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Sticking with Quality

Sivasubramanian KN, CIO, Franklin Equity - India, says they are focused on good quality companies that do well over a business cycle

In terms of an economic cycle, where do you see India positioned.
We believe that we are close to the bottom of this economic cycle and we should probably see some improvement. However, the transition back to higher growth rates will be gradual. The PMI indicators could improve with the liquidity condition easing out and interest rates softening. The key concerns remain the sticky inflation level and lack of investment growth.

You spoke of the tight liquidity situation. Can you share your views on this?
The RBI is probably intervening in the forex market to stem the falling rupee and this is impacting domestic liquidity, which in turn is being addressed through OMOs. We are unlikely to see a need for central intervention going forward to prop up the currency and this would ease the tight liquidity.
Other factors that can help in improving liquidity are credit demand and reducing interest in gold. The corporate demand for money from the banking system has been weak and will continue to be so. A positive sign has been the fall in gold imports (can help current account deficit) amidst falling demand. This trend should lead to an appreciation of deposits with the banks since the investible surplus going into gold will now find its way into the banking system.

Economically you believe we have seen the worst. Would you say we have reached the bottom in terms of pricing of companies?
Valuations are very attractive. However, it is difficult to predict the bottom of the stock market cycle given the various imponderables (especially global factors).

Are there any particular types of companies you are hunting for given this economic backdrop?
Our investment strategy is to focus on good quality companies which will do well over a business cycle through a bottom-up approach. We do not tailor the portfolio depending on the macro conditions as we believe irrespective of the economic conditions there will always be companies that will do relatively well.

How do you define a good quality company?
When we talk about quality it is in terms of the business drivers and the management. There are businesses which do well at certain points of time but over a cycle do not deliver consistently. On the other hand, there are businesses which over the entire cycle display quality in terms of either top-line growth and in their ability to defend margins and hence able to generate superior return on investments. For example, consumer related businesses as opposed to investment related businesses. The former can withstand shocks to a greater extent and so over a cycle generates more value for shareholders than companies which are a play on investments. In addition, for us quality of management is important as vision and execution are critical to delivering shareholder value along with good governance practices.

Right now, in this stage of the cycle, what are the sectors you are tactically moving into and out of?
We have always been skeptical of companies that require a lot of capital to grow their business and avoid them. We also stay away from companies with corporate governance issues.
While we invest for the medium to long term, if price corrections result in very attractive valuations, then we will consider gaining exposure to those stocks.
Right now we are overweight on Telecom because we see a lot of upside from current levels. The regulatory and other issues which have been impacting the sector have brought the share prices down quite sharply. It’s a consumer driven business and the overall slowdown in the economy did not impact it too much. It is a good quality business which is available cheap.
Financial Services and private banks have also corrected. So on a relative basis, there is value emerging in private banks and depending on how the portfolio is positioned we may add to our position there.

What if you were presented with a stock which had obvious potential for growth but the sector as a whole was not doing well.
That would depend on the individual fund manager. But as a fund house, we would look at valuations and corporate governance before making such a call.

What is your view on cash?
As a fund house we do not take cash calls as we believe that investors getting into equity funds are looking for equity exposure and not for asset allocation. Right now we see value, and are looking to deploy cash (over the last few months, we had 5-6 per cent cash).

Keeping in mind the current scenario, how important are global indicators when you build your portfolio?
We look at the global situation and indicators while evaluating companies in certain sectors and leverage our global teams to get a better understanding of the on-ground situation. For example, understanding the drivers for telecom companies in other emerging markets will deepen our analysis of domestic firms. On the other hand, evaluating global demand helps in analyzing Indian companies that are dependent on exports relatively more.

PMI: Purchasing Managers’ Index /OMO: Open Market Operations/RBI: Reserve Bank of India