The Indian mutual fund space is eternally in churn, with new fund houses setting up shop, foreign ones bidding adieu and others merging or gobbling up rivals. But a few home-grown AMCs have remained resilient over two decades and the Chennai-headquartered Sundaram Mutual Fund is one such AMC.
The fund's CIO, Equities, S Krishna Kumar (KK to colleagues) has a reputation for being a good mid-cap stock picker. I decide to catch up with him for a chat in these turbulent times for the market.
Having set up a face-to-face chat on a broiling April afternoon at the Sundaram office, I quickly wrap up the small talk and decide to pose performance-related questions first.
Turnaround themes
Sundaram's Select Focus, Select Midcap and SMILE were once go-to funds for advisors or analysts looking to recommend core funds. But somewhere along the way, Sundaram Select Focus lost the plot and has been recovering lately. So, what has been done to re-build its track record?
KK asserts that most of the underperformance was in 2009 to 2012 and that it is history now. 'I would say Sundaram Select Focus has made a decisive comeback. It has pulled back to the first quartile for a two-year period. In the last one year, it is among the top one or two funds in the large-cap category.'
'With respect to the equity team, we did two things. We hired a new fund manager, Rahul Baijal, and he has been entrusted with Select Focus and other large-cap mandates. He has done a good job. We have gone back to running a concentrated portfolio that is focused on three or four strong investment themes. This strategy has clicked. One theme that has worked really well for us in the last two years is consumer-discretionary businesses with an urban tilt. The second is government-related reforms in oil-marketing companies, banking, affordable housing, construction companies, cement and capital goods. The third theme is the cyclical recovery in the economy, evident in core sectors such as steel, cement. Finally, as a fund house, we very extensively track the rural value chain and have tried to capture the uplift in rural consumption. It is being early on these themes with good bottom-up stock selection that has seen Select Focus get back on track. It has generated a good 3-4 per cent alpha on a one-year basis over the Nifty.'
So what had gone wrong before, I persist? 'After the boom phase in the economy until 2008-09, we remained quite bullish on growth stocks post 2010. We remained heavily positioned in cyclical stocks that were strongly pegged to the economy. These portfolio choices were aggressive and not defensive as warranted. That pulled down our performance until we managed to correct it.'
Mid-cap bets
Sundaram Select Midcap has a good long-term record but has lagged behind its benchmark in the last one year. Is this a worry?
KK sees no fundamental problems with the investment strategy or stock selection there. Short-term underperformance is just the nature of the beast, he says. 'When it comes to Select Midcap, our flagship fund, I would urge people not to judge us on one-year returns. Sundaram Select Midcap has a 28.7 per cent CAGR in the 15 years since inception and 27.6 per cent over the last five years, handsomely outperforming the benchmark. From a three-year point of the view, this fund has always stayed in the first or second quartile. This shows up in the rolling returns.'
He explains that one-year return setbacks are common because of the kind of mid- and small-cap stocks that figure in the Sundaram portfolios. 'What I have observed with mid- or small-cap stocks is that they typically make a big move and then they consolidate for a while before they pick up again. With such stocks, a six-month rally can create multi-baggers and erase all past underperformance. Some of our holdings in Select Midcap and SMILE are consolidating right now. But we believe the fundamentals of these stocks are very good with strong drivers in place.'
Screening for stocks
Sundaram Mutual runs a huge roster of mid-, small- and micro-cap funds (there are several closed-end funds in its kitty, apart from Select Midcap and SMILE). So what screeners do KK and his team use to filter stock ideas?
Many mid- and small-cap stock ideas, KK says, originate from regularly running screeners on the entire corporate database. Attending conferences and seminars and talking to experienced senior managers from not-so-widely-tracked sectors like agrochemicals or chemicals also makes for great in-depth understanding, he says.
The equity team swears by a 5S approach. No, that's not a Japanese production management tool, but five key characteristics that a stock needs to make it to the buy list.
'One, we look for simple businesses and stay off complex ones, where one needs to use SOTP (sum of the parts) valuation. From past experience, we found that conglomerates which require SOTP often don't deliver the predicted performance. Two, we look for Scalability in the business over a three- to five-year time frame. The third 'S' is a Sound promoter. The management has to display the bandwidth to manage growth. We look mainly for sensible capital-allocation decisions and not just minority-shareholder treatment. Fourth is the Sustainability of the company's competitive edge - what people call business moat. This 'S' can come from technological prowess, brand, MNC parentage, a strong distribution network, etc. These factors help the company deliver consistent growth with pricing power that maintains margins and holds up against competition. The fifth 'S' is the outcome of the other four - Strong operating cash flows and return ratios.' But KK qualifies that he is not over-obsessed with 'free' cash flows because mid-sized companies often need leverage to grow.
What about valuations, I think, and KK responds to the mind voice before I can ask this. 'We are also very value conscious. We assess three- to four-year forward earnings for a business. We are comfortable buying at a PEG (price earnings to growth multiple) of 0.5 or 0.6 times. In these markets, the PEG is often closer to 1. We are prepared to pay that only where the quality of the company is very good.'
Consumption opportunities
Sundaram has kept up with a steady stream of small- and micro-cap NFOs in the closed-end space. But the mid/small-cap universe doesn't seem to be expanding, I remark. KK disagrees.
'Mid caps are basically a vehicle for investors to play the India growth story. In India, mature, core economy businesses like steel, infra and oil figure in the large-cap space. But it is in the mid- and small-cap universe that a number of new opportunities are cropping up because consumer preferences are changing dramatically. Take a look at the auto industry. From a Maruti 800 in those days, today consumers would like even Nanos to be equipped with power steering, AC and power windows. Even basic car models nowadays come with airbags. As consumers upgrade, it creates demand for a whole range of new products, components and even materials like ABS.'
As this is my pet peeve, I point out that most of the exciting new consumer trends are not reflecting in the listed universe. I have seen the same HUL, ITC, Maruti and GSK Consumer touted as consumption plays for the last decade. Where are the Olas and the Xiaomis and the Netflixes?
IPO wins
KK points to the overflowing IPO pipeline. 'We can expect many more opportunities to spring up through new listings. Between 2005 to 2008, a number of private-equity funds bought into Indian consumption plays. These are ready for exit today. We have already seen new consumption and retail IPOs in areas such as hospitals, clinics and diagnostic labs, microfinance and small-finance banks. We have had human-resource firms like Quess and Teamlease. I expect this trend to accelerate.'
While the IPOs may present new opportunities, what about their high valuations, I ask, playing devil's advocate.
KK agrees. 'A lot of capital is chasing these IPOs. Three years ago, you could find fair value, but as the market started getting interested, promoters and i-bankers have started pricing these issues very stiffly. They often discount earnings two years ahead. But, of late, the sentiment has turned. People are starting to go back on IPO plans, some IPOs are not getting fully subscribed and valuation targets are being lowered by 20 per cent or so. It's a good thing that investors have been able to push back this time around.'
SEBI rejig
How is Sundaram coping with the SEBI categorisation rules? 'There are no major changes,' asserts KK. 'In 2010 itself, we figured that there was some confusion in the minds of investors between our Select Midcap and SMILE, so we decided to position SMILE as a small-cap fund with an 80-90 per cent allocation to small caps, while Select Midcap was run as a pure mid-cap fund.'
There are no significant changes to Sundaram Balanced Fund, Select Midcap or Select Focus, which will be a large-cap fund. Sundaram Equity Multiplier will remain a large-and-mid-cap fund. Thematic funds have also not seen major mandate changes, he says.
Lessons
What are KK's big hits and misses over his career? KK is quick with this one, 'Well, one thing I have learnt is that however much you may like an idea, you must not go overboard with it. Downside protection is very important. Sector-allocation limits, stock-exposure limits are very critical. There's always a tendency for mean reversion. The lesson on balance is something I have learnt over time. The other lesson is that you mustn't fall in love with your stocks or sectors. I have seen this tendency in the equity-research business to develop a strong passion for the sectors or stocks that you once tracked as an analyst. You can never let go of them. We also love companies where we think we have a great understanding of business or where we have good management access. We tend to overstay in all these cases. But overstaying in a room is a costly affair.'
Who are the investment gurus that have inspired him? KK is quite honest. 'I am not a great reader. I don't claim to follow any global gurus. But I have worked with some brilliant fund managers in my career in India and I am still in touch with them. When in doubt, I seek out their advice. I look on KN Sivasubramanian (ex-Franklin Templeton) and Anoop Bhaskar, whom I worked with at Sundaram, as my mentors. They are a great source of inspiration, too, in terms of stock-selection process and styles. I am in touch with most of the people who have contributed in my life.'