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Managing 9,000 is a Challenge

J. Venkatesan, Equity Fund Manager, Canbank Mutual Fund, says when I look at the broader picture, I feel the rally is far from over. Opportunities exist in this market for a patient and discerning investor

A postgraduate in commerce and CA, J. Venkatesan's career started with Canara Bank in 1983. He moved to Canbank Mutual Fund in 1990. Since then, he is with the fund house, primarily managing equity assets. Excerpts from an interview:

Market is flirting with 9,000 levels. What's your view? Do you see it as a challenge or opportunity? What's your outlook for the future?

The Indian market has been in a secular bull trend since the middle of 2003 and I believe that this trend will continue for a fairly longer period. Of course, the market will have sharp volatilities as it scales newer peaks. The valuation concerns would keep coming every now and then. I believe the players would be surprised by the companies beating the growth expectations.

Market at 9000 is definitely a challenge for any fund manager. One needs to take a call on the future growth potential of the companies as stock prices build in the future expectations. While we could see plenty of opportunities and no-brainers stocks two years back, market at current levels is a real challenge. Nevertheless, opportunities exist in this market for a patient and discerning investor.

I continue to remain positive in our outlook towards capital market. The singular obsession with many of the market watchers has been that the market has already rallied and today's prices take into account all the positives that are being talked about. No doubt a lot of optimism is implied in the valuation of stocks. But when I look at the broader picture, I feel the rally is far from over. The perception of risk will come down as players gain more confidence on the broader picture.

Market at 9,000 is currently valued at about 15-16 times FY '07 earnings, which is not alarming. Seen from another perspective, the quality corporates can better the nominal growth rate of GDP (which is at about 13 per cent) in their topline and in their earnings and grow by about 18-20 per cent. Even if PE levels remain where they are today, we believe the stock prices will continue to track the earnings growth rate. Market watchers are also worried about the sudden reversal of FII inflows on account of global factors. The foreign holdings in Nifty stand at about 30 per cent. But I believe if corporate earnings growth story is strong, then if West (read US) cashes out, East (read Japan) will come to our rescue as it happened in January this year. The point is that the Indian story is well known in the world today.

Having said all these, I would also like to caution that one cannot expect superlative returns of the recent past but can reasonably expect the returns, which are superior to any other alternative form of investment available to the investors. And the market would remain volatile.

What's your message to the equity (fund) investors in uncertain times like these?
Continuing my arguments, firstly, I do not believe the times are uncertain. Only the era of easy money making is behind us. Current market conditions call for more skills and the stock selectivity would play a key role now onwards. My message would be firstly the equities are the riskier class of assets. That does not necessarily mean one should avoid it. It only means that one should allocate to equities only such portion of one's savings with which he can afford to take such risks.

Secondly, one cannot expect the superlative returns of the recent past from equities. But equities will deliver superior returns over a longer period. Hence one should always keep long term perspective in mind while investing in capital market and should not invest funds meant for short-term requirements in the capital market.

Further, instead of trying to time the market for entry, one can invest in equities through systematic investment plans. I am not too sure investors would be able to track the many variables influencing the market. Hence I believe investing through mutual funds could be a safer option to the investors as they get diversification and quality fund management backed by research.

How do you pick stocks? What are the variables that you look at while selecting stocks? Also, tell us about your research team.
Stock picking is both an art and a science and in my opinion, more of the former. As basically the stock prices reflect the future expectations, one tends to differ with another in the perceived or intrinsic value of a stock. Stock picking is the core of fund management. We take the full advantages of both the bottom-up and the top-down approaches and also consider both the value picks and the growth picks. Essentially, we focus more on the future growth prospects of the company along with the valuation. We believe in combination of different approaches like what Charlie Munger calls 'Latticework of Mental Models' involving application of various sciences to the art of investing. If there are huge growth opportunities for a company and they have the managerial abilities to tap those opportunities, then they merit a closer look.

Continuous data analysis is carried out by our research department to select the companies in terms of attractiveness of valuation and the growth potential. This is followed by due diligence by meeting the management and undertaking the plant visits. We look at variables like quality of management, the size of the market, ability of the company to scale up the operations, the competition and a host of other factors. We do screens on the selected companies and carry out simulation studies and try to arrive at the intrinsic value using various valuation tools. We also look at the possible triggers. Aside from the stock selection, for building the portfolio, the other key factors are allocation and market timing. Here the experience and how well-wired you are in the market matter the most. We look for phases of correction to build the portfolio of quality stocks. We would always look for clear 'margin of safety' between the 'price' and the 'value' of a stock and fine-tune our investment strategies.

Our research team comprises of a research head having considerable experience in the capital market and a team of management graduates. We also regularly interact with many industry analysts.

Most of your funds are heavily invested in small- and mid-cap stocks? For example, half of the assets of the newly launched Canemerging Equities is committed to small-cap stocks. Additionally, the funds' concentration is on the rise with only 17 stocks in the portfolio as on October 31, 2005. Isn't it scary?
Let me first clarify about Canemerging Equities. This is a mid-cap scheme having the investment theme of emerging equities like identifying future Infosys, etc. Here we select the companies which are likely to grow manifold in the universe of stocks having market cap between Rs 100 crore and Rs 2,500 crore as per the offer document. Hence it is not a large cap scheme. Currently about 42 per cent of the funds are invested in companies having market cap above Rs 1,000 crore, 34 per cent of the funds are invested in companies having market cap between Rs 500 crores and Rs 1,000 crores and about 19 per cent of the funds are invested in companies having market cap less than Rs 500 crore. The mandate to me is to look for multibaggers in small and mid-cap segments. This scheme is an aggressive equity product from our stable.

There is always an incubation period for the market to recognise the potential of these companies. And as players gain confidence in their numbers, the scrips would get rerated swiftly and sharply. Hence there could be a waiting period but the returns would be far superior to that of a plain vanilla equity product or that of index. I would only say that the top holdings under the scheme exhibited good earnings growth rates in the recent quarters and also have good growth potential.

A portfolio consisting of 15-20 stocks is well enough diversification to do away the company specific risks. If one understands the businesses they own, there is no need to feel scared. Further as the corpus is currently small, we are more focussed in our investment approach under the scheme.

How do you manage risk? If the market tanks from here onwards, what would be your defensive strategy? Let me explain what I consider as risk. Risk is not only beta or price volatility. Risk is owning a business whose business model is shaky. It is owning a business whose promoters may add value to themselves instead of to the company's balance sheets. It is investing in a new technology, which may fail. It is owning a business where new technology would make the company out of business, etc. Hence to overcome risk, one should be thorough with their due diligence to minimise most of these risks. Our portfolios are adequately diversified across the sectors and across the market capitalisation ranges to diversify away the company specific risks. As regards the market risk, where the overall PE derating might take place, we normally resort to use of derivatives and also increase the cash balances in the schemes as a part of defensive strategies.

Except for Canexpo, all the funds managed by you have seen sharp drop in their assets in the recent past. What could be the possible reason?

All our schemes performed better. It is natural investor behaviour to systematically enter and exit at various index points. As and when investors achieve their targeted returns, they cash out and hence the assets keep fluctuating.

Tell us about each of your fund? How is each of them positioned?

We offer a variety of products with varying risk profiles to meet the needs of different investors. I mention some of equity products. CanEquity Diversified Scheme is a plain vanilla equity product with more weightage on big caps stocks. CanExpo Scheme is an equity product investing predominantly in companies that take advantage of external opportunities i.e. companies having exports. CanInfrastructure Scheme is an equity product investing in companies that help create infrastructure i.e. companies basically taking advantage of domestic opportunities. CanEquity Tax Saver Scheme is an equity product offering both the tax advantage under Section 80C and the advantage of capital appreciation. CanIndex Scheme is a non-discretionary index scheme based on Nifty.

The products we offer under our balanced segment are: CanBalance Scheme- a product having 50 per cent exposure to equities and 50 per cent exposure to debt. CanCigo Scheme is a product having 25 per cent exposure to equities and 75 per cent exposure to debt.

Of the five funds that you manage, one is a debt-oriented fund. How difficult it is to manage a totally different fund? Interestingly, among the funds managed by you, only the debt-oriented fund (Cancigo) has delivered category-beating return this year. Your comments.

I manage the debt portion very closely. We have a good research team on the debt market as well and I do proper duration management to improve the overall yields. Regarding your query on returns, I would like to say we are committed to generate long term returns/wealth creation for our unit holders. Certain sectors exhibit strong out performance over a certain period when the players are beginning to realize their potential/turnaround. About two years back, we focused on commodity upcycle theme and CRAMS theme in our portfolios wherein we picked up many commodity stocks and pharma stocks at attractive valuation and created wealth for our unit holders. We are currently focusing on capex cycle theme in our portfolio. Many of our top holdings are companies that are going to benefit out of capex and infrastructure spending.

These scrips exhibit sharp and swift movement over a shorter period as and when their quarterly results exceed the market expectations. For example BEML went up by 125 per cent in just 45 days during April 2005. The point I am making here is that as the returns come in lumpy fashion, the comparison would become difficult. All our schemes deliver good returns to our investors and we are committed to keep up the performance. Normally people expect fund managers to do 'something smart' everyday and day after day. But we believe in the long term wealth creation for our unit holders through proper investment strategies.

Of the GIC funds that your fund house acquired recently, you will be managing Canfortune '94. What are your plans?
The scheme has a good portfolio of big cap stocks. We will continue with our strategy of creating long term wealth creation for the unit holders under the scheme.

How do you decide when to sell a stock?
Decision to sell is one of the critical decisions for any fund manager. Normally I exit a stock when I find a better opportunity. I exit a stock when I believe the stock price is running ahead of fundamentals. We have a system of review of our holdings when the price moves up by 20 per cent from our cost price or the last review price to decide on booking the profits. We exit partly if we decide to increase the cash position as a defensive strategy to reduce the market risk.