R Janakiraman, the Deputy CIO and Senior Portfolio Manager (Equities) at Franklin Templeton Asset Management Company (AMC), has been managing the fund house's small and mid-cap funds since 2008. Not only did he brave the 2008 Global Financial Crisis, but he also witnessed the 2020 debt crisis back home. Given his vast experience, we sat down with him to learn about his investment strategies, mid and small-cap outlook and an outline to improve the performance of the Franklin India Prima Fund.
Here's the edited transcript:
How will you define yourself as an investor? What kind of stocks or situation excites you?
In general, I would classify myself as a careful investor. My approach has been to make returns by investing in good-quality businesses and steady compounders. There are a few operational financial parameters that I seek out when I evaluate businesses. But in this approach, the interesting opportunities come only during bear markets. Those are the times (like in 2012-13 or 2018-19) when such good-quality businesses tend to trade below their intrinsic value.
How do you sell stocks from your portfolio?
I operate a lot in small-caps, so good-quality businesses and mid and small-caps had a meaningful increase in valuations. Internally, our tolerance level for the valuation of such businesses also went up, driven by the fact that the interest cost came down. This was because the interest cost and the cost of capital are meaningful inputs into calculating what an acceptable valuation metric is. So, even after that, I think valuation went beyond our comfort zone in many cases.
So how we tackled that situation was by trying to use a standard deviation kind of approach. If it's a very good quality business that has good earnings visibility for the next two or three years, then allow the position to continue in the portfolio up to about a one-sigma standard deviation in terms of valuation. I think once it goes even beyond that, that is where I think the odds begin to start going against the investor. So that is when we also start to reduce our exposure to such stocks.
So, somewhere above one standard deviation, that is where we start to reduce the exposure.
You started managing mid and small-cap funds at the start of the global financial crisis in February 2008. What lessons have you learned?
If you look at the mid-caps, for example, at least the upper half of the mid-cap today, the quality of the business, the consistency in terms of execution, and the width and depth of the research coverage that is available about those companies, I think that is as good as most of the large-cap companies.
Even within small-caps in 2023 versus 2018, there is a meaningful difference in terms of the approach of the small-cap promoters. Also, I think now you see far more small-cap companies where, for promoters, market cap is a meaningful objective because it was not so directly visible earlier.
And because of this objective of the market cap, the level of transparency and communication amongst the small-caps has gone up. Still, the extent of research quality is not very good. But I would say that companies are now much more willing to talk to investors and communicate with them.
Definitely, the volatility levels in small-caps have been much higher. That said, I would say that the average quality of the business has gone up.
And since we're talking about mid and small-caps, do you think the current valuations are scary?
I would not use that same brush to paint the entire category (as expensive). You have reasonable pockets of acceptable valuation, both in mid and small-caps. One can avoid those extremely valued segments and still build a reasonably effective and viable portfolio.
The second is the fact that I prefer to look at valuation in conjunction with earnings growth.
One of the reasons why, for the last decade, we saw relatively modest earnings growth was because the cyclical parts of the economy were not working, which is both the real estate cycle as well as the industrial capex cycle.
I think both of them have seemed to revive over the last two years, which means that, like I said, the macro tailwinds will be much better for the next three years or so. This means that earnings growth, especially for mid and small-caps, will be better. So, in light of this better earnings growth, does it justify the slightly higher valuation? The answer is probably yes.
The Franklin debt fund crisis led to people withdrawing from your equity funds as well.
We saw some churn in terms of our team. We saw the departure of two portfolio managers and about four analysts.
Now, more than 11 team members are on the research side. Their average experience with Franklin is now probably about five or six years. That's the average, including those who joined us for the last two years. So, to some extent, I think the behaviour of the leaders ensured that the team did not have too much of a tough time during that 2020-21 period.
Of course, we did have redemptions, we did not see those inflows. Now, we have started to see some inflows of late.
What is your view on the performance of Prima Fund?
One thing is that I allowed some of the underperforming stock in some of the positions to continue for much longer than I should have.
The second is that if we look at Prima's performance in the past, while it comes across as reasonably satisfactory versus the index across the cycle, it typically tends to do well in a flat market or a slightly weaker market. So, it will lose out in a very strong market because of the slightly more cautious approach.
Which is why I would say that perhaps it's a bit unfair to look at the performance test after the end of a slightly strong phase; maybe once we complete a full cycle, a truer picture may emerge.
Also read: Interview with Ajay Tyagi of UTI AMC
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