SANDIP SABHARWAL
Stocks,shares, finance, money, profit and the economy

The Bull Market in developed markets like the US, Germany and UK have been now on for the last 5 years. Most developed markets have doubled or more from the bottoms of 2009. However in the case of most Emerging Markets we have seen turbulent periods over the entire 2009 to 2013 period where we have had good years like 2009 and 2010 followed by an extremely tough 2011, a good 2012 and an average 2013. So it is difficult to say when the bull market started in EM’s. However for India it has actually started this year as the driver of the markets over the years previous to 2014 were either defensive stocks or stocks that derive growth from overseas markets i.e. IT and Pharmaceuticals.

First let’s look at the global perspective. To me it is very clear that the global bull market cannot end when major economies have zero interest rates. Today we have a scenario where the overnight rates are zero in US, UK, Euro zone and Japan. The first expected increase is likely from the US that too 15-18 months down the line. Euro zone is still grappling with deflationary fears and unlikely to increase rates in the foreseeable future and same is the case with Japan. When the US FED decided to wind down Quantitative Easing there was lot of fear in the markets. At that time, in my article “Do Not fear FED TAPERING for the right reasons” I had clearly pointed out that the fears were baseless and if growth revival and not inflationary spiral is the cause of Tapering then it will be good for the markets. It played out exactly that way.

Now comes the question at what level of FED FUNDS rate should we start getting worried. My guess is that till the time the overnight rate in the US reaches a level of 3% and the US 10 year bond yield a level of 4-4.5% the bull market in Equities will continue. I will not elaborate but explain in brief. Firstly rates will go up as the US FED becomes more comfortable with the growth outlook i.e. possibility of stronger growth. Stronger growth is good for the Equity Markets. The second factor then is that at what level of interest rates will growth prospects start looking dimmer. That should be around 200 basis points above the current US 10 yr bond yields of 2.5%. At that stage depending on the stance of the ECB, Bank of Japan and other central banks we will need to take a call on the direction of the markets. However this is still 3 years down the road.

INDIA

Looking specifically at the Indian perspective my view is that the Bull Market actually started after the massacre of the small and mid cap stocks was over. Small and Mid caps got smashed in 2008, Whacked in 2011 and finally destroyed in the year 2013. This was the time when people lost total hope in equities in India and redemptions from domestic MF’s reached a crescendo. The outflow from equities in general and a shift into other assets like gold, tax free bonds, real estate etc also reached a peak at this stage.

Most people tend to believe that as interest rates in the US move up they will move up in India too. This is not necessarily true. The difference between the 10 yr bond yields in India and US has swung between as low as 0.5% to as high as 6.5% over the last 10 years. Fiscal Prudence combined with lower inflation can create a situation where Indian interest rates can actually decline even as they increase in the developed markets.

Several factors led to a stagflationary scenario in the Indian economy. It started with the commodity spiral boosted due to easy money policies of Western Central banks, which in combination with Fiscal Profligacy let to high inflation and interest rates. This got combined with a governance deficit of the previous UPA government and led to a collapse of growth from 9% three years back to just 4.5% in 2013. Inflation is now on the way down and the new government is focussed on growth revival along with inflation control by a combination of Fiscal constraint and a boost to the supply side.  These factors are positive for growth revival.

The growth revival cycle in India is just starting. We saw a bottoming of growth at 4.5% last year. This should swing back to 6% this year and between 7-8% over the following 3 years. Stock markets will always do well in the period of accelerating growth. . Every economy goes through phases of profit expansion and compression while the GDP and the Turnover (sales) of companies continue to grow. The phases of profit expansion take the profits more than the growth in sales. As profits grow more than the turnover of the companies, in general the Return on Networth or the Return in Capital also move up. This leads to an upward rerating of the companies in that economy as the outlook for future growth looks positive. During this phase the Market capitalization to GDP ratio of that stock market expands

India’s market capitalization to GDP reached a level of 60% last year. This level currently stands at 85%. The case for expansion in India’s Market Cap to GDP going forward is extremely strong. The ratio moved up from 45% in 2003 to 160% by the end of 2007 in the case of India. If the ratio moves back to a level of 120% over the next five years and in the same time period we have a nominal GDP growth of 11-12%. The calculation reveals a 125-150% return potential in this scenario over the next 5 years. Basically NIFTY above 18000 and SENSEX above  60000. As such wealth creation in the Indian Markets over the next 3-5 years could be huge due to a combination of a stronger growth in profitability as well as a rerating of the economy i.e. expansion of Market Cap to GDP in the same time period.

Unlike most other policy actions of the government the entire process of disinvestment as being reported in the media has similarities to the Destructive Disinvestment of UPA Government. In recent days we have read about proposed disinvestments in ONGC, SAIL and Coal India. Initially when the entire disinvestment programme was launched in a bigger manner under the previous NDA government the idea was to use potentially positive policy moves to disinvest or sell out companies in a strategic sale manner where the ownership changes to the private sector and as such the government tag is removed from the companies, greater professionalism comes in and the process creates value for the investors. However the entire disinvestment programme subsequent to the Coal India sale a few years back became one of destroying the wealth that is imbedded in PSU’s as the sales happened at lower and lower valuations without policy actions to improve the valuations of the companies. Just to meet disinvestment targets PSU’s that are owned by the President of India and are funded by tax payer money were and are proposed to be dumped at absurd valuations.

On the other hand white elephants like Air India, BSNL etc are getting dole outs from the government again out of shareholder money. There was an opportunity to disinvest out of companies like MTNL in a strategic manner at some stage which would have helped the company not only survive but also thrive due to its predominant presence in Delhi and Mumbai. It is absurd that the government wants to continue to run an airline, a telecom company etc at a time when these companies are clearly not equipped to compete with the private sector in a competitive environment.

Strategic sales like Maruti, Hindustan Zinc etc have helped these companies adapt and thrive by improving productivity. However the way disinvestment is being carried out today, at the worst of times makes me wonder what the thought process of the government is.

The initial disinvestment of Coal India was done appropriately. However later the government decided to sell more of the company when the price was Rs 400. However at this time the Coal scandal was on, global coal prices were falling and Coal India has been unable to increase production courtesy previous policy actions of Mr Ramesh/Ms Natrajan. The market sentiments also were bad. As a result the stock price has crashed to Rs 260 levels. Coal India has Rs 50,000 Cr plus of cash, the government should have just taken an Rs 10,000 Cr dividend which it eventually decided to take in the last quarter of 2013-14 when Chidambaram was trying to show a lower Fiscal Deficit at any cost.

Similarly NTPC Follow on Offer disinvestment was planned when the entire power sector was in doldrums, NTPC capacity addition was lagging and there were fuel price issues. The issue was planned when the stock price was Rs 200 plus and fell to Rs 140 at the time of disinvestment. Similarly NMDC was dumped into the markets at a time when the iron ore mining ban issue is prevalent all over the country and iron ore prices globally have crashed. The better time obviously was when the iron prices were better and the mining issues were resolved.

I have mentioned this earlier also the better opportunity obviously is to sell high. Strategic sale of ITC will yield the government Rs 50,000 Cr, get in over $ 8 billion of FDI and also reduce the pressure on the INR. The remaining holding of Hindustan Zinc could also have been disinvested at extremely good valuations and can still be done.

It is extremely unfortunate that the thinking process has not changed and the same kind of disinvestment is being proposed. First there should be Diesel deregulation, subsidy cuts and then ONGC should be sold. Similarly there needs to be visibility on improved performance at Coal India before it is sold so that the sale is also at a good valuation and the investors also make money.

Lets hope better sense prevails and disinvestment is not carried out just as a book balancing activity.

Well the Union Budget has come and is through now. I will not write in details as every news channel and every business paper tomorrow will be full of analysis. I will just do a brief macro commentary on how I see the Budget.

Firstly I do believe that the Budget is growth supportive and anti inflationary. It is ant inflationary in two big ways. The first being the fact that the cash given in the hands of taxpayers is not very high and is actually lesser than the inflation in the economy. The tax free limit has been increased from Rs 2 Lakhs to Rs 2.5 Lakhs. The other two Rs 50000 breaks have been given on saving and asset building. Housing loan interest limit increase will make acquiring self occupied houses cheaper and the increase in limit on 80C savings as well as on PPF will help increase the savings rate. Improved savings and limited incentives to spend are anti inflationary.

The second anti inflation move is in the structure of government finances where revenue expenditure is proposed to grow at just 9.4% which will be lower than the nominal GDP growth of around 12%. The other part is the restructuring of MNREGA spending which will now be directed towards productive usage like agriculture and rural asset building rather than just paying off people for free which had created a huge labour shortage for farmers in rural areas. Moreover these spends have been restricted to last year’s level, thus an inflation adjusted decline.

The other big observation is that the budget is growth oriented. Capital expenditure is proposed to be increased by 26% plus which will boost growth and employment. Incentives given for capital expenditure to corporate, extension of excise duty cuts as well as investment allowance for smaller capital spends are positive. The power sector has got extended tax breaks and there has been a huge increase in allocations for the roads sector which is hugely employment generating. This will be followed up by several measures to ease the way business is done and project clearances made. Lot of these moves will be outside the budget. Retention of a low Fiscal Deficit figure of 4.1% is also anti inflationary as it will prevent crowding out. The direction of Fiscal Deficit which has been put out and directed towards 3% over the next 3 years implies that the Government will continue to borrow flat over the next three years and thus provide a huge impetus to economic growth by releasing funds for the private sector.

Lot of clarity on taxation has been sought to be provided to foreign investors by means of taxation of profits of foreign investors, transfer pricing as well as retrospective taxation. More moves of these will be seen outside the budget.

There will be lot of columns written with headlines like “Opportunity Missed”, “Could have done more”, “Damp Squib” etc. These need to be ignored as most people are just interested in flashy announcements and not implementation. The key focus of this government is likely to be on implementation. All said, “The proof of the pudding is in eating it” as such let’s see how the delivery plays out. 

There has been lot of hype around the EL Nino and the likely shortfall in rainfall in India this year. In my previous article I had pointed out that the two major indicators that impact monsoon rains in India i.e. Southern Oscillation Index (SOI) and Indian Ocean Dipole (IOD) had turned neutral to positive for the Indian Monsoons and do not indicate an EL Nino at this stage. As it turns out the shortfall in the monsoons in June is not due to El Nino but due to local factors.

Now to come to the impact of the monsoons on agricultural production. The good part is that there was so much noise around the El Nino that most farmers were already aware that rains might be late or deficient. As such plantations were delayed. The second and more important part is that except for West India the progress of the monsoons is reasonably fine. Moreover the shortfall of 42% in rains in June is not very significant as July and August rains are more important. Moreover statistical analysis of past data has revealed that whenever rainfall is deficient in June it is above average in July and August in 90% of such years. As such probability of above average rains over the next two months is quite high. So given that farmers delayed plantations and rains are most likely to recover we should have a reasonable agricultural season. There could be some shortfall due to reduction in yields but overall production should be good. This combined with proactive action by the government to prevent hoarding should keep food inflation under control. Let’s not forget that under the previous UPA government food inflation remained high despite excellent monsoons and agricultural production.

If we see the monthly average Long Period Average of monsoons in India the statistics are as follows

Month LPA (mm)

June                                      163.5

July                                       288.9

August                                  261.0

September                         173.5

TOTAL                                   885

As such it is clear that June is the month of lowest precipitation and the following months are more important.

This is also empirically borne out by last year’s agricultural production data for the Kharif season where June saw very good & above average rains, however the monsoon continued to weaken mid July onwards and was below average in August and September. As such although the print figure of 106% of LPA was very good Agri Output was up just 0.9% as standing crops got damaged.

The important months are ahead of us. Rains have picked up quite a bit lately and given the historical statistics the probability of good rains going ahead are high & so is that of agricultural production. As such let’s not fear now but be hopeful of decent food grain production.

Fulfillment and Contentment are the key            

This is the second and concluding part of my articles on attaining happiness in life. Let’s get the basics clear first

You need to be happy today. There is no tomorrow. As they say, how do you know that you will even be alive tomorrow or might not be facing a situation tougher than‎ today? The future holds many imponderables, the present is fully known. We need to live for today and work towards a happier tomorrow, but be ready for situations to play out differently.

Happiness also cannot be correlated to materialistic fulfillment.  Are we happier than what we were in the past? At that time our needs might have been lower and the money required maintaining our future lifestyle to the current levels might have been lower. Is the thought of the future destroying our current happiness.

The question is whether we are happier today than we were 10 years back. A decade ago my goal in life was to be the best performing fund manager and to get awarded and rewarded for that. Once I achieved that the goal post became retaining that position and remains there for a long period of time. Which I achieved for sometime but then it will never remain forever. The fall from the top always hurts the most.

Subsequently the aim and target became reaching to the top again. And the cycle went on till I realised sometime last year that this was not making me happy but more and more frustrated. I decided to then step back, focus on research and do things that I enjoy. Today I am much happier than I have been anytime over the last 5 years.

Let’s take an example to explain things.

Earlier whenever I used to trade in the stock markets I would play a high risk game and try to make more profits in the short run. This would make me tense and create stress. Sometime back I moved to a mode where I only take stress less positions. Once I do that I do not worry as worrying will not impact my profit or loss in any way. We can only do our due diligence and then let the forces play their role. As such I am much more content and happy today. Earlier I would always regret and feel frustrated over some stock that I never bought despite thinking about buying it after its price moved up. Now I am not bothered. Returns always flow from what we do and  not what we think of doing. Investing, which is my passion has become much more satisfying for me.

 Goalposts lays keep on changing. I vividly remember a conversation that we had among a lot of friends in the year 1997 where everyone lacked about their aspirations in life. One of the person, who currently heads debt markets in a prominent asset management company at that time, had a target of Rs 50 lakh so after which he wanted to shift back to his home town Bhubneahwar. Today he has 50 times that wealth but is still slogging it out and working 12 hours a day.

There are so many people who are proud of the fact that they live out of the bag, travel 200 days in a year and do not take many holidays. This does not exactly seem like a receipt for happiness. I personally have never stayed in office beyond 5.30 PM as there is mostly nothing that you cannot do in8 or 9 hours. If you cannot do it in this time then even 12 to 15 hours are too less.

There has been enough and more written about work life balance. It is a necessary condition for happiness.

Are you able to laugh at least once a day? Do small things make you smile? If not then you don’t seem to be happy. Do you give time to your family, go out with them, listen to your kids and share their experiences. Or are you just busy in things that might not matter in the long run.

Taking stress, being worried achieves almost nothing. If we need to complete a task we need to give it our maximum effort, however being stressed because of it eventually impacts the health. There are events in our life that are impactable i.e. our actions can impact the eventual result. On the other hand there are those where our actions will not impact the result. We could worry for the first, however most of us tend to take stress and worry for both kind of events.

Although we believe that we are responsible for all outcomes, in reality there are bigger forces at play. In the year 2004 at the time when the birth of my daughter was due, I and my guruji worked out her time of birth to the last minute and worked on it. We were successful in achieving the result as the doctor was very cooperative and managed it to the last minute. However in reality did we do it? The answer is no. There are bigger forces of the almighty at play who decides these events. Similarly sometime in the year 2002 a friend of mine, whose mother in law used to do some astrology, took out the time of birth for her granddaughter. Here the situation was a bit tricky as the horoscope of 8 am showed a perfectly healthy baby. However a one hour delay created a situation where the child could have a eye problem. As it happened the doctor agreed for the 8 am delivery. However at the last moment an emergency came up because of which the surgery got delayed. Unfortunately the child does have a problem with her eyes.

One of the major factors that creates discontentment in today’s materialistic world is a sense of underachievement. We tend to compare ourselves, on a continuous basis with our friends, peers and others. We might be doing better than 95% of others but create discontentment for not doing as well as the remaining 5%. We need to be mentally ready to deal with failures. If we try to do something we will invariably face failure at some stage or the other. However this is just part of our destiny we have to accept this and move ahead.

We need to manage our ego, achieve humility & respect the other person’s point of view. Our ego is our worst enemy as it slowly builds into a ghost like that in the story of “Vikram aur Betaal” where we just cannot get rid of the ghost. The other big source of unhappiness is our expectations from others. When we do something for someone we expect Newton’s Law to play out in terms of the action getting an equal reaction. This will never be true. There are always people who do more for others and in any relationship we cannot be evaluative at every stage as it will always bring discontentment.

Happiness is all about enjoying today as it is without worrying about what tomorrow will look like. Put aside all fears, jealousy, anger, worries & stress. All of these are going to get you nowhere. Be happy and enjoy life for what it is. Thank god for what he has given you do not curse him for what you do not  have. Go to temples, pilgrimages etc for peace of mind & not to ask god for the impossible. Internalize the fact that you will get what you are destined to get, nothing less and nothing more.

 

Iraq, Monsoons, Modi warning on hard decisions and beyond

The Modi Euphoria has given way to Iraq concerns over the last few days even as most strategists have turned positive on India and have upgraded their long term outlook for the Indian markets. This issue has also been impacted by the predictions of a below normal monsoon and the potential resultant impact on food inflation which has been in high double digits for the last few years. At this stage it is important to evaluate things in order to get a hang on the near term outlook.

Iraq tensions have come up suddenly, as did the Ukrainian crisis a few weeks ago. My view on Ukraine was very clear i.e. the impact on the markets was likely to be muted as it did not carry much of impact for the rest of the world. However Iraq is a different story altogether mainly due to its potential impact on crude oil prices which have remained elevated over the last several years despite extremely weak demand fundamentals. Today we have a scenario where most other global commodities like Iron Ore, Coal, Copper etc are trading near multiyear lows. Among major industrial commodities Crude Oil stands out due to the significant impact on crude prices due to unrest in the MENA region. Iraq is strategically important as it is supposed to be the country which will add the maximum to the additional supplies of crude oil over the next decade. A prolonged period of unrest in this country has severe implications for long term crude prices. Libya, which went through a transition couple of years back has seen periodic disruptions in oil production due to civil unrest in that country. The same thing could happen in Iraq. It will be important to watch the developments in that country.

The long term Brent futures curve indicates much lower prices 5 years down the line. However continual disruptions in Iraq and other oil producing countries in the Middle East could pose a risk to these projections. However the good part is that most other commodities are likely to remain muted for a prolonged period of time and could balance higher crude prices. Due to summers and this not being the peak demand season for oil products we should not see too much of spike up in prices from the current levels till August. However if the situation deteriorates we could see a $ 10 spike up which could be unsettling for the markets.

The other bogey in the bag is the Monsoons. Various prediction models have been projecting a below normal monsoon for a long period of time. These predictions have had two impacts. Firstly a lot of analysts have turned cautious on current year Economic Growth prospects due to predictions of a poor monsoon and the concurrent impact on food prices. Initial indications also point towards hoarding which could drive up food prices.

The good part is that the government is seized of the situation. Supply side augmentation and reducing post production losses is a longer term strategy. In the short run there is little that the government can do except to prevent sharp spikes. However, I am in the camp that actually believes that the El Nino threat is overblown. There are two major factors that impacts the Indian Monsoons are the Southern Oscillation Index (SOI) and the Indian Ocean Dipole (IOD). Both these indicators are actually pointing towards a normal monsoon and the SOI is actually indicating that the El Nino could be giving way to a La Nina. The IOD is also neutral at this stage.

On an overall basis the monsoons could go either way. How the situation is managed by the government will be interesting to see. There is need to set up a Monsoon monitoring committee in order to guide the farmers at this stage and also to track perishable food product prices so as to manage food inflation.

Narendra Modi has also talked of taking harsh measures in order to set the economy on the right path. The damage done to the economy by the last government is known to everyone. The good thing is that these harsh measures are likely to be stock market positive. Fiscal Prudence along with strong steps towards economic revival is important at this stage. Tax increases are extremely unlikely in a stagnating economy. The attention will be towards dealing with unproductive freebies.

The impact on the sentiments post the new government taking over are there for everyone to see. The actual ground impact will also become clearer over the next 3-4 months. I am optimistic on the direction that the government is taking and the growth outlook for the next 3 to 5 years looks quite encouraging. The key is to get over the initial period which has been hit by possibilities of higher crude oil prices as well as inflation spike induced by poor monsoons.

I have not yet revised my earlier December 2014 Nifty Target of 7654. I will wait till the second half of July to take a view on the rest of the year. Risks look balanced for the next 3 to 6 months at this stage. There are too many people on the sidelines waiting to come in on any sharp correction. This should limit downsides in the market. Any global correction will have its side effect on India too and that is also something we will need to watch out for around the end of the 3rd quarter/beginning of 4th quarter.

That said, there are huge stock specific opportunities available to be tapped and that is where investors should be focussed on. 

THE ANTITHESIS TRAITS

The purpose of human life in totality is nothing but a pursuit of happiness. What construes happiness is different for different people and unlike wealth, power or position it cannot be measured. In the current environment where we live happiness in an external sense is generally measured in terms of the money, house, car etc that one possesses or the position that one holds in society or the power that one yields. However who is to say whether Mr Mukesh Ambani is happier than the lowest paid employee of his group. I will start off the series of articles on this topic by first discussing things that lead to the opposite of happiness. The four major traits that lead to unhappiness are Jealousy, Anger &Fear.

Jealousy – Jealousy is a trait that typifies unhappiness. Most people in today’s age do not look at what they have but tend to be jealous of what others have. Everyone has their own destiny and achieves in accordance to one’s own abilities or karma. Instead of being satisfied with what we have we always tend to look for things that we do not have or we think that we should have. Everyone cannot be the richest or the most famous or the most popular in the world. When we look at our friends we need to meet them at a neutral ground. Some of our friends and peers who studied with us in School or College will always be doing better in their career or monetary status as compared to us & vice versa. However who is happier than the other is something that we cannot evaluate. It is in the mind of the person. There are different problems that everyone faces in life. Someone might have more money but might have some personal or professional problems that are not openly visible. Jealousy leads us to continuously judge people or do things to them that hurt us in the long run.

People who are jealous by nature could be just jealous of someone who does not have 99 things that they have but just one that they do not. In fact jealously is a disease which needs to be treated at the earliest as it takes away the happiness from all the things that we have for those that we don’t.

If we are jealous we can never be happy. The negativity of looking up to someone and cursing the person for what he has achieved can never bring us happiness. Two people might start as peers, but eventually not everyone will rise to the top. Destiny has a different course for everyone. We can take a man away from his destiny but not destiny away from a man.

Jealousy takes away any happy memories we might have of the past, spoils our present and makes us look into the future with scepticism. Positivity of thought is required to overcome this and this is something that everyone has to internalize & implement. A number of Indian Vedic scriptures say that a positive outlook can improve the outcome & a negative outlook can make it worse.

Anger- Controlling anger is the surest way to achieve happiness. Anger manifests itself in many ways. We might be angry at our boss for not giving us credit for what we have done, our friends and family for supposedly ignoring us, the politicians for the lack of development & the whole world for something or the other. Anger leads to irritation and a feeling of emptiness. The most negative facet of anger is that it leads us to do things that we invariably regret later.

Managing anger requires sitting back and evaluating ourselves more than others. The human brain is a very effective machine which can be pulled or conditioned to any side. We need to sit in peace and think of the almighty for a few minutes anger can dissipate immediately. Our thinking process when we are angry typically moves towards the negative. We start thinking of how we can take revenge from the person who we are angry with. The anger can be directed at our child for not doing what we told them to do or doing something that creates stress for us. At one level it is important to be concerned for our children’s well being but it cannot be always dealt with by being angry with them. The law of diminishing returns always works here, sporadic disciplining works well but continuous anger creates rebellion.

The anger can be towards our boss for not giving us credit that we think that we deserve or simply because he is our boss. There is always a difference between what we think that we deserve and what we actually deserve. It is important to adapt to what we have at a given point of time. There are times when we get more than we deserve and there are times when it is the exact opposite. However this karmic cycle has to and will take everyone one to their destiny. We have a choice of being happy with what we have or unhappy for what we don’t.

We could be angry at our government as most people were during the tenure of the last government. However as they say the cycle always turns. Good and bad times do not last forever. We need to accept things as they come and live for the present and make efforts for the future.

Fear- Fear is the most dominant trait that keeps us unhappy. Fear manifests itself in several ways, from the superficial to the mundane to the profound. For example we can be fearful of getting caught in traffic on the way to the airport and miss our flight. We could fear going into an official meeting and be worried about the outcome and what would happen if it does not go the way we think it should. We could fear for the health of our family, the outcome of a court case, our exam results etc. In fact fear can manifest itself in any form and in anything.

Fear is the worst enemy of happiness. I will explain via a recent example. On our way back from our holiday from Singapore we had got lot of stuff that we had bought out there. There had been lot of talk that these days customs creates issues on immigration if we have large amount of baggage. I was clear in my mind that we have done what we wanted to and not the customs officers have to do what they think is their duty. Lo and behold, four of our bags were marked for inspection. I took them to the customs officer and offered to open all of them and started opening them one by one. After seeing that we were not really bothered he let us go. There was no worry as internally I had already decided that I will pay up whatever they would want us to.

If we keep on fearing for our future we can never be happy in our present. This does not mean that we do not work for an outcome. However the result of our efforts is not in our hands and as such once the effort is made we should not fear for the result. I used to get extremely perturbed if I would get trapped in traffic while going for a meeting or for catching a flight. However I have slowly worked on it and do not bother now. What is in our hand is to start on time subsequent events are out of our hand and our worrying about them are unlikely to resolve them in anyway.

The way to overcome fear is by continuously talking to oneself, praying to your god or guru while taking all possible steps to achieve the desired results. For example our parent or a near relative might be undergoing a serious surgery. We would fear for the outcome. All we can do is to arrange for the best possible doctor, hospital & post operative care. There is no way we can influence the outcome and as such we should not fear but approach the entire thing with a feeling of concern and positivity.

In concluding part 1 of this series all I will say is that we need to be happy and keep our near and dear ones happy. Neither jealousy, anger, fear nor worrying about something is going to change our life. All of these always create an internal churn within us & keep us dissatisfied.

Do not regret for what we do not have, do not be angry  towards those who do not act in accordance with your views & have no fear after doing your best and what is right.

We need to be satisfied with what we have today while working for a better tomorrow. A better tomorrow is not one where we have more money or a better social standing but where we are internally happier. There is a huge difference between the two.

This article is inspired by the comments that I read in a top selling Business Magazine recently in which most Mutual Fund CEO’s, non achievers in general spoke as rote on how their fund houses are process driven and do not depend on individual Fund Managers.

Those who do not rise cannot fall. This article is for the benefit of those who have achieved something by their own efforts, have become stars in their own fields by achieving more than what a normal person in that profession would achieve and as a result of that all their performances come into the public eye. They need to be top performers all the time; otherwise they will be criticised for not meeting the standards that they have set for themselves.

I start off by my personal achievements because of which the media and the financial services fraternity categorized me as a “Star Fund Manager”. Now I was not born as a strong performer. It was due to my own efforts, my learning’s by making huge efforts without much guidance and also due to my ability to take risks which were contrarian to the current way of thinking that I outperformed most other funds right from the year 2003 till 2007 in the Mutual Fund Industry. At that time there was a huge coterie of MF professionals including a few CEO’s of underperforming Mutual Funds who would go around the entire market place making presentations on how they were CEO’s of process driven fund houses and do not rely on “Star Fund Managers”. Most of these people tend to be underperformers who have not achieved much in life or those who have climbed up due to abilities which might not fall into the professional achievement category. Most of these people live on the reflected glory of the performance of their Fund Managers. When the FM is doing well and the AMC is showing growth it is always a team effort. When performances slips and growth slips the responsibility lies with the Fund Manager.

What does a process driven fund house mean? It just means that there is an investment process. However the final call to buy, sell or hold is always of the Fund Manager. Otherwise why would the performances of the so called “Process Driven Fund Houses” also fluctuate at regular intervals from being in the first quartile to the last quartile and vice versa. The reality is that all over the world it is recognized that the ability of the Fund Manager is of primary importance to the performance of a fund.

I have  explained the impact of personalities via the example of the industry in which I have worked in. This is true across industries and across countries. CEO replacements in even large companies lead to those companies doing better or worse. Everyone would be following what is happening in Infosys today. It is an organization with over one lakh employees, hugely process driven. However lack of leadership post Nandan Nilekani has led to dis-satisfaction, an attrition rate that is double that of TCS and below par performance. A dynamic leader could change all of this.

The biggest example is that of what is happening in India today. With the change in leadership at the Prime Ministers level the entire confidence level has gone for a change. Would this have happened if it was anyone but for Narendra Modi. What better example than RBI, a totally process driven organization. However entry of Raghuram Rajan has changed the entire working style, profile and proactiveness of the Central Bank, increase confidence in the INR and on India in general.

 

Even in team sports like football , Cricket and Hockey there are players who stand much above the others in terms of abilities. Obviously these stars cannot win alone but there contribution increases the team ability many folds. They need rest of the team to excel but the team becomes excellent primarily because of them.

The second point is that who does not have bad times. Didn’t the Superstar of the Millennium Mr Amitabh Bachchan have a really horrid time during in the 1990’s when nothing seemed to work for him. He also lost lot of money and owed money to banks in his business venture ABCL. He had to use the Television Route of Kaun Banega Crorepati to bounce back and come back into the movies circuit again. It was his hard work, dedication, an ability which is more than others and a need to excel that brought him back. He did not become a Star because he wanted to; he became a star due to his achievements which were better than most others. There are several other examples of the same in various fields. There have been sportsmen like Yuvraj Singh who have been huge stars and have had very rough patches. He was able to bounce back as he wanted to perform at the top level again.

Playing politics to move up the ladder can only work till a certain level. Subsequently it is only your competence which will help you sustain. Unless, of-course you are working in a Public Sector company where the exact reverse might hold true. Pioneers in different fields who have become stars in their respective fields have had the ability to see things differently than others. People like Steve Jobs, Bill Gates, Mark Zuckerberg etc fall into this category.

The key requirements to become a star in any particular field in my view have to have the following abilities.

  • A thinking process that is very different from others which helps a person take calls that others might not.
  • A personality which makes everyone take a view on the person. Love him or hate him.
  • A skill set in their respective field which is not easily replicated. For example in the field of investments everyone wants to become a Warren Buffet by following the investment philosophy that he talks off. However no one till date has been able to do so.
  • An ability to look into the future and recognize trends that will emerge, not necessarily today but tomorrow and into the future. Either recognize what people want today or what they will want tomorrow is necessary.
  • Innovate, go beyond the obvious and have a risk taking ability higher than others.
  • Most importantly an ability to bounce back from defeat or failure. This requires confidence in one’s own ability and a positive thinking process which can help keep the past behind and live in the present and the future.
  • An ability to keep on trying despite repeated setbacks in order to meet the destiny as per one’s ability

Though different fields might require a different set of abilities I do believe that the above mentioned ones are essential irrespective of the field of work.

I will rest my case here with the closing comments being the fact that the effort require to climb up the stairs in adverse circumstances can never be appreciated by those who stand down and watch the climb or try to pull down those who are above. 

This is my 5th article on MF Investing. In this part I will talk about things that the mutual funds will tell you and which you need to take it with a pinch of salt.

  • We are a process driven fund house – This is the most often used statement by the fund houses in order to sell their schemes. However the problem now is that this is a commentary that is made by most mutual funds. The question is what is a process? A process is a set of procedures by which a fund manager operates. Now the processes that the fund house talks of is essentially telling you that we have a manual which gives the standard operating procedures which need to be followed before making an investment. The reality is that fund management is an art and it is not a science. Two fund managers meeting the same company with the same set of information might have diametrically opposite views on that particular company. One might believe that it is a sell and the other might believe that it is a buy. Have you ever thought of why the stock market operates? The reason is that at all points of time there are people who have different views on the same stock. Trading is happening because one person is selling and the other is buying at the same time. When sellers predominate at a price the price comes down and when buyers are more the price moves up. Never, never buy the pitch of a process driven fund house.

The performance of a scheme can never be taken out from the ability of the fund manager to manage the scheme. Typically in today’s context there are certain large fund houses that have some fund managers who have been around for several years and are known for their abilities. The funds of that fund house tend to be sold on the name of that fund manager. In fund management the performance will depend on the performance of the fund manager and fund manager alone. So does that mean that the pedigree of the fund house is not important? Of course it is important as it gives you the confidence that they will be able to hire the right kind of people to manage your money and if it is an established fund house or a fund house with a strong parentage then it will be there for the long haul.

The CEO’s of several fund houses will talk of public platforms and try to play down the importance a particular fund manager. Please do not believe them.

  • The other part of the story is that the performance of fund managers also tends to by cyclical. The reason for this is that most fund managers tend to have a particular style of investments and a certain way of evaluating companies to invest into. For example I am a growth oriented fund manager as it has been my belief that value without growth can remain value for a prolonged period of time. Also there are different styles of managing funds, some fund manager buy a large number of stocks and some have concentrated portfolios. I as a fund manager have always believed in concentrated portfolios. The need for due diligence should be before the investment is made and not afterwards. Over diversification in the end reduces investor returns as some stocks will be doing well and some will not be. But it is not that over diversified funds do not do better than concentrated funds. They can and they will at various points of time. The risk of a concentrated portfolio is that even if one or two stocks go contrary to expectations the performance might not be as per expectations. But, in general over longer periods of times fund managers that have conviction will do better.
  • The cyclicality in fund manager performance is very evident in the markets. It is also evident that particular fund managers might do very well when they are handling mid cap funds but do not do well when they are handling large cap funds or vice versa. The difference might lie in their ability to evaluate macro trends properly, which is required for large cap funds and micro analysis which is required for mid cap funds. So then what does the investor do if the fund manager performance will not be consistent? The way to look at it ideally is to so how much better than the average the fund manager does when his style is working and how much downside protection can he build in when his style is not working. Typically this will be clear over one up and one down cycle.
  • The one question investors should ask before investing is what the experience of the fund manager is. Over the last few years we have seen a disturbing trend where fund manager with little or no fund management experience are given large sized funds to be managed by Asset Management companies. This is a disturbing trend and investors should be very careful to see the experience of the fund manager. Normally it is seen that the graduation from handling small funds to large sized funds should be gradual, however someone who was handling a fund of Rs 20 Cr cannot suddenly start handling Rs 1000 Crores in a proper and efficient manner.
  • The other thing that investors need to remember is that Debt and Equity investing are very different cups of tea. Equity investing is all about taking the right amount of risk and Debt investing is all about avoiding the right amount of risk. As such normally those fund houses will do better that have well defined Head of Equity and Head of Debt and not an all inclusive Chief Investment Officer who lacks skills in one of the two.
  • The other challenge that investors face is that most fund houses will come with spreadsheets and try to sell funds to investors that have done well in the immediately preceding period. The scheme will then start getting inflows and suddenly grow in size. At that stage the performance suddenly slips. The reasons for this are very clear. It is easier to outperform with a smaller fund than a large sized funds, some particular picks might have done well for the scheme when it was small & the fund manager does not have the ability to pick out stocks for a larger sized fund. In the recent past there have also been examples where certain mid cap oriented funds have done well by holding a large proportion of illiquid stocks in their portfolios and as the portfolio size increases this is not possible. As a result of this their performances have faltered significantly as the market move has become more broad based and Mid Cap MF’s that had a more value driven approach to investing have done much better. 

This brings me to the end of this article. I will talk more on the subject of evaluating mutual funds in the future articles.

With a market rally that has surprised most(not all) we are today in a situation where a number of Large Cap stocks that have decent balance sheets are no longer extraordinarily cheap. This has happened at a time when the domestic investor participation in Indian Equities is at the lowest since the end of the last boom. Essentially most of the Indian investors have missed the move up in the markets over the last 2.5 years. The apathy towards equity has continued to remain high even as the economic activity has bottomed out. News flows on persistently high inflation, strong tax free returns from tax free bonds, volatility in the markets due to the volatility of the Indian Rupee have been contributors along with the negative news flow generated due to the economic slowdown and the various scams in the UPA2 regime.

Now to potentially see the best value creators of the next economic boom in India, which can be delayed but not denied we need to see and cull out the companies that have either learnt the hard way from the previous downturn and now recognize the risks they took and that those risks were not worth it or the companies that handled the downturn well by being wary of taking big risks upfront and are now in a strong position to ride the next move up.

I have typically been a bottom up investor. The reason my  approach  to  investing  has  been  typically  bottom  up is that I  have  observed  is  that  such  an approach typically  ends one to the same results as a top down approach but in a more  efficient manner. Because here one is focusing first on micro research and then trying to evaluate the same in a macro environment. Let’s look at an example from the past. One of the key sectors where I invested at the beginning of the last bull cycle was the automobiles sector. After meeting a whole series of companies in the sector in early 2002 I realized that all these company had restructured substantially over the last five years and were seeing significant volume growth coming in.  Volume growth combined with on capex and consistent cost cutting was a potent combination in an industry such as auto with high operating leverage. For example a company like Mahindra and Mahindra which used to break even only at a tractor production level of over 100,000 at a time when they were unproductive had brought down their break even levels to 30,000. My key picks at that time were M & M at Rs 100 levels and Tata Motors at Rs 75 levels. An overweight position in these two stocks based on bottom up research finally led me to the same result, as a top down positive view on the auto sector would have resulted in.

 

Lot of these companies had learnt from their overinvestment in the last cycle, which created stress and took these companies into losses. A very good example of this leering from the past in the current cycle has been that of Cement Companies that went into huge losses in the late 1990’s and early 2000’s but handled the current downturn of 2010-14 very well.

My essential point is that the last boom in India created a lot of first generation companies that had never seen a severe downturn. Now a large number of them have taken a huge amount of pain over the last 4 years. The aim of my company meetings at this time is to identify those which are now prepared to operate with a lower risk model in the next cycle and have got good business models.  The second part of companies to buy into are those which never had balance sheet stress, however the macro environment hit them badly. These companies also never focused on productivity during the boom years and now will have two things playing for them. A lower cost base and hence higher operating leverage combined with better top line growth. These companies will see a significant uptick in valuations. One of the best examples of such a company where I had made huge investments during my tenure as Fund Manager in SBI Mutual Fund in the year 2004/2005 was Kajaria Ceramics. The company had low return ratios and low operating profit levels. Over a period of time the company deleveraged, added capacities via tying up with stressed units rather than investing of their own, focused on cost cutting, developed superior products etc. This led to a rerating of the company from a 5 P/E ratio to over 25 P/E today.

In my experience stock prices move on the following two major factors.

The up gradation or downgrade of earnings vis a vis consensus earnings forecasts – Let me try to explain this in a simplistic manner. The stock markets discount news flow very fast and as such the price at which a particular stock trades are dependent on what the expectations in the markets are. At the beginning of the last bull cycle of 2003 every one was very negative on growth prospects and in general expectations of earning growth were very low. Under the circumstances as the economy revived most companies came out with results better than expectations and stock prices moved up sharply.  On  the  other  hand  at  the  peak  of  the  bull  cycle  at  the  end  of  2007  earnings  growth expectations had moved up very sharply and subsequently there was an economic slowdown and most companies  started delivering results much below expectations. This led to stock prices falling sharply.

The movement of the direction of the return ratios of the company rather than the absolute values

Measures like Return on Capital Employed and Return on Net worth are used to determine how well the company is using the money it has to make profits. Typically it is believed that higher these ratios the better it is. Although this is true, the actual movement of stock prices depends more on the direction of these ratios rather than their absolute value. That is the reason why turnaround stocks which go from losses to profits give huge returns as the return ratios go from negative to a positive value. Examples of these are Automobile and commodity stocks in the early part of this decade where they went into profits after years of losses and most stocks in these industries went up multifold.

 

Will write more on my thoughts later as this piece is becoming too long. We are at the threshold of a new economic and market cycle as I pointed out at the beginning of 2014.

Key is to ride it or walk by the side and be left behind.