Meet SBI Mutual Fund's Dinesh Balachandran. He manages assets worth Rs 81,800 crore.

Dinesh Balachandran has been at the helm of SBI Funds Management for the last 12 years. A seasoned fixed-income analyst, he shifted his focus towards Indian equity markets after a decade-long stint at Fidelity Investments USA.

Presently, Balachandran is the Head of Equity at SBI Mutual Fund, where he oversees four schemes - SBI Balanced Advantage Fund, SBI Contra Fund, SBI Long Term Equity Fund and SBI Multi Asset Allocation Fund - that has a total asset value of around Rs 81,800 crore.

In this interview, the IIT alumnus provides a glimpse into his career transition from fixed-income management to focusing on Indian equity markets, the factors that make a stock a compelling buy and how first-time investors can navigate the current market.

Here is an edited transcript of the interview.

You studied engineering at IIT Bombay and then earned a master's degree from MIT. What sparked your interest in finance then?

When I joined IIT Bombay, working in finance was not on my radar. I was more focused on engineering. With that mindset, I moved to MIT (Massachusetts Institute of Technology) for a PhD. The best part about that institution is that one can attend the classes of any department. Out of curiosity, I took a few investing-related courses at MIT Sloan to understand what this field is all about.

While it was just a few classes, something there clicked for me. The fundamental problem with a PhD-like experience is that you can go for years trying to do something and not know whether you're going in the right direction. So, the feedback loop in terms of timing is very long. However, in investing, it feels like the market always gives you a report card. It tells you whether your investments are doing well or not. The intellectual challenge associated with the financial markets appealed to me. So, I then decided to give it a shot. Initially, I thought that if it didn't work out, maybe I'd just return to my roots. But thankfully, it has worked out so far.

I'm curious about your career transition from working for a decade in fixed-income management at Fidelity in Boston to focusing on Indian equity markets. What motivated this shift?

During my stint at Fidelity, I covered everything from money markets, municipal bonds, taxable bonds, structured finance and collateralised debt obligations (CDOs). It felt like I practically covered almost all the major aspects of the fixed-income market while working in the US.

Later, I moved back to India for personal reasons and wanted to work in a challenging role. I believe that the primary difference between equities and fixed income is that the risk-reward ratio is much more magnified in equities. There is a very distinct challenge associated with that. If you go right, you can make a lot of money. While the downside risk is also higher in equities, I found it challenging. This sparked my desire to shift from fixed income to equity.

What key lessons have shaped your approach in your current role over your 12 years at SBI Funds Management, transitioning from senior credit analyst to head of equity?

There are many lessons and takeaways that I've had over the long period in the markets. However, one thing stands out clearly - the significance of teamwork, as everyone has a limited scope of expertise. For example, while managing a diversified portfolio, you have to lean on others rather than doing everything yourself. The idea of having a good team around you that can act as a sounding board is essential. Maybe it's an underappreciated trait, but I have cherished being around good team members at SBI Mutual Fund.

Having the right mindset is also crucial, as prevailing market sentiments can easily overwhelm one. Sometimes, it's challenging to stay away from where the action is taking place. In my opinion, the majority of returns come from having a differentiated perspective. For that, one should have the right temperament to stand against the crowd.

Lastly, solid research should give one the conviction to be different. From that perspective, it's critical to conduct thorough basic research to form opinions and have the courage to act based on them. If necessary, detach yourself entirely from what others are doing. These are some of the key lessons I've learned.

How does your extensive background in fixed income shape your strategies for managing equity portfolios, especially concerning risk management and asset allocation?

When I think about equity investing, a lot is about bottom-up investing based on company-by-company analysis and having a good understanding of their business models. However, a crucial top-down component also comes in, particularly while discussing cyclical sectors. In such sectors, one should have a good understanding of macroeconomics and business cycles. From that perspective, having a background in fixed income has helped me. For instance, determining which sectors will prosper or suffer during an inflationary period can significantly impact decision making. If you have a good sense of macroeconomics, it gives you a leg up.

Can you describe your investment philosophy? What types of stocks or market situations excite you the most?

I think the debate between 'value' and 'growth' is superficial to a large extent. This is because everyone (fund managers) tries to invest in the best company with high growth prospects, quality management and an attractive valuation. But in reality, you don't get all three simultaneously unless there is a Covid-19-like scenario. From that perspective, a compromise has to be made somewhere.

Many fund managers do not want to compromise on growth and, hence, don't mind overpaying for a stock. For me, valuation is an essential component of the margin of safety, and I try not to compromise on it. Many people, therefore, categorise me as having a 'value investment' philosophy. But that doesn't mean I will go and buy any company that is available for cheap without regard to its quality profile.

Regarding the second question, I think I'm inherently very comfortable in a market with a lot of fear and pessimism. Such scenarios excite me, as more investing opportunities exist in such markets. On the other hand, a market where everyone is excited about everything and valuations are high, as we are witnessing today, is probably the most challenging market for me, as getting something with a high margin of safety becomes extremely difficult.

What criteria make a stock a compelling buy for you?

There are many dimensions in which the margin of safety comes into play. One such dimension is valuation; the other is the quality of the business model. I have different valuation yardsticks for different companies. I'm not going to put every company on the same level and say that all of them should trade at the same valuation. That's the first criterion.

The second criterion is the quality of the business model. I try to eliminate companies whose terminal value might be questionable. It's like a melting ice cube, and that company might not even exist five years from now.

Then, you try to eliminate companies with questionable corporate governance and see whether there are businesses with a strong business model that are experiencing transient challenges. In such companies, many investors are overtly focused on the near term, and that's where good opportunities emerge.

There are good examples in the auto space. For instance, two leading companies in this sector had strong core competencies and good governance practices. However, they underwent a challenging phase in the last decade. Unrelated diversification and weak capital allocation dragged these companies down. But then, a new management came in with a fresh start. They started by fixing the capital allocation issue and focused only on those segments where the company was strong.

When you have a combination of better capital allocation, more focused management and a favourable macroeconomic backdrop, a stock becomes extremely attractive from an earnings cycle point of view. Since the stocks were big laggards in the previous decade, their valuations had become quite attractive. These are the kinds of opportunities that I am looking for.

As a manager of contra funds, where do you currently see contrarian opportunities in the market?

Finding great value in the current market is tough, so we've increased our cash exposure. A few months ago, we believed that the markets had overlooked the energy sector, leaving few good value opportunities. But even here, a lot of these stocks have now re-rated significantly. From that perspective, I have to deal with slim pickings in the market. In my opinion, there are no great opportunities right now.

Would you recommend starting with hybrid funds or diversified equity funds in the current market for a first-time investor?

I would encourage first-time investors to start with hybrid funds. There is no doubt that equities are one of the best ways to generate wealth from a long-term perspective. However, the issue is that even if investors want to invest in equities for 10 years, they panic if they see a short-term correction of 15-20 per cent. Therefore, one cannot ignore the inherent volatility in the equity markets, which frequently experience corrections of 10-20 per cent. So, for first-time investors, such corrections can be quite shocking, as their portfolio might be down by 15 per cent in a matter of months. Thus, it's better for them to slowly get acquainted with how capital markets work.

Hybrid funds have a better risk profile with lower downside volatility, as they also have an allocation to fixed income. This allows the investor to feel safer. When they become more comfortable with volatility and market corrections, they can move towards pure equities.

Looking back at your career, what has been the most surprising market trend or event you've encountered? How has it influenced your approach towards investing?

Some models in the fixed-income space forecast future interest rates and most use zero as the lower base. The basic thought process is understanding how interest rates can go below zero. However, during the last decade, we witnessed negative interest rates in certain advanced economies for five to 10 years. That's something I never thought would happen, but it did. So, from that perspective, one is not prepared for such events, but they happen a lot more than we think.

From that perception, you have to stay humble and grounded. You have to always assume that you don't know everything. One needs to think about the future from a probabilistic perspective rather than an absolute perspective. Another instance is the negative crude oil prices that occurred during the Covid-19 period in 2020. Who would have thought that they would go into negative territory? But that happened.

Also read: How Dinesh Balachandran pulled off SBI Contra Fund's spectacular show