‘If a company we have selected is doing badly today, do we worry? The answer is No’
Sankaran Naren is the chief investment officer at ICICI Prudential AMC. A value oriented fund manager, Mr Naren manages more than Rs50,000 crore of investors’ money. Excerpts from an interview with Moneylife
Moneylife (ML): How do you define whether a stock should be in the portfolio of a scheme or not?
Sankaran Naren (SN): We look at ratios like return on equity (RoE), price-to-earnings, EV/EBIDTA (enterprise value/earnings before interest, depreciation, tax and amortisation), and how much moat is there in a particular stock. We get money into funds everyday and we have to deploy that money. We constantly look at what to switch. For example, IT (information technology) stocks have fallen substantially. We would try to see whether we should sell something and buy something else.
ML: Does market-cap size matter?
SN: It does; because we are managing large sums of money. We can’t become a small-cap fund house. Given our scale, we have to be invested in super large-caps, large-caps and then we will get into mid-caps and small-caps. Mid-caps and small-caps are like desserts; they can’t be the main course. We have been looking at stocks with market-cap of more than Rs500 crore.
ML: What kind of weightage do you give to different parameters like RoE or earnings growth?
SN: We first look at the cycle. There are periods when people have a very negative view on a certain cycle. So, we believe that cycles tend to mean revert. I am very comfortable with a stock that has done very badly, but where we have a strong conviction. If a stock does badly there is normally a reason. We try to see if that reason is mean-reverting. For example, we never have had a tobacco stock for nearly two years in our portfolio. But when tobacco stocks underperformed we did look at them in March 2015, because we thought there was an opportunity. In a cyclical stock, typically, the RoE at the bottom would be much lower than the RoE at the top; so, very often, we buy stocks with a low RoE and wait for the RoE to increase. In our opinion, in the past seven to eight years, quality has been given a very high emphasis. So, today, we are being cautious on quality.
ML: When the market becomes overvalued, what action do you take?
SN: We switch. No one would have imagined in 2013 that the Sensex would go to 30,000. Similarly, no one believed that the rupee would go to Rs68 (per dollar) in 2013. So it is better to think in terms of switches than to think what happens in terms of a specific level. And, actually, as our size becomes larger and larger, we also do profit-booking in stages. So, if we have to cut our weightage, we don’t do it at one price point.
ML: While selecting a particular sector, what is your thought process?
SN: We would like to look at whether the sector has growth potential; whether its growth will lead to its bottom-line improvement; whether the company which we are looking at will deliver returns; how is the corporate governance; how is the taxation structure and the industry; what are the coming macro events which benefit the sector, etc. We look at all these. We look to buy stocks in sectors that are doing badly. The sector analyst tries to see whether there is an opportunity to be more positive on a sector which is doing badly. We believe, by and large, in reversion to mean. We believe, over a period of time, a sector doing very badly will do better and a sector doing very well will do very badly.
ML: There could be stocks which have value but are not looked at by the market. How do you identify such stocks?
SN: We have a team of sector analysts who look at different sectors. Their job would be to keep looking at those sectors and come to a conclusion whether it makes sense to actually look at that sector. There was person by name of Theodore Levitt who wrote about marketing myopia. So whether we will go back to horse-carriage the answer is No. Whether we would go back to landline of 15 years back, the answer is No. Will everything happen today on desktop today, the answer is No. Some of these trends have changed. So when we are looking at value, we also have to look at whether the value is such that it would remain or would it be more.
ML: A stock may seem fundamentally attractive and may have good management but the market may be avoiding it. Have you come across such stocks?
SN: In my investing career, I have seen that happen between 1996 and 2002. I have not seen it happen between 2002 and 2015. That means, stocks with improving prospects may underperform for some period but it will make money, eventually. But, even in the 1996-2002 phase, an IT company did not underperform. So I would say that, in the long run, if a company is doing very well, you get rewarded.
ML: What would be a reason for investors to avoid such stocks?
SN: In that phase between 1996 and 2002, I recall, the prevailing view was that anything other than IT and TMT (telecommunications, media and technology) was not going to make money, in the long term. Other than that, most people would never remember a situation where a company is delivering great returns for five-six years but stock prices don’t reflect it.
ML: You mentioned that IT stocks are currently fairly valued. What about energy stocks?
SN: Energy stocks are also attractively valued. But, I would say that they were more attractively valued one month back. In the past one month, technology stocks have done badly whereas energy stocks have been broadly okay. Compared to one month back, we are more positive on technology stocks today and, compared to one month back, we are relatively not as positive as we were on energy stocks.
ML: If in a well-performing sector a stock is not doing well, how do you deal with it?
SN: In all cases, we try to assess the long-term potential. We are rarely worried about how a stock/company is doing at this point of time. It is more a function of whether it will improve over a period of time. So, if a company we have selected is doing badly today, do we worry? The answer is No; especially if we don’t own very large chunks. If we own very big chunks and it starts doing badly, then that is a worry. If we see a company and it is doing very badly and we don’t own it, we always look at that as an opportunity. If we lose confidence in a stock, or lose confidence in a management, then we find an alternative which is better than that stock.
We look at things in relative terms. Historically, people have got money at the top and lost money at the bottom; so that’s why we started strategies like dynamic plan or balanced advantage fund which sell equities at the top and try to buy, as the markets fall. The reason for doing that was based on the experience we had in 2007 when as the market topped, people gave us more and more money. The money started coming in the aggressive funds and not in the defensive funds. Yes, it is true we wanted money in the defensive funds; but it came in the aggressive funds.
ML: ICICI Prudential Dynamic Plan maintains a constant allocation and hardly moves much in and out of equities. In a dynamic plan, won’t one move in and out of equities?
SN: In our model, we also consider what happens to long-term interest rates. In the past one year, as the market went up, long-term interest rates fell. We don’t believe that equity valuation can be determined on the basis of one number. It is much more complex. The reason equity weightage did not shift significantly was because long-term interest rates kept coming down. Otherwise, we do buy when the market falls; like in March, when the market fell, we bought equity. Then, after that, the market rallied and we sold equities. Now, again, over the past three-to-four days, as the market has fallen, we bought. So, equity levels are not static. It might appear that our equity levels are static to a person who sees our month-end portfolios; but it is certainly not static.
ML: Do you have a stop-loss strategy?
SN: We are not into technical trading. We may book losses, if we lose confidence in a company’s fundamentals. It could be based on events and not based on the price. So it is not that, if a share price comes down to a particular level, we will immediately look to sell.
ML: How is your fund management style different from the others?
SN: My style is more contrarian. It is more value-oriented in the conventional sense. I believe in taking risk where I have the confidence in stocks. Over the long term, I believe it will work; over the short run, there will be different periods where different kinds of styles will work. If you take 2014, someone who focused on buying quality stocks at high valuations would have been the biggest gainer.
ML: Has your fund management style changed after the global financial crisis?
SN: Certainly. Prior to the crisis, we didn’t know of the impact of macro or top-down movements on stock prices. So we moved to a model which looked at both top-down and bottom-up. We don’t try to forecast; but we try to determine the direction. There was a period when we thought that the rupee would appreciate, in 2012-13. Then, in the past one year, we had a belief that the interest rates would come down. So, to an extent, the reason for some of our portfolio choices would be the top-down approach or macro element. We believe that we have to work on both the top-down element and the bottom-up element.
ML: How would ICICI Prudential Value Discovery be different from the other close-ended schemes such as the ICICI Prudential Value Fund series?
SN: ICICI Prudential Value Discovery is currently a Rs9,000-crore fund; so it will have a very diversified portfolio and it will also have to have a lot of large-caps in the portfolio. But you cannot construct a Rs9,000-crore portfolio just on the basis of mid-caps easily. So we have large-caps and mid-caps in the portfolio. The close-ended schemes have a finite life; for that reason, we do not have a growth option. There is only a dividend option. As the market moves up, we might declare more dividends and distribute it.
ML: You also manage the ICICI Prudential Indo Asia Equity Fund, do you find Indian equities more attractive compared to other Asian stocks?
SN: A year back, we used to have a very low weightage in Asia; then, in between, we increased our weightage in Asia. Now, Asia has outperformed Indian equity very drastically. As part of our process, we will try to see whether there is a case to book profits in Asia or invest in India.
ML: Which books on markets have influenced you the most?
SN: I regard three authors as having the greatest influence on me: Howard Marks, James Montier and Michael Mauboussin. I use their thoughts to get a handle on the vagaries of the market.