Value or nothing
'We buy stocks with a minimum $1 million in traded value per day and we stick to this,' says I V Subramaniam, Director, Quantum AMC
By Aarati Krishnan | Jul 4, 2018
Quantum Mutual Fund has always been the norm defying rebel in the Indian mutual fund industry. It pioneered the direct-to-investor route, has stayed off new fund offers over the years and embraced value investing, with cash as residual in their process, which most rivals shy away from. Unknown to many, Quantum Advisors also manages one of India's largest portfolio management schemes and has been an advisor for many years to foreign institutional investors thronging to India. So, with the markets turning moody, we thought the time is exactly right to talk to the AMC that would give us the honest truth.
While the firm's flamboyant founder Ajit Dayal has been much in the news (he stepped down recently from Quantum's Board), it is its nerdy Director I V Subramaniam, who has been the investment wizard steering its equity functions for many years. Value Research decided to catch up with I V Subramaniam - Subbu to his colleagues - for an in-depth chat.
Buy or hold cash?
'With global interest rates spiking up and the notorious ZIRP (zero interest-rate policies) ending, is the Indian market in danger of a derating?' I ask Subbu, jumping straight in. Subbu is quite matter of fact that we should expect it. 'If lowering of interest rates led to the low cost of leveraging and lower discount rates and this was pushing up the prices of financial assets, then any reversal should also work the same way. We should brace for derating of financial assets.'
But there's a qualifier. 'The change in interest rates that we saw in the last four to five years has not been in market determined rates. It was more of a policy driven change. Policy architects might decide even now to continue with low rates. So even though you may think rates are going to go up, something quite contrary may happen, too. So, the advice is simple. Don't speculate and hold high quality funds that have solid processes. When money is easily available, small caps do extremely well. So, that is one area where risk could lie. We should prepare ourselves by buying stocks which are solid or where valuations still look reasonable.'
The cash positions in Quantum Long Term Equity Fund have been the subject of many Twitter debates lately. I ask him about why the fund still held a 16 per cent cash position in end February after the correction. Isn't the market throwing up buying opportunities?
Subbu says that no 'large-scale' buying opportunities have sprung up. 'Some of our existing portfolio holdings have become more attractive because their prices have corrected and we have been able to add more. By and large, India has offered a lot of stock specific opportunities lately. One has had to keep digging deeper for value. Last year, IT and pharma stocks offered value. This year some consumer discretionary names look good. Banking also looks good. So we have deployed some cash. But no, we are not deploying all of it yet.'
Is Quantum able to sit out opportunities because it's a relatively small fund? Subbu quickly refutes that. 'Size has no bearing on this. We like to go after liquid stocks that fit our criteria. We buy stocks with a minimum $1 million in traded value per day and we stick to this.'
The Quantum rule book
But with such liquidity filters, won't Quantum miss out on small-caps - the superstars of Indian bull markets? 'There are some small-caps and mid-caps which tend to have good liquidity and at attractive valuations, we will buy them. But there are some stocks that are not liquid and a small amount of money in them can push them higher. We don't want to chase them. Nor do we want to alter our stock selection criteria for different market conditions. When we went to investors, we went with the mandate of investing in the liquid names in the market, mostly from the BSE 200. Now, if we break that rule to invest in small caps, our team will be in uncharted territory and we will be doing something other than what we promised. We don't want to do that. So, we are okay with losing out,' says Subbu, reiterating the Quantum play-by-the-rules credo.
Quantum managers swear by value investing. And they've told me that they like to buy stocks at a 40 per cent discount to their estimated fair value and sell them when they hit the fair value. But does such choosiness work in frothy markets? There may be very few stocks at such deep discounts, I remark.
Subbu admits that Quantum funds will underperform in a frothy market. 'We know that. If we start tweaking our strategy based on market movements and remain invested in a stock just because the markets are great, then that will be going into uncharted territory. We had high cash positions in 2014, 2015 and 2016. Despite all this, our long-term track record looks good.' That's certainly true because Quantum Long-Term Equity is among the top two funds on a 10-year basis in the large-cap category.
The ever-cautious Subbu qualifies this though. 'When you hold cash because of high valuations, you need to be prepared for quick turnarounds, too. For instance, in February 2016, we had to very quickly deploy the cash when the market collapsed. Bounce backs also happen very quickly. At the end of February 2016, we saw an upside potential of nearly 60 per cent on our portfolio over a period of two years. Right now, the market has already given 44 per cent return since then. If at that time we did not move, we would have lost out. So holding cash also means moving very fast when corrections happen. And there will be times when we will have to sell early and wait.'
I ask him about something that's been bothering me for a while. Given Quantum's strict rules on discount to fair value, have there been long periods when the fund did not find any stocks to invest in?
'We think of that 40 per cent discount as ideal, but there are situations where we are ready to take a lower discount. We are also aware that in some sectors, we will never get that 40 per cent discount to fair value, for instance, in consumer staples. These are good businesses, great brands and are cash generating. So there's a margin of safety and hence we can accept a lower discount. I remember, in 2014-15, after the Modi win in the elections, valuations started galloping and our cash position increased to as high as 30 per cent. For a year, I think, we were not able to make any significant new investment. Only in January-February 2016, when the market corrected, were we finally able to buy. So that can happen. You may find the odd stock but not many stocks.'
What about the other problem that most value investors have: selling too early and missing a big move? It can happen, says Subbu. 'If buying a falling stock is like catching a falling knife, selling it thinking that it is reasonably valued can sometimes hurt, too. The market may continue to reward it.'
Does value work?
Given that we've been agreeing on everything so far, I decide to provoke him on his value investing thesis. Many fund managers in India say that there's nothing called value investing for this market. What you get when you try to buy cheap stocks is value traps. Can Quantum cite examples of deep value investments that have worked?
Neither shaken nor stirred, Subbu patiently responds, 'In my view, value traps are cheap stocks with no real catalyst to unlock value. It is important to identify the catalyst, but it may take some time to deliver. You have to be patient. In 2015-16, we made good profits on oil marketing stocks. A few years ago, the valuations of one of the stock under our research was at a deep discount to its replacement value. The catalyst was that the government was changing its policies on retail prices for petrol and diesel and decontrolling them. Such a thesis may take one year or even two to play out. But eventually, it did happen and the stocks did extremely well.'
But what of the cases where the thesis flops and you are really stuck, I ask. Subbu is pragmatic on this. 'Simple, if the catalyst doesn't work, then it is a value trap. But you do get selling opportunities. In the 2008 era, for instance, we picked up many stocks that seemed to offer value. Some had immediate triggers for unlocking, some didn't. So eventually, we reshuffled our portfolios towards stocks that had catalysts that were immediately unlockable. We owned couple of textile sector stock which had value but one had a catalyst which was more visible. So, we booked out of one and accumulated the other.'
How FIIs differ
I get to broader market questions and ask Subbu what he has observed about FIIs in the two decades of advising them. How are they different from Indian investors? Subbu qualifies that FIIs can be short term, too, if they are hedge funds, etc., but the FIIs Quantum has advised have always been ultra long term. 'Many of our clients have a 20 or a 30-year view on a market. They look at fund performance across a cycle, which is typically three to five years. This means they wouldn't bother to check on us until the end of one cycle. They also look at performance relative to the benchmark. The benchmarks they use can be sophisticated and tougher to beat than the Indian bellwethers. But we are fine with that.'
He explains that these FIIs are not as particular about returns, as they are about sticking to the stated style and mandate. 'They understand the style and want you to do what you promised to. They even get worried if you start doing very well in bull markets. What I find in FIIs we deal with is that they themselves have a very disciplined process and so they understand Quantum's discipline. Where we trail the benchmark, we will need to justify why - whether it is due to owning some stocks or avoiding some. Last year we did not own Reliance Industries and that led to underperformance.'
Does Subbu think that ETFs and smart-beta funds will take money away from active managers?
They won't, he believes. 'Investing through an ETF is more of a convenience. It is lazy investing and is about keeping costs low. But there are a variety of risks there, too. Investors don't have a choice in terms of good management, looking for ESG (environmental, social and governance) qualities in an ETF. Some people are beginning to question the ETF strategy. But just because ETFs have come in does not mean that alpha has fled the markets. It is still available.'
So what are his biggest lessons from dealing with equity markets on behalf of so many varied investors?
'One, a process driven approach is always better, particularly while selling. Many investors find it tough to pinpoint a price to earnings ratio where they will sell. One also has to avoid any bias while selling. I have found rechecking the fundamentals is very important when one is selling. Two, you definitely need a lot of patience to make money in the markets. Three, know that the market is always right and is saying something to you. You need to pay attention to that message, without being too dogmatic about your own views. But yes, the market does go through periods of excessive greed and fear. Depending on the time horizon, you can use those opportunities.'
So what if the market's view is very different from yours for a very long period? Will you sell out of a position, I query.
Subbu says that it certainly calls for a review and reels out an example. 'We were horribly wrong in holding one of the IT sector stock in 2006-07. We owned the stock, met the management and kept on believing that things were changing for the better. But sometimes it takes a hard knock to realise you are not right. At times though, conviction helps. In the last two years, the market was ignoring IT stocks. We have been holding sizeable positions which have done very well in the last few months. That can happen as well.'
What about his own money, I ask. Subbu has stock options in his firm. 'If I include those, my equity allocation is close to 80 per cent, else it will be 60:40, he estimates. A good part of that 60 per cent is in Quantum Long Term Equity Fund through SIPs.'
He prefers liquid funds for fixed income. But one fund he really fancies is Quantum Multi Asset Fund. 'The returns are stable at 9 to 10 per cent with low volatility. The fund manager takes an active call and decides the ratio of equity, bond and gold in the portfolio. The asset allocation is automatic.'
What has kept Subbu wedded to Quantum AMC, which has been relatively small sized, for so many years? 'It's a long list!' Says Subbu, sounding unusually exuberant. 'Right from finding a great founder in Ajit, a great mentor and friend, to my requirement of being part of building an institution. I began my career in 1992, around the Harshad Mehta scam. I saw a lot of people making as well as losing money within a span of months. So, I had this dream of being part of a research based institution with a truly long-term outlook on equities and which would be careful with investors and investor communication. Quantum fits that bill.'
He also admits that he likes playing by rules and fits like a glove at Quantum. 'The culture here is about being compliant at all times. This allows me to sleep very well. I doubt if any other institution would have allowed this. I keep telling my family that before I joined Quantum I used to look forward to a Saturday or Sunday. Now, I really look forward to a Monday. Being at home is great, but I love work. The team, touch wood, has been stable. To tell you truth, I never seriously looked at another option. I don't go around comparing pay packages with other managers,' he ends, laughing.
That conviction about sticking to its guns is what makes Quantum a hit with investors, too.