Plugging Risks

Rajat Jain says his funds have become more benchmark aware after the crisis of 2008 and deviations, if any, are also within the pre-defined limits.

Given our problems — high inflation, high interest rates, slowing economy and falling corporate profits, what do you think will cause a turnaround?
I think the root cause of the problem is the fiscal situation and that has been the biggest challenge up till now. The RBI has also acknowledged it. The second thing that we have to do is remove supply bottlenecks in the economy, infrastructure and other areas. And if you are not going to create that then inflation is not going to come down. High inflation is due to both supply side issues and excess of money in the economy. These are the challenges we face in the macro economic scenario along with current account deficit.
Further, if you look closely into the matter, you will find that the solution lies in the problem itself. We have to attack the fiscal problem and if that does not happen, any rally in the market will not be sustainable and long-lived. We really have to get the fiscal house in order first because it has reached unsustainable levels now.

There is a lot of commentary going on in the media about the India growth story. Do you think the India story is over?
The India growth story started when FIIs first came here in the early 1990s post the reforms. The real India story was the discovery of the Indian entrepreneur by global investors. And at that time there was no credible infrastructure or demographic story to speak of. Though it was the fact that you could buy well-run businesses in India — with good management and having good return on investment, something that was missing in many other emerging markets at that time. In India, you found the bottom-up story and such companies were available to you, which I think hasn’t changed much. You can still find about 15-20 good bottom-up companies being run by good management, generating good RoEs with focus on respective businesses. This part of the India story has still not gone away.
Coming back to the moot point, the macro situation is clearly unsustainable and is unlikely to change if things remain the way they are. I am sure there are good people in the government who will make some efforts to control things. Don’t forget, India is a big diversifier to the portfolio of a global investor as it is relatedly insulated from global trade flows and still has a local consumption theme. If FIIs see bright prospects then we can expect to see meaningful flows coming into equity markets.

Given the upheaval of recent times, how do you view the current economic situation of the country?
I think the picture is somewhat dynamic at this point of time and the decisions that the government is going to take are going to have a huge impact. For example, if the GST is rolled out now, despite the delays of the past, I think it will still add at least a few basis points to the net income/profits going forward. It will also remove a lot of inefficiencies which are built into the system. That is one positive that can happen for sure. Other than that I think a lot of decisions that the government is going to take in terms of controlling its expenditures are going to have an impact on the macro-economic parameters. Such revenue and expenditure decisions can make a lot of difference in the macro environment.

What makes you so hopeful?
I agree we are facing a lot of challenges. But at some point of time, those running the country will see the long-term impact of the policy logjam on the country and we might see some corrective action being taken that will help strengthen the India growth story. And as I said earlier, we can still find a lot of companies that are attractive on a bottom-up basis and have fair valuations.

What is Principal’s assessment of the current situation as a foreign investor in India. Does it have a meaningful investment here?
Principal has been in India for a long time. The company does have substantial exposure into Indian equities. But I think we are about neutral in the benchmark weight.

What is the attitude of foreign investors about India based on your interaction?
FIIs is a very broad term which covers a whole lot of investors. We have very short-term oriented investors like the hedge funds. While on the other end we have pension funds and insurance companies. In the middle we have India-dedicated mutual funds which have neither very short- nor long-term horizon. The ones who take a long-term view can still come in despite the market volatility.

How do your views reflect in your funds today? Any tactical positioning of your bond and equity funds in the current environment?
Most of our funds reflect the bottom-up stock picking style. But we certainly look at the macro economy for some sectors. Obviously, you have to have some sense of the economy when you look at the financials of a company to conclude as to how it is doing. Broadly, the funds tend to reflect the bottom-up style of stock selection and this has also been Principal’s style.
We have been neutral to underweight on Banking looking at the macro economy. We do think the challenges as a result of slowing economy are going to reflect in the NPAs. We will see news flow around asset quality to be there for the next quarter or so. We have a decent exposure to Pharmaceuticals which are bottom-up stock picks and are going to benefit from the weaker rupee. With that in mind, we have more of a bottom-up than top-down strategy except for certain sectors like Financials which, as I said earlier, is a sector where macros certainly have an impact. Moreover, we are underweight on rate sensitive sectors like Automobiles where we are seeing a slowdown which is going to have an impact on demand and hence we are underweight on certain auto companies.

Is there something which you did before 2008 but don’t do it now in your equity and bond funds? Has your risk framework undergone a change?
We have always been focused on our risk framework but post 2008 we have become stronger and more focused in the way we manage risks in our portfolio in both equity and bond funds. We are more benchmark aware now and while we do have deviations from the benchmark’s sector weights and our portfolio exposure, that is always within pre-defined limits. We analyse the portfolio regularly. Likewise, for fixed income we generate a much more sophisticated management information system on our portfolio position and the impact of movements of rates on our portfolio. We have built a much more focused and robust risk environment over the past two years.

Can you please elaborate on benchmark awareness and deviation? Are you now matching sectoral weightings or some defined universe which you never used to follow?
We always had a benchmark but we have defined it more clearly now. The first thing we did was to get the benchmark right, I mean when we have a large-cap fund then the right benchmark is used for it. We have clearly defined the BSE 100 for the large-cap oriented funds, BSE 200 for the diversified funds and then the mid-cap index for the mid-cap funds as a benchmark. And to avoid any (style) drift, we buy stocks aligned with the benchmark.
However, the funds are still run very actively and the purpose of risk limits it to bring in more consistency, but alpha is generated out of stock selection.

Is there something that is untouchable now in equity and bond funds?
There is nothing which is untouchable now, nor was there before. But we spend a lot more time on portfolio construction. For fixed income, we have been very strong on our credit evaluation process and that has not changed at all. Its just the kind of reporting and the insight which you have on your portfolio on a day-to-day basis that has improved.

Were you hit by 2008 and the liquidity crisis as well?
Yes, like all the funds, we were also impacted by that.

What briefing do you give to your fund managers?
One thing I have learnt is that you should not run fund management like a committee. You cannot just sit and tell the fund manager to reach a decision and, at the same time, you have to also ensure that controls are in place. For example, any new addition to the stock list that we buy has to be approved by me and that has to be preceded by the research on that company which our analysts do. Then, you do not tell the fund managers when to buy and when to sell. But certainly I ensure quality. We have daily meetings where we discuss the portfolios. So, we do not run fund management like a committee. At the same time we ensure that risk management is in place. The risk management is independent of the fund management team so that the investors money is well protected.

Do you have different stock universe defined for different funds?
Yes, the stock universe is defined by the market cap. And any additional stock you buy for the first time has to be approved by me and same goes for new credit.