Are we going through that phase of the market where there is universal acceptance that things will look up but the market is not due for a time wise and a price wise correction? All our assumptions in the corona front, global front and liquidity are getting challenged.
This is the second wave. There are lots of learnings from the first wave. A lot of missteps of the first wave will not be repeated in tackling the second wave. You are already seeing how the response is now local as opposed to global in terms of a lockdown. Each state is doing one on its own.
Second, there is the consciousness of economic impact. The first time around, we were keen to show the world and the world was keen to show everybody that they cared for the citizens of the world from a health perspective and hence said that the economy be damned, let us take care of health. This time, we see a more pragmatic approach. They are trying to protect areas of the economy and at the same time trying to step up vaccination.
There is a significant difference between the second wave and the response to the first wave. That is one of the reasons that the markets are not reacting to the bad news on the horizon in terms of the second wave of whatever coming through. Similarly, in terms of the other aspect of US inflation and US interest rates, there is this underlying fear that the US is going to hike rates quickly.
But despite the Fed’s dovish statements, there is just that element in the market not believing him and that is the reason there is a little bit of a check in balance. Even a year from now, we are not confident that the second wave will be taken care of and the underlying strength of the economy which has gone through a long period of low to negative demand and capex being shut down. Now the US is talking about a huge infrastructure spend, India is talking about a huge infrastructure spend. So if you give yourself a year as a forward looking timeframe, you will say that I will cover all of these negatives and I will be on a positive track.
As a buyer in the market, are you going to then look at the next one year? Volatility may be there but I do not expect it to last one year. Volatility may be there for six months and if you do not use this as a buying opportunity, you will regret it like those who redeemed post the corona crisis. So that is the second learning. This time around, we will not see panic selling happening when there is volatility. On the contrary there will be smart buying.
Have the outflow stopped? Have you got more money than what you have sold last month?
We are even-steven but there has been a 60% drop in our redemptions. So the outflows have significantly reduced. But the industry as a whole has turned positive. This again is what I was just explaining that the people who are redeeming were doing so because there was a disconnect between what they saw as an economic activity happening on the ground and the market simply rising as if there is nothing wrong with the economy.
That disconnect did not sit well in the minds of investors and hence they redeemed that saying I do not know how this rally is going to last when there is no good economic news. But over the last two-three months, the economic news got better and that is why despite the second wave happening in a few states, investors are now beginning to believe that they lost out by redeeming earlier and now they don’t want to repeat the mistake.
Second there is a genuine confidence in the activity level and economy thanks to the government action. The government is being sensitive to the economic impact of a fresh lockdown and hence managing it in a way so that economic impact is minimised. The second aspect is that people believe that it is a good time to invest. From an index perspective, the market action is going to be largely in the largecap and the larger midcap space but the economic news coming in is going to be supportive of the smallcaps and the smaller midcaps. In that frame, you will see a slow change of leadership. That is why you would not see the indices touching very great highs but the broader market will show a breadth of responsibility much better.
Sundaram is a system driven company but historically we have seen that when a CIO or fund manager changes, the portfolios change. What will happen to your schemes because of the change of guard?
We will gradually reduce our high risk, high reward positions. While there is a change of leadership at the CIO level, an underlying process shift has been happening at our company over the last six to nine months. We launched a diversified large cap, we launched a balanced advantage fund, we launched a multicap fund over the last one or two years. So gradually Sundaram is going to be going more middle of the road from a pure high risk, high reward, high small cap, microcap, high bets kind of a thing.
So independent of this move on change of leadership, there is a change in the construct of the portfolio. For example, when the Sebi reorganisation happened, our mid and small cap fund was 70% midcap, 25% smallcap. Today we have 15% large caps in the midcap fund. Similarly, look at our multicap fund. Everywhere we are moving to a more less high risk, high reward positioning and trying to get closer to the benchmark. We are managing to control the deviations from the benchmark through a process and you will see that effect in our funds. So the volatility of our fund performance will come down and the returns will be more closely in line with the broader market as opposed to the old Sundaram which was very high risk. When the markets and the economy were booming, we were giving 100% return a year but when they dropped, naturally those positions hurt us.
This conscious shift has already started happening over the last six to nine months and that move will get strengthened and you will see portfolios altering because of that. I agree that people will say that the CIO left and so the portfolio changed, but if you track our company over the last few months, you will see that the trend change is already happening and that will get strengthened going forward.
How are you looking at the portfolio mix, given the ever evolving situation?
I just spoke about the way the processes are changing. The second is that we have announced the Principal acquisition. One of the key things is our portfolio had about 58-60% mid and small caps overall as an AMC. Principal which is about a quarter of our size, has 75% large and midcap portfolio. CCI has already approved this a couple of days ago and Sebi approval is under progress. It may take a few months but as and when that approval comes and the merger happens, automatically we will become much more broad-based.
The proportion of mid and small caps in our portfolio will come down sub 50% as a natural course. Plus, we are trying to align ourselves closer to the broader market indices. The BSE 500 index has 80% large caps. If I am running a multicap, flexi cap portfolio, I cannot ignore BSE 500 or NSE 500 and the fact that they are large-cap led. So gradually the positioning is going to be what I would call a middle of the road and not so much of the extremes.
That process will translate into sectoral positioning also. A year and a half ago, we were underweight pharma to the extent we were zero and when the corona crisis came and post that pharma rallied, we re-jigged our portfolios. But obviously we were late on the curve. Such kind of positioning we will never repeat in the future. We will not be zero or strongly underweight or overweight in any sector. We will have a conscious thought of the benchmark, the sectors there and the dynamics of the market as we are moving.
We will try and operate like a horse operates with blinkers, we will operate within specified policy parameters in terms of how much overweight, underweight to the benchmarks and to the sector weights. If I say I am underweight pharma today, it will mean I am 2-3% off the benchmark weight of pharma and not zero percent. So that is a significant change that has been happening over a period of time and will get strengthened over the next few weeks.
You will see that Sundaram will be much closer to the middle of the risk reward curve in terms of our positioning.
I am looking at some of your recent buys; Happiest Minds, IGL, HomeFirst, Page — it is a mixed selection. What is the return potential you are seeing in terms of an average going forward for the year?
We are the only fund house in the country which has a services fund. Naturally our ability to buy those internet based, high-tech, fintech positions is much better because I have a Rs 1,300 crore services fund which is dedicated to these services.
So my ability to buy these comes from that fund being there in the market with money. That is number one. Number two is the fact that when you look at the return potential, I would say that safety parts to the portfolio like IT or whatever would be expected to give high single digit returns. On the other hand, our high risk, high reward component would give about 25 to 30% returns.
In the old Sundaram, I would have been very bullish and stocked up my portfolio to a great extent with these high-risk-high-reward stocks and hence the return potential would be 18-20%. But being closer to the benchmark, middle-of-the-road stocks with higher safety components, something close to 2-3% over the nominal GDP of the country is what I expect. So if they are talking about a GDP of about 10% and 4-5% inflation, our expectation would be 15%. I would argue that we would be north of that in terms of a broader portfolio returns, especially because of our new positioning.
The market messaging seems very clear that the tilt is in favour of the mid and small caps. Would you say that for at least the next foreseeable future, it is time to bet on mid and small caps?
Look at it this way. It is the sectoral performance which drives the capital performance. A fund manager — be it an FPI fund manager or insurance fund manager or mutual fund fund manager — always approaches an EIC framework, studies the economy first, then the industrial sectors within and then chooses the companies. So when a fund manager goes out and buys, he has got the sector view in his mind.
Now the reason mid and small caps have taken the lead is because there is a sectoral shift from safety to risk in the market. Whether you are buying large cap funds or mid and small, the fund managers who allocate to the cyclical, growth sectors will deliver better returns. From an investor’s perspective, rather than going and putting everything in the mid and small caps, I would say choose the funds well. Even a large cap fund with the right sectoral mix can deliver very good returns compared to the mid and small caps.
I would say that this move that is happening is excellent because last year this did not happen because FPIs were dominating the markets and that is why 75% of fund managers did not beat the Indices as they run in broader portfolios. But the next six months would see the return of the alpha. Fund managers would pick those sectors which would deliver better returns and that will translate into large cap funds, midcap funds and small cap funds. So from an investor perspective, I would say stick to the flexi cap, multi-cap category where the fund manager can do the right sectoral mix and deliver the best returns.
Don’t blindly put your money in mid and small caps as they have run up. That is not the true story. It is sectors driving the cap curve which you have to track. From an investor perspective, leave it to the fund managers to do a flexi cap, multi-cap. They will do the right sectoral allocation and deliver the best returns.
The construct of the economy is such that small cap companies are losing though they may have got lucky in the last two quarters because of inflation and little bit of pent up demand. If the basic construct of the economy is towards large and mega caps, why do you think small and midcap investing will work?
The smallest of the small cap companies is a large cap within the overall Indian economic universe, None of the MSMEs, SMEs are listed. So while you look at BSE 500, NSE 500 and say in these 500 companies, these will be the bottom end, in a lot of places where they operate, they are the dadas (big brothers) of their space because there is a huge number of MSMEs.
The lockdown and the corona crisis has given a strong push to the formalisation and digitalisation of the economy, something which demonetisation plus GST failed to do. So we are seeing this process of formalisation. The very large caps are poised to gain greater market share but not the small caps because they can gain market share from the MSMEs and the much smaller places.
The second aspect is that a company which is getting listed is getting a proportion of equity capital from investors to finance, whereas the typical SME and MSME has only the promoters’ capital contribution. The rest he is heavily dependent on bank funding and microfinance funding. Their cost of funds are significantly larger and they do not have the cushion of a debt equity ratio which is healthy because of equity. Whereas the smaller small cap companies are tapping the capital market and today the number of funds which are doing FPOs and IPOs are getting to spread the equity ownership over a large number of people and give stability to the balance sheet.
Interest being a fixed cost, the more equity you have, the less volatile is your performance. I would argue that small caps are present in lots of growth sectors where large caps are just not there. That is where small and midcaps will show leadership.
