How did you come in the fund management industry?
I am a chemical engineer from Anna University, Chennai. I joined Essar Steel and later ONGC as a production engineer. I then did an MBA in finance from IIM, Ahmedabad and joined SBI Mutual Funds in campus placement. After one year of research at SBIMF, I was asked to handle the portfolio of Asian Convertible Income Fund. I joined Sundaram Newton AMC as a fund manager for equity funds in August 1996 when they were about to launch operations. The first equity products were launched in February 1997.
What were the differences between SBIMF and Sundaram?
In SBIMF, I got to manage the Asian Convertible Income Fund by 1995, when the boom period was over. This was largely a residual equity portfolio, composed mostly of convertible debentures converted into equity. This wasn't a very desirable portfolio—the stocks that got converted were typically not frontline stocks—so my task was to reorganise it and reorient it towards the BSE National Index, which was its benchmark. Sundaram was very different—those were formative times in terms of its fund management philosophy.
Tell us about the process of fund management at Sundaram.
We have four people. I double up as fund manager. I double up as an analyst and fund manager. One other analyst is an assistant portfolio manager. Essentially, we see our jobs as equity analysts. Our investment process is based on a clear philosophy that equity returns follow earnings growth. If a company's profits grow at a CAGR of 20 per cent over a decade, then the stock will also grow at 20 per cent over a similar period. That is our fundamental tenet. We arrived at this tenet through global research as well as our own research in India.
Our second tenet is that superior returns are possible if you buy such earnings growth companies only at a reasonable price. Our basic rules of investing combine both fundamental and technical aspects of the market.
Thus, our focus is on the earnings growth of companies and of sectors, and on the relative attractiveness of companies in terms of valuation. We look at a stock's upside potential and its downside risk. We calculate all these parameters daily and review them every week for our portfolio.
The portfolio is constructed based on the ratio of the upside potential to the downside risk. Stocks in which this ratio is highest will be rated aggressively and those where this ratio is lower will be rated less aggressively. To illustrate, a stock with 60 per cent upside and 30 per cent downside will have a ratio of two.
Yes. Different products have different criteria. The portfolio which is benchmarked to BSE 200 broadly operates with 90 per cent of its stocks from the BSE 200. For example, if we have 35 stocks in a portfolio, then around 32 stocks will be from the BSE 200 and only three will be from outside the BSE 200. Similarly if Nifty is the benchmark, then none of the stocks in the portfolio will have a lower market capitalisation than the stock in the Nifty with the lowest capitalisation. The total number of stocks that form our universe is around 130. Of these, roughly 40 are large, liquid, high-market cap companies that are present in the Sensex and the Nifty. The bottom 20 in this universe are the sporadic, theme-oriented ones that come and go. For example, there are two paper companies in the universe because, globally and in India, the paper cycle seems to be looking up. The last 20 companies are cyclical stock of low market cap which are used for playing a specific cycle on which we have confidence.
Between these two lies our mid-cap range. Some of those stocks have become obsolete but we continue to monitor them even though we no longer invest in them. So while the total universe is 120, if you exclude the bottom 20 and the obsolete stocks, we are clued on to around 80 stocks at any point of time. We diligently track their quarterly results. The stocks we are less interested in, we may track less intensively. For example, we tracked Srichakra Tyres very closely during 1998-99 but today we are not very upbeat about it so we track it with less intensity than, say, Reliance or Infosys.
What did Sundaram's joint venture partner, Newton, bring to the table?
Newton is predominantly a institutional fund manager rather than a retail one. They have an in-built discipline vis-à-vis the benchmark. They are thoroughly governed by the benchmark since they have been giving their investment mandates on the premise of these benchmarks.
Within this framework, the investment expertise they bring to the table is based on the premise that the market moves around certain themes. If you identify these themes, regardless of which sector they belong to, then you come out ahead.
I'll explain what is meant by themes here. Today, globally, outsourcing is a theme. A large number of corporates are outsourcing activities that are not core to their businesses. The moment Newton identifies these themes, they go very strong on stocks that are part of the theme. This idea of themes has fetched them huge gains since their inception.
Can you illustrate this with a few more examples on how you implemented this idea of themes in India?
For example, privatisation is a theme. MNC buyback—MNCs buying back companies—is a theme. Another theme is consolidated accounts. Markets tend to look at only the listed entities of a certain parent companies, often ignoring the value embedded in unlisted subsidiaries. So when consolidations become mandatory, one can look at companies that may look better when consolidated.
No, the entire investment philosophy is centered around themes. It is their way of investing in the equity markets. We tried to replicate that philosophy in India, but unlike the global market, the number of stocks available on a particular theme may not be very high. For example, in Europe they look at leisure and welfare as a big theme that grows out of changing demographics. Like in India, two-wheeler demand is something like this. You could look at the wage-earner profile and see how demographics are changing, and what is the transport infrastructure available to this wage-earner, and one could have seen ten years ago that there would be a strong two-wheeler demand. Today, similar trends are at work. There is a huge number of graduates who are going to be employed in IT-related services which creates its own sub-themes in terms of the type of impact it will have on the demand for goods and services.
Obviously, this is going to benefit some companies. Unfortunately in India, such fundamentals-induced themes have not been very powerful. Like we tried to play the theme of the wage-revision of the public-sector employees when the Ninth Pay Commission brought about a huge one-time payment to government employees. We tried to see how this could benefit consumer durable companies but we could not convert this into a profitable opportunity.
In US or Europe, you can come up with ten or fifteen companies even under a small theme and you can play it. That does not happen in India. Here even in a big theme, you can come up with just two companies. So we had to moderate this investment style according to the way the Indian markets work.
We focus on earnings growth and valuations as our investment philosophy. Themes are more of a backdrop to our investments.
Where have you succeeded most with the idea of themes?
As I said, themes have not been a great success for us. Our success has been more with growth and growth-related re-rating of stocks. Micro-based research has fetched us more returns than macro-based concepts like themes.
We have made money where we have caught the fundamental changes right. That is the reason that today our focus is on earnings in stocks where fundamental changes will lead to earnings growth that is different from the broad consensus of the market. The actual earnings growth has to be different from the consensus expectation for the stock to deliver superior returns. Globally, this is the way most portfolio managers work.
Definitely, it does. The earnings growth in the broad market is a respectable 15 to 20 per cent. Our idea is to first capture that 15 to 20 per cent reliably. We shouldn't shoot ourselves in the leg while aiming for the sky. Suppose the profit growth is broadly 15 per cent and we want to deliver 17 per cent return. To achieve that extra two per cent, we obviously have to take certain deviant calls, but only to the extent necessary to achieve that extra two per cent.
We do not have to put the entire portfolio at variance with the broad Indian corporate sector in order to achieve that extra two per cent. If I get two or three ideas that deliver better returns than the consensus, then that is all I need to beat the benchmark and to deliver better returns. To the naked eye, the bulk of my portfolio looks like the rest of the market. But if you look closely you will see a Tata Tea, a Bharat Forge or a Union Bank. These are deviant bits that will probably account for around 15 per cent of the portfolio which I think will make all the difference. This approach has consistently beaten the benchmarks. This is also not the kind of approach that is dependent on doing very well in one cycle and that having to live with that in the next four cycles. This is a consistent approach that will probably keep on delivering outperformance continuously even though the outperformance will be milder than what someone else can deliver occasionally.
Size leads to size and lack of size leads to lack of size. It is a cycle that we have to break out of. There are two kinds of funds. There are big brands, driven by big size. Some of them have good performance, some don't. There are also funds driven solely by performance, not by size or brand.
Fortunately, while we may not be a big brand, we do have good performance. What we are trying to do is to take our funds forward by making more investors aware of our performance. Also, over the next year or two, we will commit more money towards making our products more widely known.
It is 70 per cent marketing-related and 30 per cent fund management-related. While we are a consistent performer, we are not a top-of-the-charts performer. One year of topping the charts would put our five years of consistent performance in good light. Clearly, we are aware of the fact that we need to catch investors' attention over the short-term to leverage our consistent performance. We do have some level of urgency to be on the radar on some short-term basis in order to showcase our funds.
Some of our new products are strategically meant to do this. Because of our conservative image we have been getting pre-empted in the market by some aggressive fund houses. Our Sundaram Select Focus fund is meant to rival some of the so-called aggressive funds. It will be a volatile product but will deliver the goods. We are very confident that it will be a chart-topper.
Another fund we have launched is the Sundaram Midcap. There is a tendency for fund managers of diversified funds to play illiquid midcap ideas much more aggressively than a diversified fund should play and show good returns, thereby appearing to be performing much better than others. To pre-empt such competition, we wanted to box such products into different segment so that investors can compare apples with apples. That's the marketing perspective. From the fund management perspective, we wanted to move away from this business of daily comparison of NAV with indices. Equities deliver returns only when you have the patience to hold on. Over the last ten years, some of the best returns have been provided by companies like Bajaj Auto, Ranbaxy, Hero Honda and Dr. Reddy's if you had bought them when they were not so large and held on for long periods.
The idea is to invest in promising mid-cap companies and hold on. We tell investors that enough of this weekly comparison of NAV with the indices—this is going to be a classical stock-picking fund.
You have spoken about stock research exclusively in terms financial fundamentals. However, many Indian investors give a great deal of weight to management quality. How are you able to research this with your small research team?
One-on-one meetings with the management are not the only way to assess management quality. While one can get insights into the minds of a CEO by getting to meet him once in a while, action speaks better. For example, the merger ratio between one group company and another is enough indication of what is going on in the minds of the management rather than whatever they state. We lay a lot of emphasis on the mosaic theory. We put together bits and pieces of information—which may be meaningless by themselves—which when put together, give you a complete picture of a management's ability. The actions of a management speak louder than their intent and a thorough assessment of their actions is the best way you can judge a management.
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