Financial Daily from THE HINDU group of publications
Sunday, Sep 11, 2005
Markets - Mutual Funds
`You have to back ideas strongly to get good returns' Mr Sandip Sabharwal, Head, Equity, SBI Mutual Fund
We caught up with Sandip Sabharwal, the key man behind the chart-topping equity funds from the SBI MutualFund stable, during one of his lightning visits to Chennai. Assertive and confident, Mr Sabharwal, Head, Equity, at SBI Mutual Fund, disputes the view that the Indian stock market is getting too expensive, believes that the best time to enter small- and mid-cap stocks is when they are illiquid and says that he likes to back his stock ideas strongly. "All you need is six good stock ideas to deliver good performance". We present excerpts from a freewheeling discussion with Business Line on stock valuation, liquidity and SBI Mutual's investing strategies:
Excerpts from the interview:
There are now two divergent views on where the stock market is headed. Foreign brokerages say the Indian market is overvalued; but domestic fund-houses continue to sound optimistic. Which view do you go with?
Corrections are a part of any bull market phase and the extent of correction is difficult to predict. But based on the economic scenario and liquidity situation, I do not see a more than 10 per cent correction from present levels. Both external liquidity, in terms of FII flows, and domestic liquidity, from mutual funds and investors, is strong. This will support the market on the downside. I think liquidity will be strong over the next one to one-and-a-half years.
As for valuations, I don't think they are expensive. One study uses the price-to-book value (for Indian companies) to suggest that the markets are overvalued. But we have a situation here where the price-to-book value ratio is high, but the price-earnings ratio is not so high. To me, this is a sign that Indian companies are probably much more efficient than those abroad. It shows that companies here are probably generating higher earnings with the same assets.
You also have to recognise that in India, 52 per cent of GDP is contributed by services. Service companies are typically not asset-heavy and will tend to have high price to-book value ratios. So a comparison of this ratio with other countries, which have a manufacturing-centric economy, may not be entirely correct. As for price-earnings multiples, our market is now trading at 13.5-14 times forward earnings, which is not high, considering the growth that is under way. In the last five years, the earnings of Corporate India have gone from Rs 37,000 crore to Rs 1 lakh crore a 330 per cent jump. In the meantime, Sensex has gone from 3000 to 7500 an increase of about 250 per cent. So the market returns, though spectacular, have lagged earnings growth.
Besides, many companies have embedded value in their businesses that is not reflected in their financials. Several companies have insurance subsidiaries; the investment book may be undervalued.
Many have also reduced debt and have a much stronger balance sheet today than five years ago. This has created value that is only partly reflected in their market capitalisation.
Which sectors are you bullish on?
Among the larger sectors, cement, capital goods, engineering and technology should do well.
Among mid-sized companies, we think pharmaceuticals, textiles and infrastructure may do well.
SBI Mutual holds only 25-30 stocks in most portfolios, while other fund houses own 60-70. Does this peg up the risk profile?
I don't think there is any benefit to over-diversification. Owning too many stocks is a sign that you may be buying every investment idea that comes your way, instead of backing a few good ones strongly.
You have got to back your good stock ideas sufficiently, so that they can deliver good returns. When you own too many stocks, you tend to neglect a few and you may end up making sub-optimal calls.
We like to keep our portfolios small, so that we can closely track every stock in each portfolio. We believe in optimisation of returns, rather than maximisation.
Do rising crude oil prices pose a threat to the earnings growth you are predicting for companies?
Crude oil prices do have an impact they could increase overheads that companies incur on packaging or transportation. With many of the domestic commodities now linked to global price trends, any spike in crude prices is, to a large extent, reflected in earnings. But I feel that consumer demand in India is now strong.
The sharp increase in asset prices is making consumers more immune to price hikes on the goods that they buy.
When you see the price of the flat that you own or your stock portfolio double from Rs 10 lakh to Rs 25 lakh, you do not mind spending an additional Rs 2,000 or Rs 3,000 on your fuel bill. That wealth impact, right now, is strong.
Second, the economy has several drivers today. The capex cycle is taking off, you have strong consumer demand, outsourcing is doing well and then, you have the expansion in services. Agriculture, which has traditionally been an under-performer, is doing well now because of firm trends in prices of farm products.
This has led to an improvement in rural consumer demand. You will see this reflected in the performance of consumer good companies.
SBI Mutual recently launched a fund that will invest in commodity stocks. Commodity prices have already run up substantially over the past couple of years; so where are we poised in the cycle? Do commodity stocks do better than commodities?
There is going to be a broad commodity cycle that will last 15-17 years. Within that you have several sub-cycles for each commodity, which will last for shorter time-frames. These will provide a lot of opportunities for generating returns.
Between oil and steel, for instance, oil has been rising while steel has corrected 30 per cent from the peak. A fund manager can take advantage of these sub-cycles.
Yes, commodity stocks do run ahead of commodities by a large margin, whether on the upward cycle or downward cycle. Let me explain.
Production costs for steel do not change much, irrespective of whether steel prices are at $200 or at $300.
A company may just about break even when prices are at $200; but when prices go up to $300, almost the entire gains will go to the earnings.
This leverage effect leads to commodity stocks outperforming commodity prices. But because this can happen on the downward cycle as well, it becomes very important to make your calls on commodity stocks efficiently.
A fund may be a good way to take exposure to commodities because it helps you diversify across commodities and companies, instead of playing just one or two commodities.
Over 2,600 stocks are now transacted on the BSE every day. This number is up by a third since last year. Has your investment team expanded the number of stocks you track?
We track about 200 stocks at this point in time; most of the others may not be worth looking at.
There would be some churn in the investment universe of 200 stocks; as some new stocks come in and others move out. But you simply cannot track many more than this.
One lesson we learnt from the 2000 tech stock crash was not to invest in companies or stocks that we didn't know well.
As a fund manager, I feel that all you need is six solid stock ideas in a year, to sustain good performance.
Finding 10 would be great, but six ideas would be enough to ensure good performance.
Making money in small-caps
MAN Industries, Mirza International, Kajaria Ceramics SBI Mutual Fund owns several stocks with a market capitalisation of less than Rs 500 crore. Fund managers we have spoken to say they are wary of the low liquidity in such stocks. Yet, it is stocks such as these that have delivered the impressive returns on funds such as the Magnum Global Fund or Magnum Taxgain. But Mr. Sabharwal has an interesting take on this investment strategy:
"The key to making money in small- and mid-cap stocks is to get into them when they are illiquid and under-researched, when you know that the company is going to do well. When the stock becomes fancied and when the volumes have shot up to 10-lakh shares a day, that's not the time to get into it. The gains from that point will be limited. "
What about the higher risk profile of these stocks?
"As a fund manager, you have to take a call on a company's fundamentals. That's why people are entrusting you with their money. You need not take excessive risk; you can cap the exposure to a certain percentage of the portfolio."
His outlook for small and mid-sized companies...
"Growth prospects for small- and mid-cap companies are highly leveraged to how the economy is doing. In a growing economy such as ours, I believe that small and mid-cap companies have the potential to deliver high growth. Once you believe that, we evaluate the company. Does it have the management to take advantage of the opportunities that are before it? If it has, you can be sure that it will attract good trading volumes.
The second point is that several mid-cap stocks will not have apparent liquidity, going by volumes traded on the exchanges. But if you want to sell that stock, you can easily find buyers. Funds and other institutional investors are willing to buy or sell these stocks from you and you need not transact through the market."
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