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Aarati Krishnan

"Fund size tends to grow with the markets. If you want the equity cult to grow in India, you cannot have limits on fund size. I would say that the number of Rs 1,000 crore funds needs to expand. If we have ten funds of this size, then funds will have a greater influence on the stock markets."

Mr Anoop Bhaskar, Equity Fund Manager, Sundaram Mutual Fund

THE year 2005 will be one of consolidation. But corporate earnings will pick up pace thereafter, as the recent expansion spree begins to pay off. These are the views articulated by Mr Anoop Bhaskar, Equity fund manager for Sundaram Mutual Fund, on the outlook for India Inc. In an interview with Business Line, Mr Bhaskar — who was with the Templeton group before he moved to Sundaram — shares his thoughts on a range of issues, ranging from the recent "correction" to why he thinks the time is right for a small-cap fund.

Excerpts from the interview:

What are your views on the recent decline in the stock markets?

We did expect a correction. But we would be happier if the correction happened 1 or 2 per cent at a time, rather than in sharp blips, which unsettle investors. There was a build-up in positions in anticipation of fresh liquidity and when this didn't materialise, the positions were unwound.

Going forward, the numbers for the quarter would set the tone for the markets. And it is usually the first few large companies that matter. If these numbers turn out to be good, the markets would be upbeat. If these numbers are disappointing, then nothing thereafter may make a difference.

Will corporate earnings meet expectations?

I expect 2005 to be a year of consolidation as companies are still investing in fresh capacities. The cost pressures are also there; raw material costs have gone up for most companies. But growth will be volume-driven. I think we will have to accept lower margins as companies expand their volumes. A lot of capacity expansion is happening right now and these investments will begin to pay off over a two-year time frame.

Equity dilution too is not a big issue. Earlier companies used to expand their equity base by 100 per cent; but the recent offers result only in a 20-30 per cent equity expansion. Low interest rates have also moderated the capital costs of putting up new facilities. So even if 2005 turns out to be a year of modest numbers, corporate earnings should rebound strongly from the next year.

What is the asset size that you are comfortable with managing in an equity fund?

A large cap diversified fund like the Sundaram Growth Fund can take any size. For a mid-cap fund, a Rs 350 crore size would be ideal. But I believe that you can address the problem of size by dividing the task of fund management between two or three fund managers so that each of them can look at different segments of the market. This is what happens abroad with very large funds.

The problem of fund size would not arise in a stable market that goes up steadily over the years. It is a volatile market, which goes up by 30 per cent one month and drops by 30 per cent in another, that creates problems of fund management. In the US, fund size has expanded steadily with the markets and size is not a big issue anymore.

Fund size also tends to grow with the markets. I believe that if mid-cap funds grow to Rs1,000 crore, this will on the back of a market that has expanded manifold in size.

After all, if you want the equity cult to grow in India, you cannot have limits on fund size. I would say that the number of Rs 1,000 crore funds needs to expand. If we have ten funds of this size, then funds will have a greater influence on the stock markets. Domestic funds, today, don't have much of an influence.

Isn't it an issue that the bulk of inflows into equity funds seem to happen after the markets have risen sharply?

It is an issue. But this time round, investors probably have a better understanding of what they are getting into, when they invest in equity funds. This is because a lot of inflows have happened through bank distributors. Bank distributors generally do a good job of educating investors about the equity markets. Banks have an ongoing relationship with customers and therefore take pains to educate them about risks, before investing in a product. This is different from the situation in 2000, when few distributors could explain to investors about what they could expect from a fund.

The S.M.I.L.E fund, which you have recently launched, has set apart a portion of its assets for large-cap stocks and mid-cap stocks. Doesn't this dilute its focus on small cap stocks?

I would like to clarify that this is not a multi-cap fund. We launched this fund as a small cap fund, where we would like to concentrate on stocks with a market cap of less than Rs 200 crore. Unfortunately, at present, we do not have enough liquidity in the market to play a small-cap fund, because of which have added mid-cap and large cap stocks. But over time I am sure the universe of small caps will expand and their liquidity will also improve. Since this will be a small cap fund, we would like to guard against the possibility of pullouts, which could impact the fund.

We could hold cash; but cash can be a drag on performance, especially in a rising market. Therefore, we decided to have an enabling clause that will let us hold mid-cap and large cap stocks. But our focus will be on small cap stocks and we will be looking to these stocks to deliver good returns for this fund.

Small cap stocks could be very volatile. How would you contain volatility?

We have internal guidelines to restrict each group of small cap stocks to specific bands. We would like to limit our exposure to stocks with market cap of less than Rs 100 crore to say, 10 per cent of the corpus. Stocks with market cap of Rs 100-150 crore could be restricted to another 10 per cent and stocks from Rs 150-200 crore in market cap may be restricted to another 15 per cent. We expect this approach to lead to improved liquidity for the blended basket. We would also not like to hold over 5 per cent of the free float of any stock.

This fund may be difficult to manage if it becomes big... .

I don't expect a deluge that will make this fund too big to manage. After all, there a lot of mid-cap funds being floated which will take a share of the market. We expect about Rs 150-200 crore in the IPO.

We can then start with about Rs 60 crore in small cap stocks. However, over time, both the basket of such stocks and our bandwidth in terms of stocks we track will expand, as has happened with mid-cap stocks. If the inflows happen gradually, as they have in the case of Sundaram Mid-Cap fund, I think this fund can be scaled up to Rs 500 crore.

How will you contain impact costs?

Impact costs will be an issue only if we have a volatile corpus, where we have to constantly replace stocks.

They will be less of an issue if the corpus is stable. In any case, we will be assigning weight bands to each stock, based on the liquidity of the stock and the outlook for the industry.

We will shave off a part of our exposure whenever the stock appreciates enough, to exceed this weight. We have used this approach (instead of a target price or target return) in the Mid-Cap Fund, and it has worked well.

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