VR Logo

Extremely Bullish on Long-term Growth

Corporates are seeing growth picking up, says S Krishnakumar, Head Equity at Sundaram Mutual

Jittery global markets have turned Indian equity markets volatile. This pattern could continue with the US hiking interest rates in the next few months. S Krishnakumar however believes that even though domestic markets might face some uncertainty, India is better placed than other emerging markets.

What will be the key factors driving the markets from hereon?
There are domestic factors as well as international factors which impact the Indian markets. If we see from the domestic perspective, macros have improved in the last one year. The concerns on current account deficit (CAD) have been addressed by finance ministry as well as RBI in swift manner. This year, with improving exports and lower trade deficit we can bring CAD down to about of $40 billion, at around 2 per cent of gross domestic product (GDP) from earlier highs of 4 per cent+. Even fiscal deficit is now under control and with fall in crude prices we might see further improvement.

We have also seen softening of food prices since the monsoons were not as bad as was expected. Going forward, we expect the softness in both Wholesale Price Index (WPI) and Consumer Price Index (CPI) to continue, which might give room to Reserve Bank of India to start cutting rates. Secondly we are seeing some signs on how the present government is working with the various stake holders and trying in bring in clean governance. For example, after the cancellation of coal blocks by Supreme Court, the government is likely to bring in a new coal auction policy which will be open and transparent. Secondly, the government is planning to give approvals through online mechanism. Environment and forest clearances have already gone online and I believe these factors will build business confidence, accelerate growth and kick start investment cycle. Corporates are seeing growth picking up, but the earnings upgrade cycle has not started. People are expecting more action on ground by the new government. These are the few reasons for markets to react positively.

If we speak of the global factors, there has been continuous weakness in Europe and falling growth in Asia. Right now US economy remains the only bright spot. But we might see some volatility when US starts raising interest rates next year. At the same time Europe and Japan might continue with their quantitative easing (QE) programmes which might ensure more liquidity in the markets. I think we are seeing a de-coupled monetary policy which could impact various asset classes and emerging markets. India though seems to be much better placed among other emerging markets. Given that our macros are improving, inflation is coming down, expectations of lower interest rates and growth picking up. With a strong government at centre we might see some policy decisions which might revive the investment cycle.

In such situation what will be your overall investment strategy?
In the next few quarters the US could raise rates and Europe could infuse more liquidity in the system. There might be some knee-jerk reaction but we would like to take advantage from such volatility. We might enter some high quality names which are currently looking too expensive. Having said that, we are extremely bullish on long term growth prospects and have positioned our portfolio to gain from such situations. We expect investment cycle to accelerate in next five years and have to participate in value chain. We would be looking at sectors like industrial, financials, commercial vehicles, and materials that might benefit from revival in the economy.

Second theme which we want to play is of the Indian export story. Till now China was the largest exporter, but now India has an advantage over China due to its lower labour cost and currency differentials which improve its competitive position. In the past few years India has also some established itself in the global markets as a quality conscious and reliable manufacturer. We see huge surge in export growth in the next five years and that is what Prime Minister Narendra Modi is saying of 'Make in India'. We believe this will happen earlier, and with the export story of Indian manufacturing and the establishment of “Brand India.”

Apart from that, we remain quite bullish on the consumption thematic in the long run. The consumption sector is rightly placed to take advantage of the rising per capita income driven by more job creation and demographics. Building material, lifestyle products, durables, personal transportation and entertainment are bound to benefit which we want to play over the period of time. However we always look at valuations and other financial metrics before investing in any company. Thus, the broad anchor themes would be investment, exports and consumer discretionary that will play out in India in the long run.

In the past few months when markets have touched new highs, have you made any significant changes in the portfolio?
At Sundaram Mutual Fund, we are always cautious about the valuations and if some sectors or stocks turn expensive, we trim such positions. Our investment theory is based on growth at reasonable price (GARP). Yes, in the past few months we have trimmed some positions that have run ahead of fundamentals. To give an example, we have trimmed some positions of small and midcap stocks from our multicap schemes. As we are aware that small cap index has moved up by 80 per cent in the last one year and many of the stocks have turned too expensive, we have reduced our exposure in those stocks and invested in large-caps which offered us better value. In terms of sectoral calls we have reduced exposure in public sector undertaking (PSU) banks and industrials. On the other hand we have added some names from consumer, cyclicals and cement. We are bullish on consumption because of huge growth in urban demand and on cement as it will directly benefit from housing demand, government spending and revival in investment cycle.

What is your overall investment strategy for series of Sundaram Select Micro Cap Fund?
Our main aim to launch the Micro Cap series was to look at stocks and sectors which are beaten down from the valuations perspective at the bottom of the economic cycle. As we are well aware that whenever there is an upturn in the economy, small-cap stocks tend to do better than large and midcap stocks. Since January 2008 to October last year, we were going through 'bear phase' and there was clear opportunity for us to come out with the micro cap funds that would benefit from revival in the economy. So from Series I to Series IV we predominately chose to invest in high quality multinational companies (MNCs) in the micro-cap space. They have strong parentage even though they are small in India, their parents are multibillion dollars companies globally and they have big aspirations for India growth. With technology, brand and business experience through operating in different countries they will be able to enjoy high profitability and gain market share and grow steadily. Further parent companies are focusing more on Indian companies by brining in new products and investing in capacities. Our call has gone right and since the launch of the Micro Cap Series I in December 2013; it has given returns of over 90 percent.

In May, India saw a new government coming with a clear majority and by that time economy was also showing signs of vast improvement. So we launched the next set of Series from V-Series VII where our strategy was to invest in cyclical and export oriented names that would benefit from revival in the economy. These sectors were beaten down from the valuations perspective and growth outlook looked positive for the coming years.

How difficult is to manage close ended schemes compared to open ended schemes, especially in micro cap focused schemes?
Close ended schemes doesn't see any change in the assets under management (AUM) because investors can neither invest nor exit directly. One of the major advantages of close ended scheme is that we can plan the portfolio from the long term perspective. Though there might be some initial volatility, from medium to long term it can give huge outperformance. As a fund manager it is easier to plan and manage the closed funds. We have often seen investors exit the stock market at the wrong time which impacts his overall returns. But with close ended schemes they stay invested for long term and gain from market cycle. I think for us there is no difficulty in managing open ended schemes, but we have to ensure that we keep certain liquidity in the portfolio.

How different is your approach towards micro caps as compared to large, mid and small cap stocks?
Stock selection remains the key for all the equity funds whether its micro cap or large cap. We like to buy businesses that have the potential to scale up and sustain growth through better allocation of capital and competitive strengths. Parameters like return on equity (ROEs), return on capital employed (ROCE) and operating cash flows are looked at in addition to valuations. However the big difference between micro cap and other stocks is risk across cap curve. Risk may arise in the form of relative illiquidity of the stock, inadequate track record of the promoters or even corporate governance issues. We are cautious regarding such issues. Large cap and many mid cap stocks are actively covered by 'sell side' analysts, but in micro cap stocks there is absence of in-depth research by third parties. So we build our own conviction and confidence on micro cap stocks through in-house research. In these micro cap series, we follow a bottom-up stock picking while in large cap funds; there is a bias towards top-down sectoral allocation.

How many and which stocks have you bought in your first closed-end fund seen fully priced now?
We are very particular about valuations and if we are uncomfortable then we reduce our exposure in that particular stock. We haven't exactly exited any stock and the portfolio has remained more or less the same. Yes, there might be one or two stocks which we would have exited due to liquidity issues but even now I believe the long term growth potential in the portfolio is very exciting.

Two of your mid and small cap schemes, Sundaram SMILE and Sundaram Select Midcap have regained some ground in terms of performance. What will you attribute this performance to?
I would like to say that both the funds have benefited from the valuation re-rating that took place in the equity markets, especially in the economy-sensitive sectors like cements, building materials, housing, industrial, capital goods and automobiles. We had invested in these stocks and it has helped us positively in the last one year. Sundaram SMILE fund was clearly positioned to take advantage from the revival in the economy and when it did happen, the fund gave strong returns. On the other hand, Sundaram Select Midcap fund benefited from the portfolio of well diversified high quality secular growth stories. It is a story of running with a core portfolio of 30 high conviction stock ideas where we are comfortable with the management and their ability to deliver secular growth over the medium term in the most capital efficient manner. So that has always been the strategy and it played out very well in the last one year.

How long is your watchlist which is not part of the portfolio and how do these stocks enter the portfolio?
We constantly keep reviewing around 500 stocks which are part of our investable universe (which are already approved). Within this, there are 250 stocks which we are not invested in and which are on our active radar. We keep evaluating ideas that come through our stocks screeners in terms of growth rates, ROEs, earnings growth and top line growth. Based on all the factors, we shortlist stocks. Our analyst visits the plant and meets the management. Once that exercise is done, we do our own modeling to understand the growth of the company. If we are convinced about the qualitative and quantitative aspects of the business, whether the growth is sustainable and then based on valuations we put it on approval to enter the investable universe. Once they are approved, the fund manager has the option to buy that particular stock.