S. Krishna Kumar, Chief Investment Officer of Equities at Sundaram Asset Management Company, talks to us about his investment style which has evolved to become a blend of value and growth investing, with a bias towards growth companies. This blended approach, he believes, has helped him spot several small cap stocks early in their cycle.
S. Krishna Kumar, a Chennai-bred CIO of Equities from Sundaram Asset Management Company, has a strong track record of identifying small caps in the early stages of their cycle. When quizzed about this record, he says it was a very conscious move by him and his team to focus on small caps. With an intention of offering a differentiation to its customers, the fund often focused on identifying small and mid caps in the early stages, with a view to generate significant outperformance for its investors. The success of this mantra is evident from the performance of the funds that he manages. The Sundaram Select Mid cap fund has returned 37 per cent in the last three years as against the benchmark index – S&P BSE Mid Cap which has turned in 28 per cent. Sundaram S.M.I.L.E Fund has gained around 40 per cent in the last three years as against the S&P BSE Small Cap index’s 29 per cent return. He also is the fund manager for Sundaram Select Small Cap Series, Sundaram Select Micro Cap Series, Sundaram Tax Saver, Sundaram Value Fund.
KK, as he is fondly addressed, is an engineer from Regional Engineering College, Trichy (now National Institute of Technology) and holds a PGDBA (Financial & Portfolio Management) from LIBA, Chennai. After a seven-year stint in PRICOL and Lucas TVS, KK wanted to turn his interest in the stock market into reality. Ask him how he got this interest? He says that the seeds were sown by his uncle when he used to engage in conversations about the market with his friends. KK then did a project at Kothari Pioneer Mutual Fund, as a part of his post graduate course. His experience and interaction with prominent fund managers made him consider a career in equity research seriously and when he got an opportunity to join Anush Shares and Securities, he grabbed it with both the hands. And, since those humble beginnings, KK has made his mark in the mutual fund industry over the last 20 years.
In this story, he shares with us his investment philosophy, how he has refined it over the years, portfolio construction strategies and the big picture for India in the next ten years.
(As narrated in first person)
Beyond Basics is published by Wealth Advisors (India). Visit us at www.wai.in for more information.
Investment style and philosophy
In the mid 90s, equity research was unknown, seldom restricted to a group of 50 individuals. As more fund houses and FIIs started coming in, lot more research products were built. We are a part of that system as we learnt on the job. From just looking at PE multiples or Price-to-Book ratio, we moved on to looking at replacement costs to EV/EBIDTA and other valuation parameters and took long term views in our approach to investing. Earlier one would look at basic valuations to check whether a stock is undervalued or overvalued. But as growth accelerated, there are so many new business opportunities that came up in this country and we started looking at businesses in a more holistic manner.
From just being a value-driven investor, I started blending it with growth investing. Given the kind of improvement and growth opportunities that came along, growth investing will work well in an emerging economy like ours, where more investors are coming in for the growth that the 120 crore population has to offer. So, I’d say my style evolved to a blend of value and growth investing, with a bias towards growth companies.
In reality, value investing works when growth triggers are present. Even in 2013, stocks which were trading cheaper to book, started to interest people only when there was a growth trigger.
From the framework perspective, we follow the 5S framework – Simple business, scalable opportunity, sound promoter or management, sustainable competitive advantage to ensure that you keep growing and steady cash flows and good return ratio.
As far as valuations go, we don’t just consider the PE number but also look at the 3 year to 5 year outlook the company has and compare the value we are paying to buy that. For example, five years back, Inox Leisure was trading at 30 times its PE multiple. This doesn’t mean we ignore it. Had you projected the big picture and see the consolidation happening in this industry with single screens losing out, one would have noticed a different picture.
Identifying small caps in their early stages
At Anush, we were specifically focusing on the niche of small and mid caps. We knew that the Merrill Lynchs and Morgan Stanleys of the world would focus on the large cap stocks. We wanted to provide clear differentiation to our customers. That’s how we managed to break into UTI, HDFC MF and so on, by being a strategic partner to them in the mid and small cap space. This is where I learnt to identify small caps.
On portfolio construction
While stock selection is a very important criterion, how long you hold it is even more important to show returns. We invested early into Amara Raja Batteries’ growth journey. While there were times we got tempted to exit it due to its high valuation, we looked at the bigger picture, the market share gain, company’s performance and got convinced that it will take a leadership position. Take the case of V-Guard Industries. We bought it at Rs. 120 in 2010-11 and the stock is now trading at Rs.218 split 10 times. This apart, the weightage of the stock in the portfolio (how much of a stock you have in the portfolio) also plays an important role in the portfolio returns. These factors have differentiated the success of creating multibaggers.
A factor that is very relevant to midcaps is that you need to give companies a lot of patience and time. Their market is evolving and the government is crafting policies for them. Take the case of Indraprastha Gas. Many times, government through various bodies have created uncertainty over its profitability and growth. The company had a big see-saw journey – from Rs. 100 to Rs. 350 and then back to Rs.190 and now back to Rs.850 over the last 8 years. So, one has to always build conviction about longer term picture and get reassured of that.
Keeping faith and being patient with stock ideas have given good long term returns. From a portfolio strategy this means that you need to have 3 buckets of stocks in any funds – where you are holding ideas which have moved into a secular growth phase (about 40% invested), ideas which are in the cusp of getting into the phase of higher growth (around 25% investment) and three, ideas which you are seeding and watching them (another 25 % invested). This will be the trajectory, as stocks move into the portfolio. This way we can make midcap portfolios have a long term, sustainable performance. The same strategy also extends to large caps.
There is also the top down and bottom up approach and every fund manager uses both by overlaying one over the other. I am a bottom up investor, at the same time there is an overlay of top down approach too. If you look at themes which are playing out, my focus is to look at stocks more individualistically and build on that. Even in a large cap product, we would like to look at bottom up investing in giving more focus on ideas with conviction and building a portfolio of 30 to 40 core ideas which will work in the long term.
Challenges in managing public money in mutual funds
If you look at professional fund management, we have dual responsibility where we need to maximize the upside that we capture for investors and at same time, if there are events that create uncertainty, provide minimum downside to them. This is why growth investing works if you follow the tenets of buying good quality companies with reasonable leverage in the balance sheet,having some kind of competitive advantage.This subset of companies, though a tad expensive, will protect investors during downturnand offer an upside during the growth phase. Midcap companies provide a lot of high quality to the portfolio.
As an individual investor, one will be able to take more risk for enhancing returns, but as a professional investor one needs to manage a diversified portfolio with adequate risk adjusted return to the investor. That is the challenge.
Paying up for quality and growth
The operating metrics of the company is the focus when it comes to paying for growth and quality. One needs to consider medium term return ratios, efficiency of working capital, capital intensity of business and in the longer run, the compounding growth that the company will have.
You will also be able to measure the excess growth,efficiency and the premium that you are paying for a stock, if you compare it with the market or sector and look at the valuations like PE to growth rates or PB to ROE. On a practical note, we construct parameters for this in the portfolio. And if we find that we are over paying for growth or quality, then we make readjustments by tweaking it and move into more reasonable stocks.
Opportunity in India for the next 10 years
India is going to remain one of the most interesting countries and markets in the world. This is not just from the investment side but also with respect to geopolitics, size of the consumers and investments from FDIs in the country. From an economy perspective, we will see the per capita income rise even faster than what it was earlier. The rate of pace of doubling of income levels will accelerate and we will hit the J curve in many products starting from personal transportation and consumer durables to lifestyle products.
If you look at the 7 per cent to 8 per cent growth with 4 per cent inflation, there will be a 11 per cent to 12 per cent nominal GDP growth. Every 6 years, we can keep doubling our GDP and with birth rate being one per cent, per capita income will go up well. And in the next 20 years the dependency ratio will come down. Considering all this, India is well positioned across the globe.
Consumer discretionary is going to be a big space which will cover white goods, auto, lifestyle products and the upper end of consumer FMCG. Currently, the top end of the premium products is at the bottom end of your discretionary items and a lot of morphing will happen here, in terms of consumer behavior.
The other big thing that will happen is in the rural space. India has a lot of land bank, but only 30 per cent to 35 per cent is irrigated. Government is taking effort to improve this. Further, premiums for crop insurance schemes have come down making it affordable to the farmers. Data collection on goods and pest attacks are being done, whole system is being upgraded to ensure that farmer gets crop insurance on time. Rural income, of which agriculture income of 40 per cent, is going to be lot more stable and predictable. As a result of Government efforts, the insured acreage will go up 4 times by 2020.
Secondly, what NSE did to stocks will happen in agri-commodity in India as all of them are getting connected electronically. There will be removal of opaqueness in pricing with the consumers and farmers benefiting well. Some of the reforms by the government is focused and will change the rural income levels offering stability as a result the 10 crore households will move up the ladder.
The farmer will invest a lot and hence, agro inputs like automation products will take off and so will the seed industry and agro-chemicals.
Finally, financial inclusion is a big theme. The penetration levels are poor. People are used to unorganized financing. With JDY accounts and Aadharcard, the leakages have come down while bankers are able to now assess rural clients better by tracking the bank accounts. What CIBIL has done to consumer finance in urban market, will happen soon in the rural market as well.
Disruptive innovations and the segments where opportunities lie
In India, you have seen what ecommerce has done to the brick and mortar companies. Similar is the case with passenger transport companies like Ubers and Olas. These are early days and we only hear about successes in many companies in the ecommerce space. We will follow the western world in many things. However, it may not happen in the old economy space. In finance sector, there is RoboAdvisory happening which is one more channel of distribution. My belief is that disruptions will happen but I don’t see that displacing a whole lot of players. There is going to be consolidation wave as companies strengthen themselves.
If we look at batteries segment,while we spoke about Amara Raja Batteries and Exide Industries having a huge entry barrier, companies can enter this space and use logistics players to ease their distribution issues. That is a big challenge which these companies will have in products where you don’t need after sales service.
In terms of technology, there are changes taking place on the security side using virtual reality. There are apps with driverless technology evolving that are in the early days. There is a certain basic level of infrastructure for all this to succeed. While in the Western world, it is available aplenty, in India, investing in basic infrastructure will take longer.
I did spend seven years outside the sector in the manufacturing industry. It helped me understand the businesses from the shop floor and corporate perspective. While I wouldn’t change this journey, I’d probably cut the time I spent there and enter the investment world faster.