically means a strong balance sheet (conservative leverage) and strong cash flows. It could also be a business model that results in a superior Return on Equity relative to the industry peer group.
Does that mean it will gravitate towards large caps?
It will have an automatic gravitation towards larger cap companies only because most leaders tend to have larger market capitalization. But let's say we are positive on sugar or paper. So one won't find large cap companies in this industry. If there are smaller industries and we see leaders in them, we may pick it up. So there is no market cap bias in that sense
Neither will there be a sector bias in this fund. We will invest in business leaders across various industries. There is always subjectivity in picking stocks, but we follow a disciplined and objective process of filtering the universe of stocks.
In your opinion when do you see the market changing course?
It's always hard to predict what will help the market pick up. If you read all the newspapers at January 2008 no one would have predicted what this year held in store. If you read all the popular press in 2003, neither would you find any indication of the market going to rally for the next few years.
I cannot really forecast where the market is heading or what factors will make it change course. But the fact of the matter, in my opinion, is that we have been in a slowdown for 18 months. In July 2006, the RBI hiked Cash Reserve Ratio to tame growth. This was the first signal that they were not comfortable with the level of growth they were seeing. Later they were clear that the economy is getting overheated, there were supply bottlenecks and they needed to slow things down. The market did not realise how dramatic the impact of inflation and tightening would be.
Now the RBI has changed course. It has been putting in some monetary stimulus to get the economy stabilised and is focussing on growth since the peak in inflation now appears to be behind us. It will take time for these measures to work and have an impact.
But what makes it incredibly complex and difficult is that the global financial chaos is hurting us now. We are not operating in a vacuum.
So there will be more pain in the market.
The way I look at it is that the macro risks are reasonably well known and well discounted into the price. And when you look at market valuations with reference to historic troughs, we are somewhere near those levels. But what has not been discounted is the fact that individual companies may not be able to weather the tough economic environment and come out of it. The market as a whole might have come down, but in the next two years as the economy and market consolidates, we could see some individual stocks come down a further 50-80 per cent. The coming years will tell us who is paddling without an oar and who has two oars to paddle with. This will be more apparent in the next two years.
Look back in 2000-01. When the market collapsed, all companies fell by around 50-80 per cent. Two years later, Infosys still existed, the business model was doing well, the business was doing reasonably okay and they were able to accelerate once the environment changed. But some of the other companies never ever bounced back.
Even in the 1996-98 period, a lot of companies never made it out of that rut. So what I am saying is that what is discounted is the macro risk but not the micro (company specific) risk.
Which are the sectors you are running away from?
Broadly, I am concerned about all that has done spectacularly well in the past few years leading up to January - banking, the commodities space, utilities.
Looking at the commodity prices, it's only now that we are understanding how much was demand driven and how much was speculation driven. The kind of fall we are seeing in profitability in commodities shows how sharply profits accelerate and decline. We are still negative on the entire commodities space. In the utilities space there are going to be significant challenges in terms of project closure and execution. The stocks were being treated like growth stocks which they are not by any stretch of imagination. We are also concerned about the entire capital goods and engineering space. I don't think there is much of balance sheet risk (except for those companies that have become owners of assets) and PEs have corrected but they are vulnerable to a slowdown in growth. So there may be some collateral damage from there. But I am not hugely negative on this sector. There is reasonable value in some of the companies.
We are tactically neutral towards banking right now but over the medium term I see several concerns. All the problems that show up in the economy somewhere down the road get reflected in terms of bad loans on the books of the banks. That will pressure profits and capital adequacy.
You think there is steam left in the infrastructure space?
Yes there is still steam left in this theme simply because we are infrastructure deficient as a country. But one needs to differentiate between infrastructure builders and the companies who own the assets.
The erstwhile builders have become owners of assets too. That hurts their balance sheets and does not make them as attractive as earlier. We have seen this huge pile up of capital investment and now we don't know how many projects will see the light of day because financial closure is becoming difficult.
If you are an infrastructure builder, the issue is more of buying them at the right valuations . But I would not want too much of exposure to the infrastructure owners who are implementing major projects.
What will the next big theme be?
I have no idea where these themes come from and I find them a big distraction. We have seen this happen before - the tech funds, the infrastructure theme, the capital goods funds and the natural resources funds. This is a very costly distraction for the investor.
You can invest in them like they are the icing on the cake but you must bake the cake. Investors must have a solid diversified equity portfolio - that is the cake on which they can add the icing.
Where will you be investing right now?
My focus right now is not to pick up companies that are at risk of blowing up somewhere down the road. So I am taking a very bottom-up perspective. The top-down perspective indicates that I must first and foremost stay defensive. So the preferred areas are consumer staples, consumer discretionary, healthcare and telecom (which is growing steadily though valuations might be an issue). Most businesses in these areas are inherently more defensive and the companies tend to have better balance sheets than the ones we see elsewhere. Further in this market it pays to be where there is some degree of under ownership rather than over ownership. In banking, industrials, energy, there is a great degree of over ownership on the institutional side.
You mention a bottom-up and top-down perspective. As an investor, do you favour any?
I have never understood the obsession with this. I feel it is a pointless debate. It's like saying how does one lose weight - by dieting or exercise? You have to do both. In my experience, there are some sectors where the top down call is mandatory. So you cannot help but be top-down in say steel. What matters is your call on the steel cycle and that will determine your investment strategy within the steel sector. But the bottom up in terms of the identifying the lowest cost producer and the company most leveraged to prices and volumes is very important as well in stock selection. But if you are looking at healthcare, the bottom up is far more relevant. It always has to be a combination of both and what is most appropriate.