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Possibility of substantial upside in market
Mon, Nov 25, 2013
Source : Jeni Shukla, Citrus Interactive

Sailesh Raj Bhan, MBA (Finance), CFA (ICFAI), is a Senior Equity Fund Manager at Reliance Capital Asset Management Ltd. He has over 17 years experience in Equity Research and Fund Management, with over 8 years at Reliance Asset Management Ltd since 2003. He manages assets of over $1bn in Equity Diversified Schemes like the Reliance Equity Opportunities Fund (since 2005) and Reliance Top 200 Fund(since 2007) in addition to managing the largest Pharma Sector Fund in India – Reliance Pharma Fund(since 2004), which is over $100mn in assets.

Why has the Reliance Close-ended Equity Fund –A fund been launched as a close-ended product? Why was the tenure of the fund decided as 5 years?
The reason for launching a close-ended fund is very simple. Today the market is extremely narrow. It is so because most of the money is primarily in the Foreign Institutional Investor (FII) basket. So the money is chasing a narrow set of sectors like Consumer and FMCG. A lot of money is oriented towards a shorter portion of the market with a 3 to 6 month view while long term allocations are very less. We are focused on buying on business case basis rather than on momentum indicators. So it requires a close-ended approach. The attempt is not to mirror the benchmark but have a bottom-up strategy.

Close-ended format would enable the flexibility to execute the strategies effectively over the chosen time frame - in this case, over 5 years. Further, the portfolio could be constructed based on the market merits, without possibly getting impacted by external flows. Close-ended funds also allow us to take concentrated positions in stocks / sectors and possibly offer portfolio that may be distinct and unique from other open-ended funds.

I think a reasonable investment time frame is anywhere between 3 and 5 years. We have seen 4 to 5 years of market compression or you can say flattish markets. There are a lot of possibilities of growth. In fact we have forgotten that there was a growth opportunity in India because of 3-4 difficult political and international events. We can have multiple years of growth as we move along due to the shift in policy and the environment. This time frame can allow us to capture a large part of the upside that can come through. You may need 1 or 2 years for the markets and certain businesses to consolidate. Recovery may require capital expenditure which may take a year or so. So 5 years is a comfortable window. We also have a Dividend option in the fund. When we have extremely good opportunities in this time period we will be paying out rational and commensurate dividends, say in case of a mid-cap frenzy like the one we recently witnessed.

What will be the investment philosophy and fund management approach?
Today you are able to find a universe of very good companies at very reasonable prices. These are solid businesses, with 10-15 years track record and trading below their average valuations over a period of time. The polarization that we see in the market has resulted in some mid-cap, small-cap and even some of the large cap names trading at their five- or seven-year lows. BSE 500 is priced below its book value today. We are not buying fractured business models or companies which have fallen drastically due to re-structuring. We are not planning to buy-and-hold for 5 years. We will buy and hold as per the valuation opportunities in the market. The portfolio will comprise quality companies. Quality can be defined on the basis of a few parameters:
a. Companies with sustainable business models – Companies which have crossed a certain threshold
b. Management capability
c. Operating history of 10-15 years
d. High or rising ROEs
e. Sustainable free cash flows

The fund will have a predominantly bottom-up approach. The fund will be a flexi-cap diversified fund. Today there is a lot of value in the Rs. 3,000 to 14,000 market capitalization where we might have 70 to 80 per cent concentration in this portfolio.

What has led to the recent rally in the Indian equity markets?

This is a very important question as it is quite fundamental. In the period when you had the worst news flow, there were companies that started reporting better-than-expected numbers. Expectations have bottomed out. Nobody is talking about the big India story. The upside on the signs of small green-shoots in the economy can be substantial. The rally is driven by better corporate earnings, good monsoon, fears of double dip recession in the US fading away and better stability in the Eurozone.

What is your view on the mid-cap and small-cap segment of the market?

We have seen a significant correction in the mid-cap space and an even bigger correction in the small-cap segment. If you adjust for 2-3 sectors there has been a correction in the large cap segment too. The index being at the same level is not telling us the whole truth. When a company crosses the threshold from being a small-cap to mid-cap or from mid-cap to large-cap the delta that can be achieved is huge. The companies that have survived this tough phase are a lot more valuable than what their market capitalization indicates. Mid-caps suffer more in a bad environment but when the environment will improve they will rise faster and substantially.

We are seeing a few other Asset Management Companies coming up with close-ended equity funds. How is this fund different from other funds in the market?

I think the spaces in which all these products are operating are different. Somebody is looking at the small-cap segment while the other is looking at the value theme. Our product is just about building a portfolio of growth at reasonable valuations. We want to focus on solid companies which can deliver growth. 

What risk appetite should investors in this fund have? What kind of volatility can investors expect in a fund like this?

Investors might see volatility with respect to the benchmark. This is because our participation will be in different pockets of the market where the action is today. We are trying to minimize the portfolio risk by buying solid businesses with a good track record, which survive in the tough market conditions and gain market share. Volatility is more a function of the market conditions. If the markets become narrower you may see some volatility in the interim period.

Why have large caps done better than mid caps in the last five years?

Large caps have stronger balance sheets and greater bargaining power over mid caps. Mid-cap and small-cap companies, in lot of cases are ancillaries to large cap companies. When the large cap companies try to protect their margins it affects the margins of mid cap companies too. Large caps have been able to retain most of their value whereas mid-caps are in a weak position in the current difficult economic environment.
The other factor is that we do not have equity participation from big HNIs. The predominant participation is from institutional investors, especially FIIs. FIIs have focused on a select basket of stocks and majority of their investments in the last 2 years have been into large caps. This is also a reason for this distortion and this may continue for some more time. If a big-sized Indian mid-cap focused fund is launched that may change things drastically.

Which sectors will you be overweight/underweight on?

We are underweight consumer as it is expensive although there is possibility of growth. Pharma in select pockets offers good opportunities. We are overweight on sectors like Media & Entertainment, Engineering, Capital Goods, Retail, Insurance and other emerging sectors. We might focus on 5 to 7 sectors with about 25 to 35 stocks in this portfolio.

 
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