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Stock Selection is the Key Now

A fund with well-diversified portfolio and which consciously avoids undue stock or sector concentration should be bought now

Naresh Kumar Garg has done CFA, MBA, MIE (Electrical Engineering), and IAC from London. A recipient of the prestigious 'British Chevening Scholarship for the Senior Executives' for the year 2002, he demonstrates investment technique, which is predominantly influenced by fundamental approach. He has over 16 years experience in the mutual fund industry and has the experience of fund management across all the important risk classes. He moved to Sahara Mutual as Chief Investment Officer in May 2004. Excerpts from an interview:

How do you see the market trends as 2005 comes to an end and we move to 2006? What impact they would have on mutual funds?
The year 2005 reflected strong confidence of investors, both Indian and foreign, in Indian corporate sector performance. The record investment by the Indian mutual funds and foreign institutional investors (FII) alike in the Indian stock markets in 2005 is a testimony of this fact.

The Indian economy is witnessing a structural shift with a clear focus to become one of the leading economies of the world in the next decade. The corporate performance has been on the upswing and companies across all the leading sectors have posted strong earnings growth in the last 10 quarters. The government is following a rational approach to reforms. In 2006, the investment in the stock market will become highly selective with clear emphasis on good stock selection rather than taking sectoral approach. The mutual funds witnessed a strategic shift in the sales mobilisation with more and more investments flowing into equity assets. I expect that fresh mobilisation in equity funds will continue to grow at a healthy pace. With the interest rates stabilising at around current levels, the Indian investors are rightfully seeking more attractive returns from equity assets through mutual funds.

What is your view on the current levels? Are the frequent bouts of volatility a cause of concern? Do you see it as a challenge or opportunity? What is your outlook for the future?
I believe in the valuation depth of the stocks held in the portfolio rather than only looking at index. The index level per se does not reflect the attractiveness or otherwise of any particular stock market unless it is analysed in the light of growth rates achieved by important companies and the potential in the near future. In India the P/E multiple of the index currently is at an attractive level considering the profit growth rates achieved by the leading companies in the last 2-3 years and good potential for the future growth on the back of strong demand, capacity additions and focus on cost efficiencies. Overall, the Indian stock market is at an interesting stage and good skills in stock picking would immensely help the portfolios to deliver superior returns.
The volatility in the Indian market is here to stay and one needs to equip himself with better and superior knowledge about the companies and sectors and their growth potential to remain ahead of times. In volatile times it always pays to stick to basics and have faith in fundamental approach to investment.
Maintaining a cool head in turbulent times like these may be a tough task for an equity investor. What message would you like to give to the equity (fund) investors?
In these interesting times, the right suggestion would be to pick and choose funds which have high quality portfolios and which do not have potential illiquid stocks. A fund with well diversified portfolio and which consciously avoids undue stock/sector concentration should be preferred. Investors should allocate a good portion of their savings for investing in equities through a diversified investment vehicle like mutual fund. Be long term in your investments to reap full benefits of the transformation, which our Indian corporate sector is experiencing.
What is your stock selection process? What are the variables that you look at while selecting stocks?
Portfolio of each scheme is strictly based on the specific investment objective and a disciplined approach is followed for selecting stocks from such group of investible ideas, which meet the scheme's objective. While for a diversified equity fund, there would be a mix of top down and bottom up approach, a specific equity fund like mid-cap fund would have more emphasis on the stock specific selections. While selecting a stock the management quality and capability is the foremost criteria and has the highest weightage. We also look at the sector in which the company is operating, the growth potential of such a segment, the technology being used by the company and its comparison to the most efficient technology available globally.
We put special emphasis on evaluating the strategies being consciously followed by the companies to achieve cost efficiencies over a longer period of time, whether the company has pricing power and the potential benefits of such position/strategies. We evaluate in detail the financial and business risks of the companies, the expansion plans and how rewarding the company is to its shareholders.
We use multiple valuation models for fundamental analysis to arrive at the intrinsic value of the company. We also evaluate the downside risks and the upside potential. In addition to this, we have detailed technical analysis to try and time the entry and exit points.
Tell us about your research, fund management and dealing team.
We have a compact dedicated team of research analysts, which support the investment team both in equities and debt. We put a lot of emphasis on our research on economy, various leading sectors as well as high quality companies whether known or relatively unknown but having good growth prospects, liquidity and value propositions. While the research team relies heavily on the financial information from companies and other secondary sources, the analysis of information is done in-house. We have one of the most experienced fund managers handling debt and equity. Moreover our dealing department has a dedicated experienced team to ensure the best prices for our deals. The three functions are independent as regards their functioning and reporting. However, there exists excellent co-ordination in information sharing and they blend well and investment decision is well informed.
What is your strategy for Sahara Growth Fund? What investors should expect from the fund?
Sahara Growth is a diversified equity fund with the objective to provide long term capital appreciation through good diversification across sectors. The strategy for the Sahara Growth is to predominantly invest in large cap growth stocks which promise medium to long term capital appreciation with a small asset allocation to good mid-caps with portfolio beta close to the market, i.e. closer to one.
Recent changes in income tax regulations have made ELSS an attractive category. It is also a great opportunity for the funds to attract some long-term money. How do you see Sahara Tax Gain's role in the category? Why an investor should invest in this fund?
Sahara Tax Gain Fund has a performance track record of over eight years and has been one of the most rewarding funds in its category.
The fund is positioned to give higher returns than a diversified equity growth fund mainly because the investors' money remains with the fund for a longer term enabling the fund manager to invest in stocks providing attractive returns over longer periods of time. The investment philosophy thus relies on longer-term investment strategy and hence the selection process of stocks is quite different compared to other equity schemes.
Sahara Midcap's portfolio is committed to small and mid cap stocks. What are the key factors that you look for while selecting an investment worthy small-cap stock? How challenging is it to dig out for gems from the poorly-researched universe of small-cap stocks?
I take pride in saying that we consciously attempt to stick to the specific fund objective and follow an investment discipline, which rightly reflects the portfolio composition for which investors have posed confidence by investing with us. The fund has objective to invest in companies having market capitalisation in range of Rs 60 to 6,000 crore. However, we avoid investing in the lowest range of market capitalisation owing to liquidity constraints and higher impact cost.
The stock selection under Sahara Midcap has always been more challenging due to absence of adequate coverage by good research houses, restricted availability of financial information and relatively lower visibility. Here, more emphasis is placed on understanding the business better, the management thinking and capacity to attain higher scalability. While all the companies in the portfolios have high growth potential, our selection model prefer those companies from this small but unique universe, which are deep in value.
Recently, you introduced Sahara Wealth Plus Fund. How is it different from other equity funds?
Sahara Wealth Plus Fund adopts a different approach to select stocks. It is based on Return on Equity (ROE) a company delivers. It has been empirically proved that those stocks that post higher ROE generate wealth for shareholders over a longer term period. In fact we created model portfolios purely based on ROE of stocks, and not surprisingly we found that the portfolio comfortably generated returns more than all the benchmark indices over a period of 3-5 years. It is not that we do not consider other fundamental attributes before purchase. We use ROE as a prime filter and then analyse the stocks for investment in the manner described above.
How do you manage risk? If the market tanks from here onwards, what would be your defensive strategy?
The unique feature of our portfolio construction and management is to put concerted efforts in selecting right stocks, deciding on the portfolio weightage based on important factors like growth potential, valuation depth between the current market price and the intrinsic valuation, nature of the business in which the company is, the historical long term return to the equity stakeholders and the liquidity of the stock. The portfolio is constructed keeping in mind the risk profile of companies. Adequate diversification is ensured even where we follow bottom-up approach. The emphasis is on the fundamentals, rigorous monitoring is done and a disciplined approach is followed in profit booking. The portfolio risk is adequately covered through dynamic stop losses and strict adherence to price targets for the portfolio companies. Detailed portfolio risk analysis is done regularly and corrective action is taken to ensure that the portfolio risks are well within manageable limits.
How do you decide when to sell a stock?
Intrinsic valuation of a stock is the main guiding factor for determining the continuation or exit from a stock and the process is well enshrined in our investment process. A close monitoring is kept for over/under valuation to decide on exit strategies. Relatively more attractive alternate opportunities are also evaluated continuously to maintain a good portfolio mix. Any negative news on the company/sector is analysed carefully and our portfolio position is re-evaluated on a regular basis.