Churning out returns | Value Research Mihir Vora is a man of wit who has certainly done the rounds - SBI Mutual Fund, Prudential ICICI Mutual Fund, ABN AMRO Mutual Fund and HSBC Mutual Fund where he is head of fund management - equities.

Churning out returns

Mihir Vora is a man of wit who has certainly done the rounds - SBI Mutual Fund, Prudential ICICI Mutual Fund, ABN AMRO Mutual Fund and HSBC Mutual Fund where he is head of fund management - equities.

Mihir Vora is a man of wit who has certainly done the rounds - SBI Mutual Fund, Prudential ICICI Mutual Fund, ABN AMRO Mutual Fund and HSBC Mutual Fund where he is head of fund management - equities. When we commented on the male-dominated asset management business and pointed to pictures of seductively clad women in the dealing room, he promptly told us to look across the room at the picture of John Abraham, whom he stated was even lesser clad than the women.

What does he do in his free time? He claimed to be a family man at heart who loves to spend time with his two children and quickly took a jab at us by asking us if we wanted to know which his favourite books were.

No, we did not ask him that question. Instead we got his views on the market and the funds he manages.

Do you feel that the recent RBI measures to curb inflation will choke growth?
What the RBI is attempting to do is control unnecessary speculation in certain sectors, either by direct or indirect means. Broadly, I would say that the RBI is on track. The positive to look at is that there is ample liquidity available for growth. We are not facing a structural shortage of liquidity in India. The problem is a deluge of liquidity. It's a problem of plenty and these are short-term.

Have interest rates peaked in your opinion?
It's too categorical a statement too make. There is some upside scope even now given the fact that fear of inflation remains. But I don't believe we will witness a 200-300 basis point hike in interest rates from this time onwards. I don't believe interest rates are going to shoot up drastically.

Will corporate earnings slow down?
Yes. I think it will start slowing down from this year onwards. We have witnessed about 30 per cent compounded earnings growth for the past four years. I don't think that will be the case for the next three years or so. Realistically, one should expect an earnings growth between 15-20 per cent.

Over the past few years, we have already seen the best of the commodities cycle and the best of the local cyclicals in commercial vehicles, cement and capital goods etc. They had a negative and abysmally low profit base, which has been corrected in the last four years. Now we are into normal profitability levels, meaning further margin expansion will be difficult. It has already taken place. So now top line and bottom line growth should be in sync with each other. In the last few years we have seen bottom lines grow much faster than top lines. That is not going to happen anymore.

But you are positive on a 15-20 per cent growth?
As long as our GDP grows at 8 per cent, 15 per cent bottom line growth is possible. When you talk about 8 per cent real GDP growth, you have inflation at around 5-6 per cent which will mean 12 per cent nominal GDP growth. Add a bit for efficiencies and economies of scale and you will see that 15 per cent top line and bottom line growth is possible.

In such a volatile market, what specific strategy are you employing for fund management?
Well, there are a number of ways to deal with the volatility. We have begun using derivatives to some extent for hedging and portfolio balancing. Derivatives help when impact costs of entry and exit are high in some stocks, markets are volatile and liquidity tends to dry up. To some extent, we use cash calls to shift our asset allocation, though not frequently. Moving across various market capitalisations is another method. If the view is conservative, we shift into large caps. If aggressive or bullish we will turn to small- or mid-caps. Sector preferences may vary from time to time. If the market is volatile, one tends to opt for less volatile sectors. We might get more aggressive if we are looking at a secular run.

What risk measures do you have in place?
We have two people dedicated to risk management and measurement who are not part of the investment team. They look at the risk from the company and portfolio management side. So they do the performance attribution and risk analytics on a monthly basis. What we mean by performance attribution is to break up the performance of the portfolio every month into components. This will tell us why the fund has outperformed or underperformed. It is essentially to confirm that the portfolios being run are managed in line with their objectives. Each portfolio will have an internally defined limit of tracking error.

We also measure portfolio liquidity risk. We want to ensure that if there is a large amount of redemption in a portfolio, liquidity should not be a big threat. Sometimes, fund managers tend to go overweight or underweight which works well in a certain market conditions. But when the market turns against the fund manager or the call, it tends to have disastrous consequences. We want to avoid this. Our risk control systems ensure consistency and “true-to-label” portfolio management. Each fund has a specific positioning. When you launch a fund with a stated objective and positioning, the compliance and risk control systems ensure that each product is run true to label. For instance, if mid-caps don't do well, the large-cap fund is not expected to under perform since it does not have a mid-cap orientation.

Which are the sectors you are avoiding because of volatility?
In a situation of rising interest rates, we would reduce exposure to interest-rate sensitive sectors. Banking, construction, capital goods to some extent, automobiles - all these sectors have some linkage to interest rates.

Which sectors are you avoiding because of steep valuations? Real Estate? Airlines?
No we are not avoiding these sectors. We do have some exposure to real estate - not very heavy - and I believe that after the recent correction, some of the stocks are looking attractive again. We also have some exposure to airlines. Given the current valuations, a lot of the negatives have already been incorporated in the price. If you look at the sector per se, the top line growth, it is a fast growing sector for sure --- a secular growing sector. What needs to be monitored is the degree of competition and the fuel costs. That is what we are closely monitoring.

Where valuations are concerned, we are not too happy with the FMCG. It's growing but the growth-valuation equation is not favourable. For the same reason, we are also significantly underweight on large pharma companies. We are also avoiding the oil and gas sector.

What sectors are you looking at this year? What are your contrarian bets?
The broad thematic calls have not changed. The only sector where we have reduced exposure sharply is the banking and, now, cement. We are consistently overweight on IT services and reasonably weighted in favour of telecom. We have also been bullish on the infrastructure-linked sectors - engineering, capital goods. We have also been quite positive on the automobile sector. As for contrarian bets I would like to take a close look at banks in the next couple of quarters. Right now the sentiment is bad. Banks as a sector have underperformed significantly. Given the current growth that is happening, we would like to take a contrarian bet on it.

What sort of an investor are you?
I am a growth investor at heart with a very, very intense focus on valuations. I would like to pay a reasonable price for the growth that we are looking at. I am pretty good in identifying growth opportunities and also fairly adept at timing the entry and exit. The sole criteria for a stock being in our portfolio is valuations adjusted for growth. I tend to churn my portfolio quite frequently because as stock prices keep moving, so do valuations. Valuations are monitored on an online basis and we discuss our portfolio positioning every day. If we find no opportunity, we may sit on cash or switch to another stock or sector. I am not a typical buy-and-hold investor but if you look at the portfolio you will see a fair amount of continuity because we see growth continuing and we see stock prices moving in line with growth. So if a stock goes up 40 per cent and earnings have also gone up 40 per cent, valuations have not changed and we continue to hold on to the stock. But if a stock goes up by 100 per cent and earnings have grown by only 25 per cent, then there has been a valuation expansion which will force us to take a very close look at that stock.

Your fund house focuses on the top-down approach to investment. How does that fit in with your investment style?
It's a combination of top-down and bottom-up. We are about business cycle investing. We believe that we need to change our portfolio positioning based on our views on the local and global business cycle. So the top-down overlay comes from the call of the business cycle - on the global and local level. The bottom-up approach comes from stock selection within sectors.

Time-to-time, when we see a shift in the cycle, we also change our style from pure growth investing to a blend of growth and value investing. Or a bias towards more value investing if we believe the cycle is turning for the worse. Essentially, I think most fund managers in India are growth investors. India is an emerging market and we are a secularly growing economy. In a bad year we grow at 5 per cent, in a good year at 9 per cent. We have not seen huge downturns in sectors except in the late 90s.

Just because India as a secular growth story is pretty well established does not mean that we can ignore the reality of the business cycle. So though the bias may wary, most fund managers have to use the combination of top-down and bottom-up because they cannot ignore sector or economic fundamentals. The problem with value investing is that it typically may not suit the profile of an open-ended fund investor. When you buy value, you know there is a limited downside but what is not known is when the upside will get unlocked. And we have not seen many investors who can wait that long. Investors have a mind-set of quick returns. True value investing may not suit most investors.

After a great run, why did HSBC Equity dip in performance?
The HSBC Equity Fund is a pure large-cap fund. After a superb run till 2005, the fund underperformed for a few quarters. That was essentially because of sector picks, which worked very well earlier and then underperformed. These were PSU banks, oil and gas, computer hardware - which we were overweight on earlier - and sectors like IT, telecom, engineering, capital goods which we were underweight on. So we got hit on both, underweights and overweights. So what we did at the first two quarters of last year was to sell a lot of our oil and gas and PSU bank holdings. We added a significant amount of large-cap IT, telecom, engineering, construction, capital goods, and private sector banks.

HSBC Advantage India and HSBC Equity share similar portfolios. How do you differentiate between them?
One factor is theme concentration. Advantage India is a thematic fund - it focuses on two or three broad themes that we believe are driving India's growth. Right now the themes are infrastructure, consumption and outsourcing. So within the infrastructure theme HSBC Equity has a 25 per cent exposure - capital goods, engineering and cement. But the exposure will be much higher in the Advantage India fund, around 35-38 per cent. Another differentiating factor will be the market cap exposure. HSBC Equity is a pure large-cap fund so 90 per cent of the portfolio will be large-cap. Advantage India has no market cap bias and right now has a 30 per cent mid-cap exposure. Moreover, at some point in time if we have a very strong call, we may increase the sector concentration in Advantage India and run only two themes. So despite there being a commonality in terms of the broad theme/sector calls, the risk profile of both is very different.

HSBC India Opportunities underperformed the category in 2005 but did well in 2006. Reason?
The sector mix is one reason. We had about 5-10 bottom up stock picks which did very well. It also managed to capture a lot of upside on the realty side.

Like the Advantage India fund, the Opportunities fund does not have to restrict itself to a particular market cap. But it does not have to focus on two or three themes. So it also has pharma and real estate stocks which you will not find in the Advantage India fund.

Do investors confuse HSBC Unique Opportunities with a contrarian fund?
This fund looks at various elements. It looks at any situation out of the ordinary. So it will have a bit of contrarian investing, value investing, special situations investing and mid-cap investing. The target investor will be one who is willing to invest for three years or more and able to stomach more risk. For instance, a stock like Infosys will not feature in such a portfolio. Because we are looking at “not normal” business conditions. A stock like Reliance was a special situation when they launched their telecom business. Bombay Dyeing was a special situation two years ago when the company decided to stop textile operations in Bombay.

What is your message to investors?
The India growth story continues. India is still a long-term market for investors. What must change are return expectations over the next few years. Valuation re-rating has taken place and we are not expecting it to happen for 2-3 years. PEs were single digit in 2002 and now normalised at 15s and 20s. Earnings too have peaked. Commodity sectors were just breaking even four years ago. We are back to normalised profits and normalised margins. So we are not expecting an extraordinary jump in earnings going forward.

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