Chasing Value | Value Research Sankaran Naren, Co-Head (Equities), Prudential ICICI AMC, says he is a value investor and normally likes to buy stocks where there is no consensus on the optimistic side
Interview

Chasing Value

Sankaran Naren, Co-Head (Equities), Prudential ICICI AMC, says he is a value investor and normally likes to buy stocks where there is no consensus on the optimistic side

Sankaran Naren, Co-Head (Equities), Prudential ICICI AMC, says he is a value investor. He normally likes to buy stocks where there is no consensus on the optimistic side

How do you see the market in the coming days?
Volatile. Very volatile. Looking at the short-term, valuations have clearly run up. Investors were favouring the large-caps because they were not very leveraged. But gradually, after all the acquisitions, we are seeing large-caps also leveraged. This is a concern. Neither do we think that the market has factored in the rise in interest rates.

The quarterly results have been stupendous. And if you look at the corporate results, based solely on that, you can say that the market is doing extremely well. But if you take into account interest rates and inflation, you can see that the markets are extended. Interest rates and inflation will have an impact on near-term valuations.So there is room for slowing down.

In India, investors are primarily underweight in equities as compared to real estate. Real estate is more leveraged than equities. From that angle, domestic leverage in equities is low, specifically now. Eventually the market will recover as we see inflows when it goes down. We have to correct the balance. Look at a stock like Bharti Airtel that has a two per cent public holding. Now we are seeing a situation where local holdings and domestic mutual fund holdings in large-caps are down. So after a correction, the markets should bounce back.

What about your long-term view?
In the long-run, things look positive. The reasons being starting June 2008, we will soon have gas. This will improve our resources as far as the energy side is concerned. Also, for the first time in my investing career, I have seen government revenues increasing due to the boom in the economy and not due to high tax rates. These are two powerful positives that can help the market move.

The demographic story is good. The growth dynamics are positive. But I would like to see growth without inflation going too high. Or rather, without high asset inflation, particularly on the real estate side. In the near-term, an investor may even get a negative return on his investments because valuations are expensive. But in the long-run, an investor can expect a return of 14-15 per cent per annum.

Don't you feel that is a low estimate?
Some say that corporate profit as a percentage of GDP can't continue to expand beyond a point. So if you go by that argument, we have an 8 per cent GDP and 5-6 per cent inflation. So in nominal terms, GDP grows by 15 per cent. If you assume that in the long-term corporate profits stay stable to GDP, it is very difficult to expect huge returns, as we have been seeing over the past few years. In my opinion, corporate results were good because the large-cap companies managed their debt burden very well by borrowing overseas and reducing their cost of funds. Some of the high debt-oriented sectors have not done too well because the interest rates have begun to pinch. Sooner or later profits will be impacted. And we have seen margin pressure in the two-wheeler industry. Over the medium- to long-term this will extend to other sectors too.

We think a 15 per cent return per annum is low but the international investors don't think so.

Do you see a slowdown in FII inflows?
We think that they are pumping in a lot of money but all these global strategists tell us that they are underweight on India. So even if they put small percentages of their portfolio in India, we think it is a huge amount. Since they are underweight, they have the scope to go neutral or overweight. In the long-term, they all accept the fact that they need to be overweight on India and China.

Which sectors are you bullish on?
At this point of time, I am bullish on healthcare, utilities and consumers - selectively because the large-caps can be costly. Till I see headlines stating that real estate prices have fallen across the country, I will avoid real estate. We have even cut our exposure to companies which have real estate as part of their reason for investing. So we have cut our exposure in indirect real estate players as well.

You joined Prudential ICICI AMC around two-and-a-half years ago. The funds have been doing very well. What is the reason? Any change in process?
Today we have a fairly large team. Including me, there are five fund managers, four analysts and three dealers. Each of us has sector responsibilities. We meet regularly with clarity on what has to be discussed. Every morning we only look at the immediate issues. In weekly meetings we discuss sectors and in monthly meetings we discuss strategy. As funds get larger, we have realised that we cannot time sector entry and exit. As our AUM has increased, we have had to follow processes in tune with our size. We cannot say this is my top sector and I won't sell. With an AUM of Rs 15,000 crore, if we have 15 per cent in banking, it turns out to be Rs 2,250 crore. You cannot expect to time entry and exit to perfection.

For instance, we bought cement stocks six months before the boom became apparent. And we have now trimmed our allocation to cement as the boom continues. In May, when yields were at its highest, we increased weightage to banking. As yields came down, we slowly sold banking and reduced our sector weightage. We have to be ahead of the market and be patient. Yet we cannot wait for the sector to peak and then begin to trim it. That is what we have realised where non-secular stories are concerned. br/>
Is there any particular investing style that you adhere to?
I am a value investor. And I know that most people regard that as dull. I normally like to buy stocks where there is no consensus on the optimistic side. And I would love to sell stocks where there is consensus on the optimistic side. So as a result, in the 2000 boom, I completely missed technology. This was in my pre-fund manager days. In this boom, I missed real estate. Not that I regret missing the consensus bull ideas. Because I have seen the period 2001-03 when everyone was distraught but I was pretty happy. In 2000, you could have aggregated 10 non-tech stocks and it would equal the valuation of one small infotech company. But a few years down the line the returns told a different story. Look around and you will see that out of 100 fund managers very few follow a value strategy, in one sense of the word. My value fund takes contrarian bets and it is the worst performing fund but is my favourite fund. In the long run, it will pay off. As long as 100 follow growth and 10 follow value, the 10 will always win. If majority follow value, then it will fail.

Everyone is growth oriented. So people start seeing capital goods as a secular story for the next 10 years. And when that starts happening, there is scope for the value investor.

There are so many equity funds in your kitty. Yet, not one fund is known for its particularly huge size. Any reason?
There are two reasons for this. For one, we do not want one single fund getting too big. I believe that if funds become too large, it is difficult to manage them and to outperform the benchmark. Our biggest local fund -Dynamic Fund - would be around Rs 1,750 crore. If you see stocks that a $1-billion fund can have, it is much narrower. Indian markets are not yet exposed to purely benchmark performance. Relative return plays a large role here. If the market becomes very benchmark driven, then you can probably have a scenario where some of the funds will get consolidated. Also, in such a scenario, some of the smaller funds will find it easier to do well.

In the current scenario, I would say that an open-ended large-cap fund should ideally not be more than Rs 3,000 crore while for an open-ended mid-cap it should be Rs 1,500 crore.

This is one reason why we have started Fusion - our close-ended funds. Because you can manage mid-cap more easily when there is a lock-in period.

Secondly, there will be a number of funds because each will cater to a particular need in the market.

Tell us about the various funds in this context.
We were of the view that the three growth drivers of the Indian economy are infrastructure, outsourcing and consumption. Based on this, we have the three theme funds: Prudential ICICI Infrastructure, Prudential ICICI Services Industries and Prudential ICICI FMCG.

Prudential ICICI Discovery is the value fund. This will be of significance to a long-term investor since value stocks have underperformed growth significantly in the past few years, particularly the last two. From a slightly shorter term view, Prudential ICICI Dynamic Fund will be a good choice. This is an opportunities fund that will take cash calls as the market goes up. So now, in a scenario where valuations are expensive, this fund will always have a certain amount in cash. Prudential ICICI Growth is primarily a large-cap fund. Prudential ICICI Emerging STAR is a mid-cap fund. Prudential ICICI Power is a blend of large-caps and mid-caps. Of course, this name is very misleading.

Where your thematic funds are concerned, the portfolios include all sorts of stocks other than the theme.
We run our theme funds like multi-sector funds. Very rarely does a sector goes over 30 per cent of the portfolio. May be in Prudential ICICI Services Industries, it could be 26 per cent. In Prudential ICICI Infrastructure, we have rarely crossed 25 per cent. We do not have formal methods of risk control but internally we all agree that we don't have to take a high level of risk to achieve returns. So you will not see very concentrated sector bets in our portfolios. Select stocks may have a weightage of up to 6 per cent but it would be more the result of price appreciation.

Our infrastructure portfolio would have all stocks excluding technology, FMCG and pharma stocks. It would include banking and metal stocks and commercial vehicle companies. During the tech boom of 2000, we witnessed how a narrow definition of a theme fund can result in huge losses. Hence, we took a decision to have a much more broad-based definition of a sector in a theme fund. And we have seen the benefits. Post May, when construction fell, we were not as overweight in it like some others and so were not as badly hit.

What is your advice to investors today?
Investors must have a proper asset allocation and do a proper risk assessment before investing. They must recognise the risk in every asset, including real estate. And in this time in the cycle, they must not be leveraged.

Indian investors must partake in their own country's equity. Look at stocks like NTPC or Bharti Airtel. Both had visibility for years. But you will find that the public shareholdings in these companies have become quite small. The problem is that investors are looking for very high returns. Remember the craze for RBI bonds some time back where the returns were 9 per cent and tax free! Had investors invested in any equity fund at that time, they would have got a much better return. But at that time people were not keen on investing in equities. For debt investments, an investor can consider FMPs. By the time it matures, he will have the cash to invest in equities if a correction has taken place by then.

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




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