Change Agent | Value Research Sandip Sabharwal has a tough task ahead in his new responsibility as the CIO (equity) of JM Mutual Fund. Being a small fund house with mediocre funds, all eyes are set on him to see how he delivers

Change Agent

Sandip Sabharwal has a tough task ahead in his new responsibility as the CIO (equity) of JM Mutual Fund. Being a small fund house with mediocre funds, all eyes are set on him to see how he delivers

Sandip Sabharwal has a tough task ahead in his new responsibility as the CIO (equity) of JM Mutual Fund. Being a small fund house with mediocre funds, all eyes are set on him to see how he delivers on all fronts

What were the key drivers of the current bull run?
The prime driver has been the overall performance of the economy. Earning growth of companies has been impressive even in times of severe wage inflation in many industries and high commodity prices, which lead to higher input costs. In my view, corporate earning growth in 2006 should range between 35 per cent and 40 per cent.

The second factor has been strong liquidity. Last year we did see a drop in FII inflows by around $2 billion, yet it was substantial at $8 billion. Domestic mutual funds pumped in around Rs 13,000 crore. Besides, there is also money that flows into equity which is not that apparent. For instance, ULIPs have been growing substantially and putting money in equities.

Do you think liquidity will be an issue going forward?
Valuations are at fair levels and not cheap. To sustain fair valuations, one has to have substantial liquidity. The key factor now is if liquidity will support the market. I do not see domestic liquidity being an issue. As of December 2006, the cash position of MFs was around Rs 12,000 crore. So even if no fresh money is raised and this finds its way into the market, it will provide ample liquidity.

It is difficult to take a call on FII inflows at least for the first two months of 2007, since the global liquidity tightness might continue at the start of the year. But for the year as a whole, I don't see the foreign inflows coming down. The BRICs theme has been getting substantial attention globally. While India and China are considered as separate investment themes, they will continue to get funds next year irrespective of how other emerging markets are faring.

What factors are you concerned about this year?
Given the current consumption and investment demand scenario, the economy will grow 9-10 per cent in 2007.

The biggest risk to the market is inflation. In an attempt to control inflation by containing liquidity, the RBI is raising interest rates. If interest rates shoot up too quickly, it will have an adverse impact on the economy. When economic growth slows, it will have a multiplier effect on the way markets behave. The good news is that most commodity prices have come down. If this translates into lower inflation, the risk to the economy would reduce substantially. In that case, we would see the entire interest rate regime peaking out by the middle of the year and then falling.

Low commodity prices will be good for India because we are into a big investment cycle where commodity consumption is high. The bull run in oil seems to be over and if oil sustains at $50-$55 per barrel, it will be extremely good for India.

What about a global slowdown?
A slowdown in the global economy will only negatively affect India sentiment wise and will slow down the fund flows from FIIs for a while. This will impact the market in the short run.

In the long-run, the impact will be positive. The bulk of India's growth comes from domestic consumption and investment. A global slowdown will result in a drop in commodity prices, which means a drop in input costs which means inflationary expectations are controlled.

The sectors one must watch out for, positively and negatively?
Technology, because of the sharp momentum in the kind of deal flow happening. Even mid-sized companies are getting large orders. So even though there is wage inflation and concerns of rupee appreciation, large-sized deals combined with the pricing power tech companies have today should sustain their earnings growth over the next few years.

Cement is a clear demand growth story and it will be much higher than the historical averages. There are huge investments in housing and infrastructure. The capacity expansion is not that much so it will give a lot of pricing benefits to cement companies. Automobiles is an interest-rate sensitive segment. So when interest rates rise, these stocks tend to correct. There has been a fear of slowdown because of rising interest rates. But volume growth has been good for a number of companies and most companies have been able to sustain their margins even though input prices have gone up. Given the fact that growth in per capita income is strong, auto sector demand will continue to be strong. Some sectors, like capital goods and construction, are overvalued but the fundamentals still remain strong. So here we will see some consolidation before stock prices move up. In real estate, valuations have gone much ahead of what the intrinsic valuations are but the growth momentum is there. After a few corrections, these sectors will look good. I am avoiding the commodity-led sectors like oil and gas, metals, steel etc.

I have a contrarian view on the airlines sector. There is extreme pessimism. If you look at individual airlines, 40-50 per cent of the cost is due to fuel and if oil prices come down the way they are expected to, these stocks will benefit. None of the institutions hold any of the stocks. So a positive may lead to a huge rally.

What are the challenges you face in J M Mutual Fund?
The key challenge is to ensure that JM Mutual Fund is recognised also as an equity fund house and not just a debt player. On the fixed income side, the funds have performed well and we also pioneered the arbitrage fund. The equity corpus has been very small - just Rs 200 crore out of Rs 4,000 crore managed by the fund house.

But I faced a similar situation in SBI Mutual Fund. Over the past three to four years, the equity corpus grew from around Rs 300 crore to Rs 6,000 crore by the time I left. The key reason for the growth was that it was performance led. Our research focussed investment philosophy helped us identify a large number of winners when they were relatively unnoticed. This is the kind of investment philosophy we are seeking to implement here. Earlier there was just one person on the fund management side now we are three, along with a four-member research team, a technical chartist and two dealers. This is a team that can sustain growth till we have assets around Rs 6,000 crore.

What changes do you plan in the investment philosophy of J M Mutual Fund?
My first task was to bring about a cogent investment philosophy for the fund house. Broadly, I am a firm believer in the bottom-up approach to investing where decisions are taken on the basis of evaluating a company on its merits. Before investing, I like to meet the management of the company to get a proper perspective on their capabilities and ability to deliver above-market returns. I also look at return ratios, growth in sales and profits and trends in the movement of return ratios.

Occasionally, the analysis is top down. For instance, three years ago when I was in SBI Mutual, we saw the potential of a huge infrastructure boom. The key was to find companies that would exploit this opportunity. We picked up IVRCL Construction and Nagarjuna Construction. Both have gone up by multiples of the price we purchased them. Similarly, in 2004 we looked at the sugar sector and figured that these companies would grow rapidly over the next few years. The industry was witnessing a volume growth and a number of these companies were setting up plants. We picked up Balrampur Chini which went up 7-8 times. I am an aggressive growth investor. Once I take a broad industry call and specific company call, I like to take an aggressive exposure. The aim is to have concentrated well-researched portfolios, which would be around 20-25 in terms of the number of stocks per portfolio. My firm belief is that unless a particular stock is at least 3 per cent of the portfolio, the performance of the stock may not impact the overall scheme performance to a great extent. A small portfolio can be well monitored while a large one will mean half the stocks are underperforming at a given point of time, which reduces investor returns.The number of stocks in most JM funds has been brought down from 45-50 to 20-25.

How difficult is it restructuring the portfolios of the funds?
It is relatively easier to restructure the portfolio of small funds than that of large ones. The largest fund was only around Rs 55 crore when I joined.

Sector funds do not interest investors too much and these products are not going to grow. Over the long-run we will look at consolidating them but right now will run them as stand-alone funds. The funds with specific mandates will be run accordingly.

JM Equity will be the flagship fund with an opportunities tilt. We will move between large- and mid-caps. We will work with a maximum of 30 stocks.

For Emerging Leaders Fund we will identify companies which could be a multiple of their current size in a few years. This will be a growth-oriented fund which will have a concentrated portfolio where the churn will be low.

JM Basic was an oil and gas fund which later got converted to a basic fund that can now invest in capital goods, engineering and oil and gas. Since the size was small, the portfolio was very concentrated with around 11 stocks. By the end of this month, we will increase this number to 20 stocks to ensure adequate diversification. This fund will target current growth industries.

JM HI FI Fund concentrates on sectors which benefit out of economic liberalisation. We plan to come out with a mid- and small-cap fund because we believe these stocks will outperform the broad market over the next few years.

Won't you have a problem looking for good buys at current levels?
In an economy that is growing so rapidly, one can always find a few good ideas which can grow aggressively. One does not need 40 or 50 multi baggers to generate huge returns.

There is a difference between actual risk and perceived risk. The key is to identify companies where the growth is so strong that it takes care of the valuation fears. Out of 10 ideas, you need just three or four very good ones for the entire portfolio to do very well.

Today the GDP is around Rs 40,00,000 crore. If it grows at a nominal 14 per cent, that is Rs 6,00,000 crore, some companies may double and treble in sales. One has to hunt for such companies which will outperform in terms of growth in turnover and earnings.

The long-term returns from equity is around 18 per cent. I think this year the overall market growth should be less than that. The test will be in picking up sectors and stocks that will outperform the market.

This interview appeared in January 2007 Issue of Mutual Fund Insight.

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