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Interview: Spirit of Discovery

When Sanjay Sinha took over the helm of equity investing in SBI Mutual Fund last year he faced a tough task ahead considering the success of his predecessor. But he has done a good job and confesses to ending 2006 on a great note

When Sanjay Sinha took over the helm of equity investing in SBI Mutual Fund last year he faced a tough task ahead considering the success of his predecessor. But he has done a good job and confesses to ending 2006 on a great note

Sandeep Sabharwal did an impressive job with his funds and achieved a lot of popularity. How did it feel taking his place when he quit SBI Mutual Fund? Intimidating? Apprehensive?
(Grins) It was very challenging for a number of reasons.

The first being the high expectations of investors - thanks to the spectacular track record of the funds. And to top it all, almost the entire investment team had also moved out except for two. Setting up a new team from scratch was no easy task in October-November 2005 given the level of activity and movement one was seeing in the asset management companies at that time. With these factors at play, there was an apprehension that assets would shrink. But none of these fears really materialised. In terms of performance, we have done reasonably well. We enjoy 5-star rankings at Value Research and our funds are top quartile performers. We have a brand new team in place. In addition to me, we have four fund managers, four research analysts and two dealers - one dedicated to derivatives. We plan to increase the number of analysts but are being very selective and would prefer those with a proven track record in analysis. In April 2005, SBI Mutual Fund was managing Rs 1,400 crore of equity assets. Today, that figure has risen to Rs 10,000 crore.

Your assets have grown because of the plethora of NFOs that SBI Mutual Fund has come out with. The money coming into SBI Mutual Fund is a mix of both. The new funds have also got in money but our existing ones too have grown. Take Magnum Contra which was managing Rs 220 crore in April 2005. It now manages Rs 1,400 crore. Magnum Taxgain managed around Rs 80 crore at that time. It is now a Rs 1,100-crore fund. Magnum Global too has grown to Rs 900 crore.

So what's behind your success? Any magic formula?
Yes. Hard work! There is no shortcut to generating performance. The key is in having a right mindset. You must consciously avoid being a closet index manager. Don't judge your performance according to the index you are benchmarked against. You must work at outperforming it. The fund manager has to look at the universe of stocks and then figure out how he can best create a portfolio that will deliver a superior return.

This is a mammoth task as we have 2,500 traded stocks. So you need a team that will be able to look at the more addressable part of this universe. This research team should be capable enough for the fund manager to trust with their advice. We need to keep the spirit of discovery alive in the hearts of analysts. Just because the stock did not look promising, does not mean it has to be ignored forever. The fundamentals could have changed. So it's not just looking at new ideas but even older ones with a fresh approach.

How do you begin your selection?
The first level of exclusion will be the size, by which I mean, the free float of the stock available. A large number of stocks will get excluded at this level. Then we look at some sectors, which we think are the emerging ones. By now the list will be substantially reduced. In some sectors, margins may continue to be under pressure or secularly falling despite factors in the environment indicating that margins should be rising. Then they would get eliminated. Then we run a check on the quantitative measures. Is there any particular factor that throws up the company on the screen or draws attention to it? For example, banking stocks that have a very high price-book value would get excluded. Capital goods or engineering stocks that have a fairly slow earnings-growth momentum in an environment when the order book is growing tremendously would get eliminated.

Magnum Contra was known for its aggressive bets which you worked at toning down when you took over. How do you position that fund? Don't you think it is by nature an aggressive offering?
Not particularly. This fund is not positioned on its style of management. So I would not say that it has to be aggressive or conservative.

This fund will zero in on stocks where there is a gap between the expectation of the market, as reflected in the stock price and the inherent value of the stock. When you exploit this expectation gap, you are a contrarian investor. And that is what this fund is all about.

It does not refer to just an under-owned stock. That is a very limited definition and would not ride various market cycles. For instance, in today's market there may not be many stocks which are under owned. Yet that does not mean there are no good contrarian bets out there. So this fund will zero in on stocks where the market's growth or earnings expectation is more subdued than ours. This does not make it more aggressive or conservative or more risky than any other diversified equity fund. It just means that an investor will have to have more patience with this fund. This year, we had a high exposure to the engineering sector. It January, the sector looked expensive in terms of valuations. But now, a year down the line, it has paid off. Because our top line and earnings growth expectations was much more aggressive than the rest of the market.

There is a myth in the minds of many investors that if FIIs don't buy into a sector, the value of it will never get discovered. We don't believe that this will prevail for too long. We believed that banking was a good sector since the stocks were trading at good PB values. So we bought into this sector and it was much later that the foreigners bought through ETFs.

But you did tone it down in terms of exposure to a stock.
Yes we did. Individual exposure to a stock is a personal decision. But even at a lower level of exposure it is possible to generate substantial performance. You don't always need a high exposure to a stock to generate returns. With moderate exposure one can also generate a sustainable performance. We also toned down the mid-cap exposure and increased the number of large-caps. This turned out to be timely because this year large-caps outperformed.

As a fund house, SBI is known for astute stock picking. Yet some of your new funds don't fit in with this perception.
Your organisation has a stand of not recommending NFOs. But all funds have to start as NFOs. And we have been working at providing a very diverse mix and filling in all the product gaps. Everyone has a perception. People tend to view fund houses in a particular way like this one is bottom-up stock picker but that one has a more top-down approach. There was this misconception that SBI Mutual Fund was primarily a mid-cap oriented fund house. But that's not so. We are good equity asset managers not just mid-cap players. Our multicap fund has done extremely well.

Your One India Fund sounds like an incongruous offering. What's the logic behind that fund?
This fund is benchmarked against the BSE 200.

We divided the stocks in this index into four regional portfolios. We then backtested these four portfolios and stocks over the past five years. We discovered that every year one particular regional portfolio stood out in performance. And over the past five years, at least two of them outperformed the BSE 200. So the logic is that if we put the bulk of our assets in two of these regional portfolios, which are expected to do better than the others, then the chances of the fund outperforming are higher.

BSE 200 is a tough index to outperform. It has a large number of stocks with a fair number of mid-caps. Yet, from 2003, except from May 2006 till date, it has underperformed the mid-cap index. If you look at the performance of the market from the Sensex levels of 3,000 to 14,000, the journey will show that many stocks which were small-caps became mid-caps and mid-caps became large-caps.

We don't think that 14,000 is the end of the road. The market will go much beyond. So we have to identify more small companies across the nation that will benefit from the macro economic growth in the economy. To do so, you must have your ear to the ground. That is why we targeted the various regions with a mix of companies.

What were the main drivers of the market, late 2005 and in 2006?
Interest rates, commodity prices and the thrust on infrastructure.

A prominent factor impacting market sentiment in 2006 has been interest rates. There was a lot of market activity revolving on whether the Fed would raise or lower interest rates. Much of the gains seen in the stock prices were a direct function of the commodity prices having gone up. We saw that happening in steel, non-ferrous metals and oil related stocks. The crash in May 2006 was also triggered by the commodity prices softening overseas.

In the Indian context, it was the thrust on infrastructure and the order books that the engineering companies were able to build up.

The performance of the banking sector as a whole has also been a function of the performance of interest rates. When the G-Sec yields spiked briefly… about 8 per cent, the banking sector hit bottom. Thereafter, G-Sec yields have actually been coming down. The banking sector has been able to overcome the obsession with the impact they would have on their treasury books and the core earnings of the bank determined by their interest income.

If you look at year-on-end performance, banking has been one of the best performing sectors in the market.

Will these factors continue to dominate 2007?
Yes. All these factors will continue to have an impact on the markets this coming year.

Another factor to consider will be the relative flow of liquidity into the market from the foreign investors vis-a-viz the domestic investors.

In December, FIIs were largely negative and mutual funds largely positive.

In 2006, India cornered a major proportion of flows that has moved into the emerging markets. Whether the same proportion will get allocated in 2007 is to be seen. It may not be the case. But India has a lot of issuance of new paper in the pipeline. Markets are at a level where you need a lot of liquidity just to sustain that level.

The rally appears to have been liquidity driven but in hindsight, that has not been the case. Why did the money come to India in the first place? Because the foreigners believed much more in India's growth story than we did. But look at the way the economy has transformed over the last three years. I don't think we have reached the end of the growth story. We are just at the inflection point.

The hardening of the interest rates is another issue if it restricts consumption. Then it will be a tough year. But if the momentum of domestic consumption is strong enough to tide over the rising interest rate, then we are in for an equally good 2007.

Domestic consumption is a big factor because it contributes to 65 per cent of our GDP. There is an impression that there is a lot of leverage consumption thanks to benign interest rates. If the interest rates tighten, consumption too will tighten. But we have to take into account the very strong growth in income supported by a high aspiration level. If this outweighs the tightening of interest rates, then the domestic consumption story is in place.

Which sectors are you bullish on in 2007?
Engineering. We believe that a lot has to be done in infrastructure. The 11th five-year plan outlay has earmarked Rs 14,50,000 crore for infrastructure with a substantial amount to be raised by the public-private partnership route. This opens up a new space for the engineering and infrastructure-related sector.

IT is another sector given the superior growth compared to other sectors. India has a large educated population which can be channelised to knowledge-based activity and the IT sector provides that platform. Concerns of wage-cost inflation and rupee appreciation will continue.

Many have given up on commodities as a sector but I take a contrarian stand on it. I am not referring only to metals, it could be agro and cement. The near-term outlook on the sector is not very bright. But because of the paucity of natural resources and demand which is not slowing down because of the Indian and Chinese economy growing the way they are, we believe that commodity prices will not remain low for too long.

I am not very bullish on pharma as a sector though individual stocks will do well. Just like in 2006, we will see stock specific activity.

I am also cautious with oil and gas which is dependent on government policies which will be populist thanks to the state elections.

Mid-caps should do well in 2007.