We aren't married to any one style | Value Research Anil Sarin, Chief Investment Officer, Equity, Global Asset Management, Edelweiss Financial, talks about what differentiates the AMC from its competitors
Interview

We aren't married to any one style

Anil Sarin, Chief Investment Officer, Equity, Global Asset Management, Edelweiss Financial, talks about what differentiates the AMC from its competitors

Edelweiss Financial has succeeded in making a splash with its differentiated schemes. Anil Sarin, an investment manager with a long stint in fund management, venture capital and hedge funds, has recently joined the group as CIO - Equity. He deep dives into how the fund house picks stocks.

We aren't married to any one style Anil Sarin, Chief Investment Officer, Equity, Global Asset Management, Edelweiss Financial

What differentiates Edelweiss AMC from the other fund houses?
Edelweiss Financial has many different businesses in India - broking, investment banking, distressed credit, asset management and portfolio management services (PMS). What we are trying to do at the Global Asset Management division is to increase the interface between these different groups to form a more holistic view of the opportunities that are available.

Secondly, Edelweiss has historically been very strong in quantitatively driven trading. However, the fundamentals side had got less attention over the years. Now we are trying to meld these two styles to give a better product to our investors. We think our quantitative approach can really differentiate us from the rest.

How do those quantitative skills help in improving your funds?
We have found that the use of quantitative parameters in investing really helps in a down-cycle. We have experienced this over time. Our Absolute Returns Fund, for instance, may not rise as much as the market in a bull phase, but it will also contain the quantum of fall in a correction much better than other funds. Over the long term, this leads to a better return.

In other funds such as Emerging Leaders Fund, we are using quantitative approaches to identify stocks. In the large-cap space, the leaders are well identified. Everyone knows what firms are the leaders in banking or autos. So in large caps, a fund can only differentiate itself through sector allocations and sector rotation - knowing what sectors will outperform in the future and allocating funds to them.

But in mid and small caps, the choice is enormous. By using quantitative techniques, the job of identifying stocks becomes much easier. Of course current financials are not everything; there will be turnarounds, mergers, acquisitions. But by using quantitative screeners you can screen much faster the stocks which you would like to own in the mid- and small-cap space.

Are these quantitative filters based on technical analysis?
No, we mainly use fundamental filters, combined with other factors. For instance, we track the insider action in stocks, both on a quarter-to-quarter and on an episodic basis. We can then put our choice of companies through this screener to see if insider actions coincide with our view. Basically, blending analysis with such quantitative data helps us to be ahead of the game in identifying stocks. Thereafter we can decide if these stocks deserve the small investor's money.

When do you sell a stock?
You can take one of the two approaches. You can buy stocks for the long term and ignore short-term uncertainties about earnings. But this approach can work only for a few stocks in your portfolio - for the companies which are in an expanding market, have a good competitive edge and so on. You cannot take this approach for the whole portfolio. Our approach usually is to look for 2x by 3. Basically, we look for stocks that can double in three years. Yes, this is easier if you are starting out in a bear market and harder in a market like today's. But this filter ensures that a mediocre stock is not bought. It also prevents us from blindly following a trend. About a year ago in this market, ROCE had become an end unto itself. If there was a 30 per cent ROCE business, people were willing to buy it at any P/E.

Take Symphony - a stock which is part of our portfolio. If its P/E is already at 80 times, the question we ask ourselves is whether it can outperform from this level. If it can't meet our bar, we may trim our positions. In this context, one factor we really emphasise is idea velocity - the generation of new ideas. It is only if you constantly have new stock ideas, that you can sell older positions in the portfolio.

The focus of your funds seems to be on mid and small caps to a large extent. But many fund houses, as a risk containment measure, don't buy stocks that are below a certain market cap or level of liquidity.
We currently have an advantage that our fund sizes are small, so we can explore these opportunities. Second, over the last decade or so, the corporate attitude to investor relations has dramatically changed. Earlier companies would only deal with large investors and there was a quid pro quo: You buy my shares and I will give you extra attention. But now companies are willing to address themselves to investors at large. Thirdly, many companies put out additional disclosures on volumes, expansion plans, segment performance and conference call transcripts on the web.

Sometimes we find that tracking a company's statements in its concalls helps us gauge if the management is keeping its promises. So, if you organise your teams in a manner that goes after such information, there are a lot of ideas to be found.

The survival rate among mid and small caps in India is really low. How do you deal with this?
Absolutely right. The mortality of companies increases as you go down market-cap rankings. But mid caps also deliver superior returns over the long term. This is where qualitative factors become very important. Is there a competitive edge that the company enjoys? Is the company growing in the right segments? At the same time, we try to identify our mistakes early, admit to them and exit them. Booking losses early is very critical to successful mid-cap investing.

There is a lot of polarisation in the market today. Quality stocks are trading at very high P/E multiples. Cyclicals and leveraged companies are trading at rock-bottom valuations. How are you dealing with this?
I am glad you asked this. In the markets, different styles tend to outperform at different time periods. In 2000 or so, dividend yield and value strategies were popular. Then there was a phase when growth stocks were all the rage. Thereafter we have had this big 'quality' phase. The last four-five years have been marked by continuing outperformance of these quality stocks. But we think that if you focus only on this segment of the market, you can lose out on opportunities that may deliver over the long term.

We follow a hexagonal approach where we look at six factors to select stocks. Quality is one parameter. Secondly, we also look at counter-cyclicals. In 2013, if you had bought infra stocks, your portfolio would today be up three times. Thirdly, we look at what we call 'fallen champs'. We look at turnaround stocks like SKS Microfinance. For more than a year, the stock was available at ₹80-100. RBI had come out with new norms that said that MFIs would be eligible for priority sector lending, while many other NBFCs wouldn't be. But if you were looking for ROCE, you would have missed the stock.

Fourth, we look at firms that are climbing the value curve, but suffer from poor perception based on the past. One example is Aurobindo Pharma, which we participated in. Throughout 2000-2010 it was perceived to be a commoditised pharma player with falling realisations and high capital intensity. But the company had realised this and had begun to change from being an API player to being a formulations player. It also integrated forwards into owning its US marketing network. This changed its margin profile. It was available for ₹200 then; now it trades at about ₹1,580.

Another important area is special situations. Here Granules India is a good example. It was a commodity player which built enough competence to be a cost leader. It acquired a firm which had eight-nine better molecules and consciously climbed up the value chain. The stock moved from ₹220 to over ₹1000.

The last and sixth theme we look for is leadership in a niche sector, such as movie exhibition, content creation, education and so on. If you obsess about ROE and cash flows in such ideas, you would never buy them.

This hexagonal approach ensures that we aren't married to one style. We are able to cast our net wider for stock ideas for our fund portfolios. When the theme changes from growth to value or from value to quality, we hope to suffer less.

The fall in global commodity prices has accelerated recently. So, will that be a trigger to improving earnings in India?
Yes, of the emerging markets, India is the only nation (apart from Turkey) which is a large commodity consumer. Insofar as FIIs have an allocation earmarked for emerging markets, they may allocate more to India. The letting up of inflation will also lead to lower interest rates. When interest rates and inflation fall, the companies which are the most efficient converters of commodities benefit. In this quarter you saw all the FMCG companies retain high margins by holding onto prices, while raw material costs went down. But it is not just FMCG firms, others such as steel product makers may benefit too. Not only this, we will see substitution happening. Some companies may start using aluminium or steel in place of wood. We can expect these factors to come together to boost profits. Companies with distribution strength, brands and conversion economies may be able to expand their margins.

Will the parliament logjam affect FII flows or market returns?
One thing being understood by political parties at large is that business as usual will not carry on. Development, governance, corruption are starting to make a difference to electoral outcomes. Recent municipal elections in MP show that, despite a scandal there, people are choosing economic betterment. Economic betterment also strengthens the middle class and civil society and brings in transparency. So economics is making more and more of a difference to politics. Even in Bihar the critical arguments are not about caste alignments but about development. This realisation should help sorting out of the logjam in the parliament.

This interview appeared in the October 2015 Issue of Mutual Fund Insight.


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