Wizards of Dalal Street 2015 - Sankaran Naren

http://www.moneycontrol.com/news/mf-interview/wizardd-st-s-narens-checklist-for-winningstocks_3710101.html

In 2009, as markets around the world were breaking down, Sankaran Naren, one of India's top fund managers came across The Checklist Manifesto, a bestselling book by doctor-writer Atul Gawande. The book deals with the simple yet powerful concept of the utility of creating check-lists -- it has achieved widespread practice in fields from medicine to aviation -- in order to reduce mistakes. Naren then went on to create a similar checklist that encapsulated the key points of his own investing framework. In an interview with value investor Ramesh Damani for his CNBC-TV18 seriesWizards of Dalal Street, he outlined the three key criteria underpinning his market philosophy: pay close attention to fear, valuations and flows. The checklist helps Naren, chief investment officer at ICICI Prudential AMC, reinforce his rules when emotion is ruling high in equities and helps him take a contrarian approach to investing. For instance, earlier this year, metals firm Glencore lost about 90 percent of its value in London, following the commodity rout. "It was led by smart people, had cash and was certainly not the worst in the world," he said. "That was the lemon moment. But for you to gather the guts to look at metals as a sector. But in the 15 days that followed that day [when Glencore hit a low], some metal stocks in India rallied 40-50 percent." During times of bull market peaks, he keeps a market capitalization rule that comes in handy. "In early 2008, the mcap of some property stocks was more than the entire pharma industry and of some power stocks more than the FMCG pack," he pointed out. Below is the verbatim transcript of S Naren’s interview with Ramesh Damani. Q: Aviation, medicine, stock picking, disparate disciplines, but something ties them together, doesn't it? A: If you at it in aviation it is completely prevented accidents. In medicine it has reduced the number of mistakes and that the same thing holds good for investment because in investing also if you reduce the number of mistakes you can make a lot of money. Q: How did you come up with this checklist theory of yours? A: Actually as part of our work we try to read books and there was a very nice book written by a person called Dr Atul Gawande called The Checklist Manifesto. It was a fascinating book because it was written by a doctor and there was a lot of reference to investing. That got me interested. Q: Atul writes that, okay, you clean your hands for example, you have better outcomes in surgery or you use Quinine and you can cure Malaria for example. Markets are more nebulous, aren't they? A: Markets are nebulous in the short run and there is clearly emotions which play a role but there is a history to market. You will see that there have been in crisis, there have been euphorias, there have been bubbles. So, what happens, if you look at the 11 years that I spent in mutual funds we have seen all kinds of market. You get a good grip if you use checklist on where you are in the cycle. For example you know when you are in euphoria, you know when you are in fear, you know that at points of time that you are in bubble. Q: What is the checklist for putting money in equities?  A: In equities if you ask me, there are three things which matter; whether there is fear, how is the valuation and third is what is the flows. For example, whenever Foreign Institutional Investors (FIIs) sell, you have to put money in equities, because fear is rising. In fact they looked at the last 20 years and found that whenever FIIs have sold aggressively, like 1998, 2002, 2008, 2011 and recently in August-September 2015, those fire opportunities to invest. But if you did not have a checklist you would be wondering what would happen tomorrow, because every day you are worried what is happening in China, what is happening in emerging markets, but actually our checklist gives us the confidence to say it is time to put my money today. Q: If checklist was all there was to your investment process, a database specialist would be a great stock picker but clearly that is not true. A: That is why even if you make use of checklist, it does not ensure complete elimination of mistakes. It is not like in the airline industry where you can not have any accidents. You do make mistakes because markets behave differently, people in the markets behave differently, so it only reduces the number of mistakes. But once you reduce the number of mistakes, you are on a good wicket in the market over a long period of time. Q: You met Atul Gawande. What did he explain to you about the checklist process? A: He actually is a medical doctor and as a medical doctor he was telling us how beautifully using checklist reduce the number of mistakes in the operation theatre and he found there a lot of people like Mohnish Pabrai and others who use this checklist, what he wrote about medicine into investing and then he finally wrote the book. Q: Give me an example in life where in your career a checklist has actually helped you. A: Clearly if you ask me, you can see a bubble, for example if you look at a situation of fear, take metals for example in August-September in 2015, at that point of time, the key characteristic is fear. You have a company called Glencore Xstrata, which is listed in London, is down 90 percent and then you go and look at the company, it is led by smart people, has cash, it has not been the worst company in the world, so if you look at that day, you can clearly see that that is what I call almost like a lemon moment in metal. So for that day for you to gather the guts for you to look at metals as a sector and tell the external world that metals looks like a good pick was such a difficult thing and I couldn't believe when the 15 days which followed that day certain metal stocks in India gave 40 percent. Q: Lots of periods in last 10 years, India is a very volatile market where you had fear and greed in equal measures. August 2013 the new Modi bull market, the Modi's election has the checklist helped you through all these situations? A: Clearly we started learning about it only after the 2008 crash. So, till August 2013 as a house we were telling people to invest in our US bluechip fund because their checklist told us that till the current account deficit came down the US market would be more interesting to Indian investors because of the situation that dollar could keep appreciating against rupee. However, once the current account deficit came down in August-September 2013 we actually stopped marketing our US fund and we actually got the opportunity to look at investing into domestic closed ended funds and we launched some of them. Q: How does Naren a Mechanical Engineer become interested in the stock market?  A: There is a long history to it. My mother passed away when I was 14 and I didn't have any brothers and sisters. My father used to have the habit of investing in public issues in 70s and 80s and that made him pretty interested and therefore he educated me right at the beginning which I am talking about in 80s in Chennai on the merits of equity investing. Q: Let us move on to contrarianism which is the hallmark of your investing style. First let me ask you a question. Have you used WhatsApp? A: Yes. Q: Jan Koum was the guy who designed WhatsApp and he claims that he designed it because he wanted to call his father in the Ukraine and did not have the money to make the call and spawned a USD 20 billion empire as a result of that, that is his story. What is your story about contrarianism? How did you get into that? A: In 1989, when I passed out of IIM, I started looking at the secondary market and I had an absolutely phenomenal investing experience between 1989 and 1994. Q: Everyone is a genius in a bull market, we had a great bull market at that time. A: So I was a genius growth investor who could make huge money, who could think of good ideas which were multi baggers. You know I always believed that by being an Mater of Business Administration (MBA) degree holder who knew how to look at an annual report, I had information arbitrage and I could make money off it. That I would make money so quickly in that boom was not something known to me, but when I made it, obviously you get drunk and then you make mistakes. Q: What was that mistake? A: The mistake was I thought that the foreign investors were very smart. There were a number of companies in 1994 like Natural Energy Processing Company Limited (NEPC), Southern Petrochemical Industries Corporation Ltd (SPIC), many of these companies they did Global Depository Receipt (GDR) issues. Q: A dishonour list, if you will sometimes. A: I do not want to mention that. I thought that I was buying some of these stocks at one-third the GDR price and I felt I am investing much better than their foreign investor who invested at three times the price, then after that I lost 90 percent and here I was in 1997, not knowing after the Asian financial crisis why I lost so much of money after being so smart? So that led us to a team of friends who had all made the same mistakes. Q: The team of friends were a group of fellow investors in Chennai, right? That influenced you a lot. Just tell me a little bit about that. A: Yes, actually that group you know were all people who needed, in those days I would call psychiatric help, because all of us had lost money in the 1994-1997 period. So we all needed support to know what mistake we made and looking for answers. So we got into this group. When we entered this group and then went about the process, we realized that you cannot be a momentum investor in the long run to make money. You need to know when to buy and you need to know when to sell and most of the time when you want to sell, the others should be interested in buying and you should be interested in not buying. So, that is how the whole concept of I would say contrarian thinking came and for which our first experience was in 1999-2000, the tech bubble when we saw stocks like Global Tele, DSQ software, Penton Media. Q: They went to stratospheric heights, they were the most celebrated stocks. A: And we had to avoid them and most people around us said, these people have more than 10 years of experience in equities and they are saying these companies are useless, we are making money. But contrarian investing that we have to look at the stock and come to a conclusion, we were negative on many of them. So contrarian investing helped us to stay solvent. First, we were considered irrational in 1999-2000, we did not get it and then we realized that we were solvent when the others became insolvent in 2001-2002. Q: But it is painful to hold through that kind of a bubble rise. Being a contrarian investor Buffett was one at that time and every day the stocks rise and your stocks fall. So, how do you handle that intellectually? A: It is very easy when you are managing your own money, but in 2007 I was running funds which many of them underperformed the benchmark in 2007. Out of the same streak of what I call contrarian investment and when you are handling other people's money and you are underperforming benchmark people came to me and said you are running value discovery but why are you not able to beat the benchmark and I said the contrarian investing style and whatever I had learnt in investing over 17 years told me that you have to be careful and I am going the infra names although I was running the infra fund then. Q: But when you do contrarian investing, it is not just about being different from the crowd, you want to find triggers for a change, right? So, how do you assess the sector that you like? A: Sometimes the triggers in 2007 frankly we never knew there was a global financial crisis coming in and towards the end of 2007 as the markets kept going up we didn't know what that trigger would be. But our 1999-2000 hat definitely told me that something will happen. When will it happen I don't know but 1999-2000 told me that it will happen and you won't know the reason. Q: You look for anecdotal reasons that the public starts coming to the market, people talk nonsense, is that some of the checklist of a bear market? A: Clearly off bull market. In that period I had analysts coming into my room and telling me the stock looks very cheap on 2014 earnings. Q: In 2008, that triggers a bell. A: That clearly triggered a bell and market caps in that period there were market caps which were astounding. If you look at some of the companies then like some of the real estate companies were higher than the entire pharma sector. Q: A power company was bigger than the entire FMCG basket I remember. A: Correct. So, those market caps don't lie. Earnings can go up cyclically, it can come down cyclically but market caps gave me the best reasons to stay rational but it was tough.

Q: Let us talk about value investing, growth investing, value investing are they two different species?

A: Warren Buffett says it is joined at the hip. It is not like it is zero, one. Q: Indian naturally favour value investing as a cultural ethos? A: I have been surprised to know that Indians favour value investing in everything other than investing in stock markets. When it comes to sale of Amazon's or Flipkart's of the world they believe in value investing. Q: We want a cheap shirt but not a cheap stock? A: Yes, that is clear. Q: How do you distinguish between a value stock and a value trap? A: Intrinsically I think Indians are not value investors. They have to go through a cycle to become value investors. You don't start being a value investor on day one. I have a team of colleagues, many of them young and many of them will question me on many of my value investing stocks. I find that conversation with them has really helped to me avoid many value traps. Q: Give me an example of a value trap that you avoided? How about the PSU banks which were the favoured sector in the market but you avoided them. A: In 2008 due to what happened in the global financial crisis money went to public banks all over the world. That was a very interesting period where what you saw that in a sector where both private sector and public sector is there, the public sector gained in the year 2008 across the world. So, people got into this perception that what as true in other sectors where private sector gains would not happen in banking. Whereas if you looked at the entire process, you knew that was a one time event out of GFC. Q: Your checklist told you that problem is there in the credit cycle? A: Yes. That is why from then on it was pretty easy to know that private banks would gain at the expense of public sector banks. Also 2008 proved  that banking was a more unsafe sector from an equity investor point of view and you had to do your rigorous work than any other sector because of the persons whom I used to watch the Legg Mason Value Fund of Bill Miller, his fund got destroyed in 2008. Q: He just got a whole bunch of wrong stocks. A: Yes because he had 38 percent weightage in financials. That combination I realised that you have to be very careful in leverage sectors. Q: That is after 20 years of outperforming the S&P continuously almost, the man went overweight and got a divorce.  A: Yes.    Q: You have a reputation in industry of not being afraid to trade your stocks. A: Sometimes you do it but for example in 2012-13 for almost two years now I have been underweight some of the quality stocks and quality stocks have continued to do well. However what I find is with this whole world of passive investing which has come in the rest of the world there are opportunities which come due to induction of stocks into some index, dropping of stocks from index and those give me very good arbitrage opportunities. Q: Other than your famous checklist, the famous contrarianism, what else do you look at? You have often said that current account deficit is something you pay a lot of importance to. A: I do pay a importance to many factors. I believe that if you see capital being allocated well in a country or in a company, you tend to make money. So, you always look at how capital is allocated. If you feel capital is allocated well you tend to make money and that is true of a country also. If you see why India is one of the better equity opportunities is because there as a country we have allocated capital much better than some of the other countries which may have grown faster but have not allocated capital well. Q: You are referring to China perhaps. Summarise for me what is S Naren's investing philosophy? A: I would say that look for opportunities in fear, look for opportunities in greed and communicate. ICICI brand has given me the opportunity to communicate to the country and use this opportunity to make equities a good asset class for the entire country, educate people. I have been in equity markets form 1989 but the average investor has not managed to make the money that the markets have given him. Q: People fail to understand that index in 1980 was 100, it is closer to 30000 now, 300X move has been made and if your wealth hasn’t multiplied by that amount you have been doing disservice to your portfolios? A: Absolutely. I think the entire savings market through the mutual fund industry  is a beautiful opportunity for an investor and that is my main hope that we will try to increase assets that we can collect from investors and make money for them in the long run. Q: I have a checklist of rapid fire round with you. You enjoyed your education the most where - IIT or IIM? A: IIM. Q: Would you prefer on a Sunday playing Bridge with your friends in Chennai or listen to Carnatic music? A: Listen to Carnatic music and playing Bridge together. Q: Are you an early riser or late sleeper? A: Early riser. Q: Tea or Coffee? A: Coffee. Q: Your favourite city in India? A: Chennai. :-) Q: If you had a choice of dinner with Atul Gawande or James Montier what would you pick? A: Having met Atul Gawande this time it would me James Montier. Q: Sensex 50000 by? A: I can't predict and I don't believe that you can forecast so accurately. Q: Your favourite ratio when you read a balance sheet? A: Price to earnings (PE) ratio. Q: An Indian investor that you admire the most? A: Nimesh Shah. Q: An Indian CEO that you have admired the most?     A: I think right now it is N Chandrasekaran. Q: A stock pick that you are most proud of? A: LMW in 1989. Q: Your dumbest stock pick to date?  A: It has been textile companies and spending lot of time on many textile companies. Q: Name the one thing that keeps you up at night? A: I think the responsibility of managing our public money. Q: One contrarian theme that you are focusing on right now? A: Last few months it has been metals and oil and gas. Damani: What you have said is that what is comfortable is really profitable but in the last 30 minutes you have not only given us comfort but also some profitable ideas how to invest your money.

Inspiration from the World of Sports - Howard Marks Memo

http://www.oaktreecapital.com/MemoTree/Inspiration%20from%20the%20World%20of%20Sports.pdf

Consistency and minimization of error are two of the attributes that characterized Yogi’s career, and they can also be key assets for superior investors.

“Baseball is ninety percent mental and the other half is physical.” That was another of Yogi’s dicta, and I think it’s highly useful when thinking about investing. Ninety percent of the effort to outperform may consist of financial analysis, but you need to put another fifty percent into understanding human behavior. The market is made up of people, and to beat it you have to know them as well as you do the thing you’re considering investing in.

Logically speaking, the bargains that everyone has come to believe in can’t still be bargains . . . but that doesn’t stop people from falling in love with them nevertheless. Yogi was right in indirectly highlighting the illogicality of “common knowledge.” As long as people’s reactions to things fail to be reasonable and measured, the spoils will go to those who are able to recognize this contradiction.

Likewise, smart investors know the goal isn’t to find the best companies, or stocks with the lowest absolute dollar prices or p/e ratios, but the ones whose potential isn’t fully reflected in their price. In both of these competitive arenas, the prize goes to those who see value others miss

So rather than judge a decision solely on the basis of the outcome, you have to consider (a) the quality of the process that led to the decision, (b) the a priori probability that the decision would work (which is very different from the question of whether it did work), (c) the other decisions that could have been made, (d) all of the events that reasonably could have unfolded, and thus (e) which of the decisions had the highest probability of success.

The fact that something worked doesn’t mean it was the result of a correct decision, and the fact that something failed doesn’t mean the decision was wrong. This is at least as true in investing as it is in sports.

So there you have some of the key lessons from sports:

• For most participants, success is likely to lie more dependably in discipline, consistency and minimization of error, rather than in bold strokes – high batting average and an absence of strikeouts, not the occasional, sensational home run

• But in order to be superior, a player has to do something different from others and has to have an appropriate level of confidence that he can succeed at it. Without conviction he won’t be able to act boldly and survive bouts of uncertainty and the inevitable slump.

• Because of the significant role played by randomness, a small sample of results is far from sure to be indicative of talent or decision-making ability.

• The goal for bettors is to see value in assets that others haven’t yet recognized and that isn’t reflected in prices.

• At first glance it seems effort and “common sense” will lead to success, but these often prove to be unavailing.

• In particular, it turns out that most people can’t see future outcomes much better than anyone else, but few are aware of this limitation.

• Before a would-be participant enters any game, he should assess his chances of winning and whether they justify the price to play.

Wizards of Dalal Street 2015 - Anand Radhakrishnan

http://www.moneycontrol.com/news/market-outlook/india-safer-than08-like-auto-franklin-templeton_3465401.html

India safer than in '08; like auto: Franklin Templeton

It is important to look for companies that have growth potential, that are slightly underutilised in their current capacity, says Anand Radhakrishnan, CIO, Franklin Templeton. In that context, he likes sectors such as automobiles, select auto ancillaries and banks — including some of the public sector banks, he says.

At the moment, he says the world is a little awash with liquidity. "Clearly, there is a risk to global equity markets, but when it comes to India, the risks are much less today than what it was in 2008," he adds.

Below is the verbatim transcript of Anand Radhakrishnan's interview with Ramesh Damani on CNBC-TV18.

Q: You have been now 20 years in the market, what were your early influence in the stock market?

A: It was after I did my graduation and post graduation in management. It was quite by accident I took up a career in fund management. I joined SBI Funds Management Limited out of campus, IIM-A, and started a career in equity research.

Q: That time management consulting or FMCG were the favoured career jobs.

A: Predominantly people use to go for big consulting firms and IT was not a big thing and Lever and P&G were very sought after. Investment banking within that merchant banking was preferred than investment management. So, SBI and UTI were the only lone of recruiters in the campus at that time. People did not think of it as a big career at that point of time. So only two of us joined from IIM-A out of which I continued to pursue the career, the other person eventually moved on to IT.

Q: What peaked your interest ?

A: I think once I joined the company and the first couple of years were pretty heavy in terms of the experience. Markets were at all time highs and lot of things were happening in the economy. We had Dr Manmohan Singh as the finance minister, liberalisation in India was going through some fantastic growth opportunities. Lot of sectors were opening up and we got to meet lot of companies. SBI is one place where there was lot of freedom. It was the second largest firm in terms of AUM at that time. So, companies always used to give us appointments whenever we wanted to meet them. So, within 2-2.5 years I could kind of meet like 100 plus companies, visit their factories and learn different industries. I have been to automobile companies, textile companies, some of the consumer staples. So, the spectrum of opportunities, the breadth of it and the exposure I got was very interesting.

Q: Sensex was stagnant during that time.

A: It was a very challenging phase. Since we were into research we were supposed to kind of predict where the Sensex would be in a years time or two years time much like what is happening now. We were all very young and inexperienced and we did this thing of projecting the 30 companies earnings, attaching a multiple and based on that when we did that Sensex was about 4200 and we said that in a years time it would be something like 5100 and we thought we were being very conservative and we never saw that number for the next six years. So, it was a kind of rude shock for us because we thought we are very good in projecting things and we could kind of foresee what was going to happen but economy went totally the other way. For six years the Sensex earnings was growing at 1 percent kind of CAGR and then IT boom happened which kind of made the pain more bearable but if you had participated in the boom it was a bit of a pleasure but if you hadn’t the pain continues.

Q: When did you get into active fund management though? From research when did you move into fund management?

A: In 1997 when I switched jobs and I joined Sundaram I started managing a small fund, it was called Sundaram Growth Fund. We also had a tax fund, these were the two funds which I started managing actively.

Q: Growth fund, that is the key to your investing style, growth?

A: Yes.

Q: Give me an example?

A: Growth can be looked at in multiple manner. For example it can be an existing industry or a space in which a new player is coming with either innovative product or services or a disruptive approach to doing that business.

Q: Would Uber qualify as that?

A: Uber is definitely a good example of that. Taxis have been in existence for a very long period of time and when someone comes and takes market share. So, that is one way of doing it and those days outsourcing was a very big thing. Not IT outsourcing alone, anything that is not very core to the company were getting outsourced. So, the effort was always to find what is the next growth idea, what is the next opportunity. It can be either an existing big opportunity in which you are a new player or a new opportunity itself in which one is an early entrant.

For example in India when some of the private banks got into banking space banking space was very well established but these companies came with better products and better services and for example, the introduction of technology into banking happened aggressively through private banks and because of that they had gained dramatic market share and we saw that very early and some of our large investments in the private bank space whether it is IndusInd Bank, Kotak Bank, HDFC Bank all these things happened with the view that it is an established space but these companies are doing innovative things and products and services and gaining market share.

Q: So you want growth. That is your DNA that you want to find growth almost at all cost?

A: Most of the time, predominantly we would like to go after growth. Occasionally we don't mind playing a contrarian bet but nothing like identifying - because people come to invest in India, whether Indians investing in India or overseas investors in India they don't come to buy value stocks out here. Because India is a growing economy. So, we think that growth - because there is economic growth being pretty good and companies overlay their business on top of this economic growth. By and large if you are invested in good compounding growth ideas you are fine as long as the company is run well, they don't make dramatic capital allocation mistakes and they reinvest in the business for growth. Large part of investment problem is solved.

Q: Clearly, and promoters have sky high ambitions. They want to bet the balance sheets on, especially if it is borrowed money, on a number of projects. How do you distinguish the wheat from the chaff?

A: It is tough. We have made our share of mistakes. It is good to be very early in the game because in 1990s we were allowed to make mistakes. So, we did realise it is more like baptism by fire, learning on the job but unfortunately today people do not have that luxury. People cannot afford to make one mistake in the current scenario.

Q: Underperform, you lose your job.

A: Yes, the risks are pretty high. On those days the risks were not so high and that kind of helped us to learn out of our mistakes and there were enough examples were also abound. Overambitious promoters, excessive leverage, betting too much with equity or betting too much with debt. So, all kinds of mistakes or unrelated diversifications doing too many things at the same time. So, all kinds of mistakes happen.

Q: And you have to guard yourself against them?

A: Yes.

Q: We went into the break saying growth, that is what you like. The fun that you are now CIO of Franklin Templeton, Templeton was a different kind of investor, wasn't he?

A: Yes.

Q: Tell us about him.

A: Sir John Templeton is a very well known value picker and he is more behavioural based value picker, as in his basic tenet is to buy stocks when others are afraid to buy.

Q: When there is blood on the street I was told.

A: Yes. So, he strongly believes in the tenet that bull markets are founded on depth of despair, pessimism. They grow on scepticism, they mature on optimism and they die on euphoria, this was his words. And he strongly believes on playing on the behavioural aspects of the market. That is one way of making money which is to buy when others are throwing out the best stocks and to sell when others are greedy for their money. But when Templeton took over Pioneer they took the theme which was essentially growth oriented stock pickers. They were buying ideas which were growing very well.

Franklin Templeton has this philosophy of when they make an acquisition they continue to allow the teams to follow their approach. They don't try to fit you into their existing culture while the firm takes a lot of steps to sensitise investment, investment managers on the bigger philosophy they are also allowed to follow their own style.

Q: The 2013 bull market, what is it rewarding this time around?

A: The market has significantly rewarded the quality companies. Quality has been the most sought after aspect of the current market rally and quality in terms of business, in terms of financial parameters, low leverage, high cash flows and repeatable cash flows, low volatility of earnings.

Q: But to ridiculous level?

A: Like it always happens at every cycle. In 2003 the old economy, the traditional industries were excessively undervalued. By the peak of the market the consumer staples and pharma companies were excessively undervalued. By 2014-15 in some way the pendulum has swung the other way.

Q: We run thousands of crores. How do you fish in these seas?

A: These are very challenging time especially when we know when the market pendulum has swung one way and then to make choices and position your portfolio not necessarily for the next six months or one year but looking through that into next two or three years is a very tough proposition.

Q: So, give me a check list of how do you do find companies now?

A: Currently we are looking at more than current growth. I would say we are looking at the growth potential of that company. For example a company who may not be growing pretty well but doesn't require too much of capital to grow their business because they already might be sitting on excess capacity, underutilised capacities, reasonably less - not excessively leveraged balance sheet, but we don't mind a bit of a leverage because we think that both operational leverage and the financial leverage essentially can - if think grow better into the future you will get good growth, we don't want excessive leverage in that.

So, you are looking for, therefore, companies which are slightly underutilised in their current capacity, balance sheet may not be pristine clean because pristine clean balance sheets are anyway overrated or that pendulum swing has taken their valuations to a very high level, but it should be reasonably clean.

Q: I could be wrong but it almost seems like you are suggesting commodity stocks?

A: Commodities might be like a really deep value. They are going to be stressed for some quarters at least if not for some years going by the way things are now.

Q: Which sectors? Tell me which sectors.

A: One is automobiles, both four-wheelers and two-wheelers. Some of the auto ancillaries definitely qualify for taking a very pro-cyclical kind of a bet into next three, four years. There is definite value, they are not overvalued compared to the broader market. Similarly, we are seeing opportunities in cement. We are seeing opportunities in banks. Even if you are cyclical investors, even one may find value in some of the public sector undertaking (PSU) banks also while I would still put a lot of my money in high worth private sector banks. We can find value in some of the good utility names at this point of time.

Q: Are you scared that if a global meltdown takes place that a repeat of 2008 will happen?

A: The world is a little bit awash with liquidity. Clearly, there is a risk to global equity markets. When it comes to India, the risks are much less today than what it was in 2008. 2007 we were at cyclically peak earnings. Commodities were at all time high, economic growth was at all time high, Sensex was roaring, valuations were at all time high.

Today if you look at it commodities were at all time low because of high inflation of interest rates are at very high level. So, we are nowhere near the kind of real interest rates that were prevailing in 2007. So, in whichever way I cut and dice the risks are lot less today from a global contagion to affect us because what we saw then was a very synchronised expansion across the globe and therefore a synchronised fall.

Q: One of the disciplines as a fund manager you need is when to sell, what is your selling strategy?

A: When one invests in the market we have to leave some money on the table for the next buyer. So, one of the thing which we always try to believe is that, you don't try to catch a top in terms of a sharp rise or its valuation. So, once we have that approach, we may be little bit early selling into a stock but we will never be late.

Q: Does it cause angst within you when the stock keeps climbing? Like you could have sold Eicher say at Rs 10000 and it kept going up after that.

A: We have sold Eicher from Rs 5000 level onwards right up to Rs 20000 levels, that has been a good performer for us. When you look back probably we could have held back some of the positions but this is discipline. It might not work in one place but on an average this works fantastically and it also prevents your portfolio from getting overloaded with winners. So, doing top slicing is a discipline which you follow.

Q: What is your discipline in terms of stock not working out? Suppose you buy a stock and it is down 10 percent, when do you throw in the towel?

A: When your thesis is totally wrong you have to relook at it. If your underlying assumption have not changed dramatically and only our initial purchase price was wrong, and at this level probably it is worth a buy, continuing to hold on to a stock is equivalent to buying that stock afresh. So, we would like to hold on. However if the underlying thesis itself has unravelled and has not played out the way we would have imagined it to be playing then we gulp it and sell it.

Q: If it goes down and your thesis holds, would you average down?

A: We will average down.

Q: You are willing to put your cheque book there?

A: We will put the cheque book there.

Q: What is then your overall arching philosophy, you told you like growth, you like discipline, you have investment hypothesis, 20 years into your career if I asked you what is your style, can you give me a summary?

A: If we believe that the company is better than what people are thinking it to be that I think is the big opportunity. The whole idea is to in your understanding is it coming out to be better than what the markets understanding of that company is. Even if it is a good company, market may be thinking it to be a good company but if you think it is a superlative company and therefore it warrants a big bet, so we go out and bet that. That is the kind of style. That is where I think lot of money is made. Wherever there is a deviant view there is a opportunity.

Q: Does it surprise you that how many times markets do get it wrong?

A: It surprises me enormously because I would like to believe that over a period of time market becomes less responsive to the high frequency data points and more behaves like a weighing machine. It surprises me to see that even today or even during the current time also more often than not in the shorter term markets behave like voting machines.

Q: Who do you admire, which fund manager do you admire?

A: 20 years you have seen all kinds of cycles. I think even domestically we have had quite a bit of fund managers who have done pretty well. So, even my own firm, my predecessors have done a fantastic job. Some of my other peers have also done a brilliant job of delivering consistent returns over long terms. So, they have to be admired.

Q: To the new batch at IIM from where you graduated if you have to suggest to them what they need to do to prepare for career in fund management, what would they need to do?

A: They have lots of body of knowledge and material right in their finger tips today than what we had 20 years back, which is the internet. It almost like all the theories of investment management, all the styles are reasonably documented and available to individuals.

Q: On a practical level can you do anything to make yourself better?

A: Practically they can go and invest on their own. That is probably the best and it is better than reading books.

Q: Losing money helps a lot?

A: Yes provided the parents give them some money.

Q: That is how you started your career right? You invested in IPOs?

A: My first few months salary after my engineering degree I went and stood in a queue in Surat and applied for an IPO. That company no longer exists but nevertheless I am very proud to say that I went and stood in a queue there. So, investing on your own definitely helps.

Q: You had a brilliant career on Dalal Street from Chennai, being away from Mumbai, does that help you in your career?

A: Distance brings objectivity and also reduces noise. Being in a quiet environment helps you to focus on reading the financial statements better and also think in a slightly different manner.

Wizards of Dalal Street 2015 - Sunil Singhania

http://www.moneycontrol.com/news/market-outlook/sunil-singhanias-investing-approach-believenumbers_3582201.html

Sunil Singhania's investing approach: Believe in numbers

A hawk-like focus on the balance sheet along with a conservative nature tuned to avoid irrational risks -- that is what makes Sunil Singhania ticks.

In an interaction with noted value investor Ramesh Damani for his CNBC-TV18 show Wizards of Dalal Street, Singhania, chief investment officer at one of the country's largest mutual fund shop Reliance, said he was a "strong believer in the balance sheet" and said he often uses numbers on companies' financial statements to get a true sense of the business.

"If the company has been diluting too much equity or if there is lack of cash flow [it shows up]," he said, adding that his team at Reliance MF also evaluates smaller numbers such as sundry debtors or inventory build-up to get a sense of the larger business.

Singhania also spoke about another unique aspect of his investing approach: looking at a whole host of global companies.

And there is an instance of how looking a larger picture helped him make an investment decision: "We passively track 2,600 companies in 20 countries," he said. "We found out that in each of the countries, the market capitalization of cigarette companies was significantly lower than the spirits company in each country."

In India, though, United Spirits was trading at USD 1.5 billion to ITC's USD 40 billion valuation -- the former, however, being troubled with issues. "We thought if the company solved its problems, we would double our money. USL had 50 percent market share in India, which has 15 percent market share in the world. So you had 7.5 percent market share of the world!"

Singhania also spoke about his noted partnership with Madhu Kela, former fund manager who was earlier with Reliance and who later moved to a larger role at the fund house's parent company.

"He was the instinctive guy. I was the numbers person," he said, adding that while Kela pushed on aggressively taking intelligent risks and closing deals, he focused on drilling down on the risks.

Below is the transcript of Sunil Singhania’s interview with Ramesh Damani on CNBC-TV18.

Q: I have heard a lot of investing styles in the wizards of many years, buy low, sell high, high PE, largecap investing, but you bought a total new phrase to the world of investing. A zebra in lion country, pray tell me what that is.

A: Four or five years I was in Chicago and I visited this fund called Columbia Wanger and this book is written by Ralph Wanger and it is basically based in the period, in the late 80’s and early 90’s where there was a lot of risk aversion in the US. And when you mirrored it in the period between 2011 and 2013 where there was massive apprehensions about investing in India stocks, that is where how you relate it. 

So, the concept is very simple. Zebras always move in herds and most of the zebras want to be in the centre of the herds. 

Q: Because of perceived safety?

A: Perceived safety. So, the lion attacks, there is this perception that I am at the centre and I will be saved, as a result of which there is very little grass for the zebras to eat, so there is very little return in companies which are very obvious choices.

Q: And well-known to investors.

A: Well-known and where the perceived risk is much lower. And the Zebras at the side are the zebras which eat the best grass, where the perception is that they are more at risk, but when the time comes, they are the fastest to run. 

Q: But can you give me an example of how you are zebra in lion country by example of a couple of stocks that you picked?

A: I will give you an example. In 2012-2013, there was this offer for sale (OFS) which was mandated by SEBI. All companies which had promoter holding over 75 percent had to perforce sell it.

So, there were a lot of good quality multinational companies which had to perforce sell their shares and that was the last opportunity which any large investor could buy in a meaningful way. 

And that was sort of a zebras at the side where no one wanted to buy those companies because the near-term fundamentals were not looking as rosy, but these were companies with good technology, good business model, established multi-year track record companies overseas. And that was one thing which we just lapped it in a big way.

Q: Can you give me an example of something you got right in that period?

A: I cannot name stocks.

Q: Not recommend them, name them.

A: I basically said, multinational companies, obviously we were able to buy. Companies like Honeywell, Alstom, Styrolution and Bluedart - we missed out.

Q: All of them did their OFS.

A: Yes. So, that was a great opportunity.

Q: Opportunity, in 2003, when Reliance Funds started, very low size, very low equity cult in India. Describe the early years to me.

A: It was fun. Madhu had joined.

Q: Your predecessor Madhu Kela?

A: Yes, Madhu Kela, one year before I joined he had brought it up to a scale of Rs 100 crore. Then I joined. That time my friend used to tell me that Reliance is so small, why do you want to join Reliance? 

But, Reliance had that energy and working with Madhu was the best thing to happen. It is full of energy and full of passion. It was a great learning and good thing about the period that time was no one wanted to invest in these smaller companies and we went ahead, we invested in them and it worked out.

Now, obviously everyone wants to invest in smaller companies, but that time it was a rarity.

Q: But, you were the zebra even then? You were looking for the outside opportunities?

A: As I said, there is so much opportunity in India and even in smaller companies have such good balance sheets, such good promoters – not all of them, but quite a lot of them. And that is an opportunity because that I where you can create a difference. Largecaps in India also have great opportunity but they are well researched. We can only allocate money to them. You cannot create significant alpha by doing so. So, you have to have a mix of both.

Q: Ralph in his book said that when you invest in a smallcap, you meet the owners, you invest in a largecap, you meet the executives, there is a difference there, is there not?

A: There is a difference. The other thing is that in a smaller company as you rightly said, there is a passion to grow. In a larger company, obviously, there is stability, but there is a limitation of how much risk or how much growth they can basically undertake. So, there are good largecap opportunities also, but if you have to create significant alpha in a growing economy like India, it has to be mid and smallcaps.

Q: But also the trends that have engulfed our world, telecom revolution, bringing down calling rates, digitisation. That is spawning a new generation of entrepreneurs, is it now?

A: 100 percent, and again, it is very right that all these new sectors, perforce have to start small. Take the example of technology or even Infosys, it started a USD 20 million company. Now the market cap is USD 30-40 billion. The sector was zero. Now, it is almost 10 percent of our market cap. Same is the case with telecom. I am very sure, same is the case with digitisation or e-commerce and so on and so forth.

So, any new sector which comes up, has to perforce start small. Media, where you are also very bullish. Most of the companies with a companies have a market cap of USD 50-100 million. Now, some of them are going to be multi-billion dollar market cap companies, but you have to research them right now, you have to invest in them and hopefully, you will be right.

Q: I know now that you have fund of large size, over Rs 50,000 crore of assets under management. You have a more rigorous research process. Can you just step us through that?

A: The challenge being a mutual fund manager is to manage consistency and as well as expectation. That is where you have to marry returns with risk and that is where process becomes very important. We always focus on where we went right. We never focus on where we went wrong. And that is where you have to be very clear.

Q: So, how do you focus that? How do you decide what is your benchmark risk in a portfolio.

A: It is an evolving process and we believe that we do not have a 200-year history of fund management which is good because you are not fixated with laid down processes which might be outdated. We have grown up on dalal street, we have learned a lot on dalal street apart from what we have learned in classrooms and we try to marry whatever we learn every day. 

So, in the processes, very clearly, one is we have a large team, we have the flexibility of not having a headcount like a lot of multinational companies would have, we have complete liberty so we are a very strong large team because of the inherent style of working, people are sticking, they are happy. 

Equity investment is all about happy people. You cannot invest in a very profitable manner if you are not happy.

Q: We talked about your research methodology. When you meet management what are you probing for them and is there a different between probing a large cap company and a small cap company?

A: In a large cap company as I said the business model is established. The size of opportunity is established. The management team is very focussed, clear and stable. In the midcap and the small cap it is exactly the opposite. You have to probe the passion and the honesty of the management. 

You have to probe the scale of opportunity because most of these companies would be in businesses which are sort of niche or which are in early stage and ultimately it all boils down to whether the passion is matching the ability of the company and the scale of opportunity to grow. 

One thing which recently we have started to do is probe the new generation because what is happening is a lot of Indian companies have come to a particular scale based on the promoters, founders who had their thought process but the second generation or the third generation guys are foreign educated or well educated, they have a different thought process in terms of value creation, in terms of growth and lot of companies where we have found the second and third generation is good the companies have gone through a different orbit.

Q: You said you probe the honesty of management. How do you probe that?

A: One thing is I am a balance sheet believer and in balance sheet 80-90 percent you get an indication.

Q: Numbers don't lie?

A: Numbers don't lie whether the company has been raising capital very frequently or not. Then cash flow - you can show as much profit as you want but if there is no cash flow there is no use of profit. So, that becomes a key indicator. 

Sometimes sundry debtors, inventory, working capital cycle, unnecessarily bloating off gross block these are all signs where you sort of make out and if the pay out is very minimal if the company does not require it for growth you hear the bells ringing somewhere.

Q: You also look at global companies. Why do you do that?

A: We invested in the largest liquor company in India, the United Spirits and it turned out very well and it was a very simple analysis which we did. So, we track around 2,600 companies across 20 countries on a passive basis. 

In one of the presentations we found out that the market cap of cigarette companies globally was significantly lower than the spirit companies in each of the markets. In India the largest cigarette companies used to trade at a market cap of USD 40 billion and the largest alcohol company used to trade at a market of USD 1.5 billion for obvious problems. 

Our thought was it that if the problems got sorted we would double our money, but if it would not then we would quadruple our money. And if you actually see 15 percent of the world population, 50 percent market share - technically you have 7.5 percent of the world's market share in the fastest growing alcohol market and it was not a very simple fundamental sort of drive but it was a good way of at least having a thought and it worked out well.

Q: Somewhere I read that Jindal Steel, you guys were so excited you couldn't wait to visit the plant. Got a small cap company into a major company. What trickled you into that investment?

A: There was a big tailwind for commodities at that point of time. So, we were lucky in the sense that between 2003 to 2008 you had a super bull cycle for commodities. And you had the start of it, the valuations were so low. We had the second generation guys, as I mentioned earlier, come into business, each were managing their own parts of the business. 

There was massive investment which they had planned and they had the raw materials or the backward integration to back. So, it worked out well. So, from a very small company it became a large size company and with that the PE multiple also expands.

Q: But what gave you the confidence that in commodity business with unknown entrepreneurs in a manner of speaking that you would get it right?

A: So, that is where the personal visit comes into place. So, when you visit the facility and you see the infrastructure which has been created, you are very sure that this infrastructure is capable of managing maybe 5-10 times more capacity than what they already have. And somewhere down the line you have to take a call.

Q: They say in cricket that fast bowlers hunt in pairs. Are Madhu and you like that, I mean, you go visit companies, the one two punch, the big picture, the numbers guy. Was it like that?

A: It worked out well. So, Madhu is a very passionate guy, believes in instinct and a very number focussed guy. So, it works out well and I would say very clearly I am a very cautious buyer and somewhere down the line even if you find stocks if you are not able to buy it does not work. 

That is where Madhu's strength comes in. He is able to close the deal, be a little bit pushy, and from my side wherever I feel that the numbers are not matching the broad picture one thing we have to remember is that it also makes sense to avoid making mistakes. So, we all talk about how we pick stocks. We never talk about how we avoid stocks.

Q: Rule number one - don't lose money?

A: Yes, that is the biggest thing, otherwise you won't have money to invest.

Q: Another stock that has been well associated with your house has been Divi's Lab. The pharmaceutical space, even today a lot of excitement. What was the story behind that?

A: Again, this is a company which has never raised equity at all. In fact the Intial Public Offering (IPO) was also offer for sale (OFS) because of a very early stage dilution they had done to a private equity guy. After that the company has never ever diluted money. 

If you see the amount of dividends they have paid they have paid almost Rs 1,000 crore of dividend since start of their life. Even now they are continuously growing at 2-25 percent. Very high ROE, very high quality management, very high quality company.

Q: When you walked into the company did you know this was a special company for you?

A: As we started meeting them more and more regularly the confidence levels improved dramatically and that is where investing is one thing, maintaining your investment is another thing. 

You can buy something and sell at twice the price you might be happy but the same company might be 50 times your prices or 100 times your price, which is what happens. So, buying is one part of it, maintaining it and ensuring that you don't sell early is also another part of it.

Q: You are an India bull, what is the India opportunity that you see?

A: There have been only 15 economies in the world who have reach USD one trillion in economy size, of which nine have graduated to the USD two trillion size - of which India is one. So, we are one among the only nine countries. And only three have been able to graduate to the USD four trillion size - US, China and Japan. 

Our belief is that India would be the fourth or the maximum the fifth economy if Germany keeps on growing to reach the USD four trillion of size. That makes us really unique in the terms of opportunity. 

It took us 67 years to be a USD two trillion economy, maybe in the next seven to eight years, we would be USD four trillion. In fact, there was an article by economists intelligence unit - they had researched it, which talked about India reaching a size of USD 63 trillion by 2050.

Q: You mean you are saying from USD two trillion to USD 63 trillion?

A: That is the economist intelligence unit forecast.

Q: We will be toasting on Dalal Street if that happens. 

A: Our belief is that we have just tasted the tip of the iceberg as far as wealth creation is concerned. There is a long way to go.

Q: You buy stocks that you hold for a decade, a lifetime, or do you try and ride the cycle up and down? How does Reliance Growth Fund position itself?

A: Most of the strategies especially in the midcap segment is buy and hold. Having said that, there is always an opportunity in the market of making use of inefficiencies both on the buy side as well as on the sell side. 

But one thing we have learned is that do not restrict your upside. There have been so many businesses, our own business – 10 years back we did not think we would managing Rs 3 lakh crore put together.

Q: You are now 20 years old?

A: Yes. On October 8, we completed 20 years as far as the Reliance Growth and Reliance Vision is concerned. 

Q: So, would you say Sunil Singhania from the one in 2000, when he joined Reliance Fun, 2008 and 2015, were three different investing styles during this period?

A: I think the core is the same. But obviously, the learnings have ensured the number of mistakes you tend to do have reduced quite dramatically.

Q: But the smart money always tells me and I want your opinion on that that what they teach you is bunk. Low risk low return, high risk high return, it should be basically low risk high return. Do you not feel that is a better strategy for the midcaps?

A: It can be a better strategy, but it is not always possible. So, maybe 2012-2013 was an opportunity where the risk was low and the returns were very high. So, it will basically depend on the time. It will also depend on your continuous research. 

So, even now we believe when we read balance sheet that there are a lot of companies which would fall into that category where the risk is low and the returns can be significantly higher. There are some companies where there is an option value which we do not take into account, but which can suddenly play. We do not know whether it will play in the next six months or two years or three years. 

So, we own stocks in a commodity exchange company. Right now the markets maybe discounting the current opportunity. But we do not know. Suddenly the opportunity can really play out.

Q: India is a huge commodity market - huge commodity trading market anyway. Fund management is a high pressure business. You watch the NAV daily.

A: It used to get to you in the past, but now you have learned to live with it. And our investors also have known us for such a long time that it might be possible that in two to three months, things might not work out. 

If Titan does not work for one year, it does not mean that Rakesh Bhai is not a great investor. The investors have learned that. When we communicate with them they also know what you are playing for. But as I said, if you are 80 times in 20 years, I do not think you could have done better.

Q: I have been told that no offence, but you are so focused on balance sheets that you are almost boring, you do not have a personal life.

A: I do not think that is true.

Q: I want to have some fun with you. I am going to take you through a rapid fire round. An Indian investor that you admire the most.

A: There are many, but I would say Madhu because I have worked very closely with him.

Q: A global investor that you admire the most.

A: I think Jeremy Grantham.

Q: If you had a choice of dinner with Peter Lynch at Fidelity or Ralph Wanger of Acorn, who would you choose?

A: Ralph Wagner.

Q: Are you a morning person or a night owl?

A: Not a night owl definitely.

Q: Your favourite financial ratio?

A: I would say cash flows.

Q: The Sensex becomes 50,000 by?

A: Not later than three years.

Q: The best MD or CEO of an Indian company that you have met?

A: There have been many, but I admire Jai Shroff for the effort and the energy he puts in his business.

Q: United Phosphorous?

A: Yes.

Q: The stock pick that you are personally the most proud of?

A: I would say Bajaj Finance because it was at a time when people had just written them off, but it is one of the stocks where we sold early.

Q: Conversely, a stock pick you are disappointed in yourself with.

A: Sugar companies, five or six years back. Disaster.

Q: Your favourite travel destination.

A: I like Manhattan, but scenic-wise, I like London and Switzerland.

Q: A CA or a CFA education?

A: I think both. CA teaches you the basics of accounts. CFA makes you more aware of how to apply them.

Q: Spending a night with a balance sheet or going to a Bollywood movie?

A: Bollywood movie.