Mid- and small-cap stocks will be the best way to play the recovery says Krishnakumar S, Head-Equity, Sundaram Mutual Fund, in an exclusive chat with Business Line . Excerpts:

Sundaram Select Midcap and SMILE have done well despite this being a fairly difficult period for mid-caps. What helped this?

Sundaram Select Midcap and SMILE have generated 28 per cent and 13 per cent annually since inception. Following a bottom-up approach and investing in businesses that are scalable with good management bandwidth, healthy balance sheets and pricing power helped the funds outperform even during such turbulent times. These include Bosch India, Amara Raja Batteries, Bajaj Finance, Mahindra Finance, Coromandel International and Rallis India.

Triggers such as subsidy sharing by upstream companies have not played out and your energy fund continues to struggle. Does the theme still hold good?

We’ve been disappointed too. The severe policy paralysis in India has affected the prospects of the energy sector over the last three years, be it in coal, power or oil and gas.

It is unfortunate that the ramp-up from Reliance’s KG D6 field did not happen which would have otherwise bettered the prospects of fertiliser, power and other user industries.

However, efforts to free up petrol prices, increase diesel prices, and plug the loopholes in kerosene and LPG subsidy will help refiners wipe off under-recoveries over the next six-nine months. This will reduce the subsidy burden for ONGC and Oil India. So, this may not be a lost opportunity but just a delayed opportunity.

Meanwhile, we understand the pressure on investors too. We plan to merge Capex (dividend and growth portfolios) into an Infrastructure Advantage Fund and the energy fund will also be merged into the Infrastructure Advantage Fund.

This will give the fund manager flexibility to diversify across themes such as road, port, power and oil and gas and thereby improve the fund performance.

Despite the rally in large-caps over the last one year, Select Focus and Growth Fund have underperformed. Why? What are you doing to address this?

Both these funds have outperformed their respective benchmarks over a three-, and six-month period, thanks to our strategy of aligning the fund closely with its benchmark.

Following the growth slowdown and US Fed tapering concerns early last year, we decided to reduce the sector and stock deviations relative to the benchmark to reduce the portfolio risk.

At the same time, fund managers were encouraged to take two-three active bets in stocks where they had high conviction. For instance, with the recovery in the US economy leading to the tapering, we took an overweight position in IT companies that benefit from an improving economy, consequent increase in IT budgets and a strong dollar. This actually paid off. The underperformance of Select Focus over its benchmark has shrunk to less than a per cent from 4 per cent last January. Though undoing the past will take time, if you see the three- and six-month rolling returns, we have bettered the benchmark.

Given the limited stock universe in the media space, what will be the way forward for your entertainment fund? The fund has underperformed over a five-, and three-year perspective. Why?

The fact that the fund has delivered benchmark-beating returns over the last one year points to the corrective steps taken. Entertainment is not just about media, it’s everything beyond work. Going on a holiday, visiting a multiplex, going to a mall, downloading a game on your mobile, eating out — all these too form entertainment. Thanks to lifestyle changes and higher disposable incomes, entertainment now accounts for a bigger share of income and time.

The universe may not be as big as, say, 1,000 companies but we have at least 100 companies across these sub-themes/segments. A concentrated benchmark is one of the key reasons for under-performance of thematic funds. Consider CNX Media — Zee and Sun TV account for over 60 per cent of the CNX index.

Being thematic we could not invest more than 10 per cent in a stock. So, massive outperformance by the index heavyweights will certainly impact our fund’s relative performance.

However, we’ve changed the same to a sectoral fund with SEBI’s approval since August 2013, which has now enabled us to invest more than 10 per cent in a single stock if required.

What are the most promising themes from a two-three-year perspective?

Following the steep correction, small- and mid-caps look attractive now. With a pick-up in growth, utilisation levels, profitability and cash flows will improve for these companies. Mid-caps may be the best way to play the recovery. Banks and domestic cyclicals may also have a good run once economic activity gains momentum. With a stable Government and a reformist leader, PSU stocks may re-rate from here.

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