Anil Sarin of Edelweiss Global AMC correctly predicted the dot-com crash in early 2000. Aarati Krishnan catches up with him to know what Indian investors should watch out for now, and other things
08-Feb-2017 •Aarati Krishnan
Anil Sarin, now the chief investment officer - equity at Edelweiss Global Asset Management, is no longer directly involved in the Indian mutual fund industry. But it was a story told by an ex-colleague of his, now a senior honcho in the fund industry, that prompted me to meet up with him.
He told me that Anil, as a young fund manager in early 2000, was so convinced that a bubble was building up in the dot-com space that he argued vehemently with his colleagues to book profits on tech stocks. He didn't entirely succeed in convincing them. But his timing was exactly right as the dot-com crash unfolded soon.
After fixing up a telecon with him in the second week of December, I spent the week in suspense as Cyclone Vardah swooped through Chennai and proceeded to rip apart telecom towers and phone lines. But my voice call to Anil miraculously went through and we jumped straight into the interview.
I ask Anil to deploy his trend-spotting skills to tell us what Indian investors should watch out for now. Should we be bracing for a big market crash after events such as the Fed rate hike and demonetisation?
Anil flags two global trends that are disruptive - dollar strength and the commodity rebound. "The dollar has been strengthening quite a bit after the US elections and dollar strength has usually triggered a global equity correction." But Anil thinks that emerging market (EM) currencies are oversold and believes that the time is ripe for EMs to come back. The commodity rebound, though, may not be great for FII flows into the country.
What about that big black-swan event that has come flying out - demonetisation? Does it change the sectors and themes that we should bet on? Anil doesn't think that a big market crash is round the corner though. Why?
"Indian savings rates are high. Until now, these savings were going to four windows: gold, real estate, fixed income and equities. Now, two of those four windows are temporarily shut: gold and real estate. The savings remain constant. So what was going into those four windows has to go into just equities and bonds."
But he also thinks it makes B2G companies a good bet and reduces the attractiveness of B2C companies. Err... what are B2G companies? They are companies that sell to or deal with the government. Anil's logic is as follows. Until recently, investors were keen on companies selling directly to consumers because these firms had revenue visibility and pricing power. But demonetisation has triggered a negative wealth effect for consumers. Likely job losses in the informal sector also cloud the consumption story. But with the government likely to benefit from demonetisation and emerge as the largest spender in this economy, it is companies that receive their business from the government that now offer visibility. B2G companies are value bets, too.
Anil cautions that to make money now, you have to be bottom-up. "On a stock-specific basis, there are many sectors and firms doing well and that still trade at reasonable valuations."
Under the radar
Are there any such good stocks that the armies of analysts have failed to unearth, I silently wonder. But he goes on to cite some live examples.
"Take a sub-segment within textiles: the makers of towels, bed sheets - home textiles. They have high return ratios, strong revenue growth and are foreign-exchange earners. These companies have good visibility and economic margins and yet are in low-teen valuations. Or you can look at specialty-chemical companies which are well placed to tap both domestic and export opportunities. There are some pharma companies in the mid-cap space which offer very good return prospects. There are NBFCs which have been unfairly battered and have a very good chance of growing their loan books once temporary hitches are over. They also make higher NIMs [net interest margins] than banks," he rattles off in a rapid-fire fashion.
Anil has told me that Edelweiss' long-only business focuses on identifying '2x by 3 stocks', stocks that double every three years. Sounds great, but with market dynamics changing so fast, aren't such secular-growth stories hard to come by?
Anil says that to do this, it is essential to be contrarian and to avoid 'groupthink'.
Taking a potshot at the crazy valuations for 'quality' stocks in the current market, he says, "A quality stock is thought to be good at Rs 800, Rs 900, Rs 1,100 and even Rs 2000! There is almost no discrimination based on valuations. So when the earnings momentum of such stocks slows down, the impact on the stock price is disproportionate. Then investors ask, 'I bought a high-quality stock, how come it is losing money'?"
He cautions against blindly following the big names in the market. "What is good for an older investor who has made a lot of money, may not be good for a new investor who is just starting out. A seasoned investor may have made his money and may be focused on capital preservation more than anything else. He may be quite happy sticking to the stocks that are right up there on the quality curve. This may not be suitable for somebody who is trying to build wealth. He needs to have a more open mind about the new opportunities." Good point!
Can retail investors hope to compete with professional fund managers in unearthing these '2x by 3' stocks? Anil is one of the few industry professionals who don't make stock picking out to be rocket science. He says quite frankly, "I don't really subscribe to the view that only fund managers who do this for a living can identify such stocks. Yes, if you don't have much time to spare, you can leave it to the fund manager. But otherwise anyone can do it."
Follow the insider
So what are the two or three things that an ordinary investor can do to identify multi-baggers? Anil doesn't try to hoard trade secrets and shares practical tips for do-it-yourself investors.
For one, "Look for companies where promoters are increasing their stake, whether through creeping acquisitions, preferential allotments or buybacks. This information is available in the public domain on BSE. This is even collated on a monthly basis."
As Anil reasons, "The insider always knows more than the outsider. Plus, self-interest beats all other interest. If someone with self-interest is going in one direction, it makes sense for you to also move in that direction".
Edelweiss has found that portfolios built around stocks where insiders have recently increased their ownership usually beat the market. "Individual stocks may make or lose money within that, but if you build your portfolio around this principle, you usually do quite well," cautions Anil.
Two, look for companies with continuous deleveraging. Interest costs coming down every quarter, with flat depreciation and healthy sales, is the indicator to watch for.
Fallen champs and hated sectors
Three, one must deliberately look for stocks in special situations, counter cyclicals and fallen champs. How this is done, I ask. Anil isn't cagey.
"To identify fallen champs, you look for a sector where profits are suddenly turning around from a continuous down cycle. You can then go back to the previous cyclical high and see how much operating profit the firm delivered at that time. A comparison of market cap with that profit can help you take a call."
"In counter-cyclicals, you need to look for a really hated sector and then look for triggers that can change that view. Two years ago, nobody wanted to buy cement stocks, but they have been a great turnaround story. Today, no one touches paper companies, but we see promoters increasing their stakes in this segment. In the September quarter, we have seen a distinct improvement in the earnings patterns of paper companies," he adds.
To make money from 'special situations', Anil favors betting on companies in the midst of demergers and spin-offs where the new entity gets listed.
Mid caps deliver
Our chat so far tells me that Anil leans towards mid-cap investing. So is the view that mid and small caps are risky correct? Is there merit in hunting for good businesses, while ignoring the market cap?
"I would sympathise with that view. Mid-cap investing has worked very well internationally." He refers to internal studies by Edelweiss which show that in the US, over a period from 1994 to 2016, the small- and mid-cap index delivered double the returns of the large-cap index. "In China, mid caps have outperformed large caps by 2.7x in the last 11 years. In Germany, we have 28-year data showing mid caps delivering more than large caps. In India, from 2000 to 2016, if you invested equal amounts in the Nifty 50 and Nifty Midcap, you would have made six times your capital in the Nifty 50, but 12 times in the Nifty Midcap," he rattles off.
But caution kicks in and Anil notes, "This is not to say large caps are avoidable. There is a survivorship bias in evaluating these mid caps." He advocates a prudent allocation to mid caps in the portfolio so that you don't need to meet your emergency needs by selling mid or small caps.
Follow the money, not gurus
Having spent two odd decades in equities, does Anil have a favourite investment guru? Is he a sishya of Buffett? Anil gives a very contrarian answer to that one! Following gurus doesn't work!
"We have a culture of blindly following celebrities in India. But equity investing is all about independent thinking. You cannot blindly mimic some large investor's moves because it may or may not work for you." He reiterates the point about wealthy HNI investors seeking capital preservation, while capital growth is the main thing for the ordinary investor. That may call for totally different stocks and sectors in one's portfolio.
So what style does Edelweiss follow? 'Any style that makes money' is Anil's answer. "Any strategy that makes money for me is fine with me. In our team, we try to see what has worked in the West. It doesn't matter who it has worked for - Buffett or Phil Fisher or Marks. We re-run those strategies in Indian conditions. If we see that a strategy works on back testing, we adopt it. Everybody likes to be inspired by the greats. But we only adopt whatever works on back testing. We are wedded only to returns, not to the personality".
With his stints in both private equity and asset management, where does Anil put his personal money? Mostly in stocks, he says. He quickly adds the disclaimer, "I may be a wrong example. Mine is a risky approach. I put a great deal in equities and over 22 years that has worked to my advantage. I am not advising others to be so skewed."
Anil says he merges the private-equity and mutual fund approach while selecting stocks. "I think like a consultant or private-equity investor while selecting a business. I don't take high return ratios at face value but dig deeper into the root cause for those ratios and identify patterns of success. If I find that a new entrepreneur is shaping his business around the same root causes, I bet on him. That has me led to some multi-baggers."
Has he made any investment mistakes that he has learnt from? For the first time during this chat, Anil doesn't have a quick answer. "I have so many mistakes I am unable to prioritise them to give you a good answer," he says with a laugh.
But he does have lessons that he would like to share. "Whenever I have missed out on an opportunity, it has been because of a closed mind and a very set opinion. Now I have deliberately forced myself to evaluate companies where my inclination tells me not to go there."
A second mistake is to get influenced by rising prices and to increase your positions for the fear of missing out. You need to overcome this, he says, as it often leads to big losses later.
His one piece of advice to every budding investor is to have an open mind. "For the youngster today there are so many resources to read, watch and listen to gain knowledge. What you need to avoid is being caught in an echo chamber. This is why people are getting surprised so often, in politics and markets."
I can certainly feel my mind buzzing with ideas after this refreshing conversation with a truly different money manager.