Tricoloured balloons and flags adorn the walls and cubicles of Reliance Mutual Fund’s office in Lower Parel on the eve of India’s Republic Day celebration. But the mood on the Street is far from cheerful, with the market continuing to tumble thanks to poor earnings and a struggling economy. However, Sunil Singhania, the 47-year-old chief investment officer of the country’s third largest mutual fund house is not buying into the doomsday prophecies. “The first attribute that one needs in investing is to be optimistic. Why are we even talking of India’s growth story unravelling even before it has played out? Abhi humne dekha hi kya hai? If you believe India is going nowhere over the next five years, then you are getting into a defensive mode, and that is no fun,” he says. That sense of unbridled optimism is also one of the reasons why Singhania has topped the 10-year return track record, even as his company leapfrogged from being an also-ran to emerge as India’s third largest fund house, managing Rs.156,000 crore in assets.
Singhania got hooked to investing in college, and that passion continued during his CA articleship. After completing his CA, Singhania began working with his uncle, himself a chartered accountant. Although Singhania made a tidy sum by partaking in IPOs back in college, it was only by poring over balance sheets of companies that he gained insights into businesses and their potential. “In the ’80s, you did not have too many annual reports. So, I used to analyse whichever balance sheets I could lay my hands on,” says Singhania, who joined a small broking outfit and later moved to Advani Share Brokers, which was among the very few institutional broking houses catering to FIIs back then. It was also around this time that Singhania completed his CFA.
But it was hardly a cakewalk for Singhania, as back in 2001-2002, nobody was interested in buying anything other than tech stocks. “It was a frustrating time, as stocks of really good companies were available at multiples of 2-3x. Though we believed that these companies had it in them to grow tenfold, no one was willing to buy,” recalls Singhania. Even if he did manage to sell some ideas, clients would give him an earful if they ended in the red. Although mutual funds were still trying to find their feet back then, Singhania remembers Madhusudan Kela, the head of equities at Reliance Mutual Fund at the time, as being among the very few clients willing to listen to his ideas. So, when the opportunity arrived, he switched sides to join Kela. “My friends tried to dissuade me from joining Reliance MF, which back then had just Rs.100 crore in AUM, by saying that it was a small player,” recalls Singhania. But Kela’s infectious energy and Singhania’s strong understanding of finance made for a potent combination, as the duo dared to venture into names that no one had backed before. “The good thing about that period was that no one wanted to invest in smaller companies, so we went ahead and invested in them. The only way for us to generate alpha was to pick names that were outside of the large-cap universe,” explains Singhania. Jindal Steel and Power, Torrent Power, Divis Labs, Lupin, Jindal Saw, Jain Irrigation and Kirloskar Brothers were some of the names that made their way into the fund’s portfolios.
What made Singhania’s task easier was that a lot of these names were available at less than cash profit in 2003, a trend that was visible in 2013 as well, albeit in select pockets. “Our view was that if the sector was facing headwinds, due to which the company was available at a substantial discount, the cycle would turn where the stock would be significantly valued,” mentions Singhania. Putting this in context, he explains that the fund bought a tyre company three years back, when it was valued at 1/10th of sales and its market cap was two times its cash profit amid falling rubber prices. Ditto was the case with some textile stocks that were trading at 2-3x as the market was not assigning them higher valuations despite the changing business models in these companies. As envisaged, the market ended up re-rating the stocks, thus vindicating Singhania’s stance.
Singhania believes a lot of money can be made in picking trends early on and ensuring that one buys into a company that is better placed to make the most of the trend. It was around 1997 when Singhania got sold on a stock after buying three Hepatitis B injections, each worth Rs.3,500, for his newborn son. “I also ended up buying 100 shares of GSK Pharma’s earlier avatar. Within a month, the share purchase helped me settle the entire hospital bill,” reveals Singhania, adding that trends can be visible in one’s own spending habits. Reading, too, helps a lot in honing one’s analytical mindset. Singhania refers to a chapter in the book Freakonomics by Steven Levitt and Stephen Dubner that takes a look at the drastic drop in crime rate in the US during the ’90s. The general view around the time was that good administration was the reason why crimes had fallen, while some felt it was because the economy was doing well. Ultimately, the authorities traced the roots of the social change in their own decision to legalise abortion in the ’70s, which meant that the US had fewer unwanted kids in the ’70s and, as a result of that, in the ’90s, it had fewer ‘unwanted’ 20-year-olds, resulting in fewer crimes.
Using the same perspective in the Indian context, Singhania talks about how he bought into companies where a new generation was taking control of the empire and unleashing changes that would alter the course of the company’s growth. “In a lot of Indian companies, the second or the third generation is well educated and has a different thought process compared with the original founder-promoters in terms of value creation and growth. A lot of companies where the second and third generation is good have entered into a different orbit,” says Singhania. For example, when the fund bought into the RP Goenka-owned CEAT, it was not seen as being investor-friendly, but when Anant Goenka took over the reins six years back, he brought in a different perspective. “Goenka understood the importance of RoE and RoCE, and instead of focusing just on manufacturing, which was a low-PE business, the company started focusing on branding and outsourcing. Soon, the return ratios started trending higher and, as a result, the stock started trading at a higher multiple,” explains Singhania.
In the current context, Singhania believes there are quite a few themes that will play out in the future. “I always believe that we are behind the world by 10-15 years, and from an asset manager’s perspective, this makes life easier in the sense that trends that used to take 20 years to come to India are now taking maybe 20 months or 20 days to appear. So, it’s very easy to figure out what would be the next sunrise sectors.” Over the next 15 years, urban consumption, logistics and financial savings are the key themes that Singhania expects will see greater traction. Brand play is one theme that is already visible in the fund’s portfolio. “Look at something as basic as shirts; earlier, purchases were driven around festive occasions but now we shop throughout the year,” says Singhania. Not surprising, then, that his fund owns close to 10% of the Tata-owned Trent, which has a joint venture with Zara; Aditya Birla Nuvo, which owns Madura Garments and its brands Louis Philippe, Van Heusen, and Siyaram Silk Mills.
While the potential of the logistics sector is humongous, Singhania believes financial savings will be a much bigger theme in the coming years. He cites the example of Capital International, one of the largest asset managers in the US, which took 100 years to reach a size of $2 billion assets under management. But over the next 30 years, it grew 1,000x to $2 trillion. “In India, the AUM business is at just $200 billion, and our view is that over the next 15 years, it could multiply manifold to $2 trillion, as we are a large country of savers,” says Singhania, adding that QSR, home delivery and building materials are some of the other parts of this urban consumption theme. Although Singhania is keeping a watch on changing consumer habits and trends, he is also clear that he shouldn’t have more than 20% of his exposure in urban consumption. “At the end of the day, I also need to have a portfolio that balances any underperformance.”
What separates Singhania from the rest is his flexible approach to investing. “As a fund house, we are relatively young, with 14-15 years of investing experience. We know what works in India and are willing to adopt changes and be flexible. India is a growth market — it is not a value market. If a company is available at 20 P/E, I am willing to endure a higher valuation, but in sync with its growth potential,” he explains. The fund tracks 450 stocks in-house, with an analyst for each sector, and soft-tracks 1,300 companies, having created its own knowledge management software that is a master cheat sheet for everything: financials, annual reports, broker research reports and global data sourced from Bloomberg. Every Monday morning, Singhania and his team take valuation sheets of Indian stocks to track what is moving and why. “If there isn’t any particular reason for the stock to trend higher, we ignore it, but if there is any merit, we dig deeper,” he says.
Keeping a weekly tab also means that the fund can take advantage of sudden windows of opportunities that the market throws up. “Some stocks might move up and down irrationally. If I’m able to sell something today and buy it later at a much lower price, I would do it.” For example, in the last week of May, the MSCI Index re-balancing created some volatility in the market. “So many companies went up just because someone had to compulsorily buy and some went down because someone had to compulsorily sell. We will not miss such opportunities,” he points out. Besides tracking the domestic market and 2,800 global companies across 20 markets, a four-member quant team also makes a weekly presentation on global fundamentals. “The idea is to know what is happening globally in terms of companies and sectors, as that can give you a lot of insights that can be applied in the Indian context,” says Singhania. It was during one such meeting around three years ago that Singhania noticed that in a sample size of 20 countries, the market cap of cigarette companies was half or lower than that of spirit companies. In India, it was the opposite, as the market cap of the country’s biggest tobacco company was 20x that of the country’s largest liquor company because of the problems that the management was facing. “Our call was that you were able to capture 55% of the market, and India being 15% of the world population, technically, you could own 8% of the world spirits market for $1.5 billion. If the liquor company’s problems got sorted, we could double our money [with Vijay Mallya continuing to be the owner]; if not, then we would quadruple our money [assuming that it would have finally been sold to a new owner],” reveals Singhania. The stock in question, of course, is none other than United Spirits, which is spread across 13 of Reliance’s schemes, adding up to 15.58 lakh shares, as on January 2016.
While RIL MF looks for bargains and new ideas, Singhania is clear that he cannot hold stocks that have leverage or cash flow issues. “Cash flow is a balance between growth and stability, and you have to be very careful about sizing up opportunities. Between 2004 and 2007, if one would have looked only at cash flows, then infra and power companies would have not made the cut. But post the crisis, one had to look at cash flows to determine if the companies would survive or not,” he explains. Similarly, if a company is investing in growth, which could have a short-term impact on its return ratios, Singhania is willing to back it.
Managing challenges within the confines of the institution’s investing mandate is something that Singhania has mastered. For example, in its infra and power fund, RIL MF has avoided leveraged companies and has instead opted for quasi-infra plays through capital goods companies such as Thermax, KEC International, Texmaco Rail, Tata Power, Torrent Power and other MNCs such as Alstom. “In a sector that is going through a bad patch, sound stocks will not perform but they will not go down the drain either. They might look expensive on an EV basis, but they have huge tech and operational leverage in play,” mentions Singhania. For example, in the case of Alstom, staff costs went up from 11% to 25% of sales as the company began investing in capacity, which unfortunately coincided with a slowdown. “If sales go up, staff costs will come down to 15%, which adds to your performance. So, what was 10% operating profit will suddenly become 20%, and no debt means all of it flows straight to the bottomline. So, we are willing to give a higher multiple for companies where there is operating leverage in play rather than financial leverage,” explains Singhania.
The fund manager was a big buyer into the offers for sale during 2012-2013 for most MNCs that had to comply with the 25% public shareholding norm. “There were a lot of good-quality multinational companies that had to perforce sell their shares. For large investors, it was the only window to buy bigger stakes in a meaningful way,” says Singhania.
Of course, getting it right each time is just not possible, but there have been quite a few occasions when Singhania was quick to jump off the gravy train. At one point in time, the fund was holding close to 8% in Bajaj Finance, a stock that it had bought in 2009 when its market cap was around Rs.400 crore. The fund started selling when the stock price hit Rs.1,800 and completely exited when it touched Rs.2,000 a share. Same was the case with Eicher Motors, in which the fund had bought a 10% stake at Rs.200 a share in 2009 and sold off the stake between Rs.1,500 and Rs.2,000. Today, the stocks are trading at around Rs.6,500 and Rs.18,000, respectively. “We went wrong with assessing how much more growth was left and sold it thinking ‘Yeh stock 40-50 P/E ho gaya’. What we did not fathom was that the company could grow at 40% for another three to four years. Had we stayed on for another four years, the return would have quadrupled,” Singhania says.
Though the Sensex has corrected more than 20% over the past five months, Singhania is not too worried. The reason: everytime there has been a sharp fall in the market, the subsequent two-year returns have been quite favourable. From a macro perspective, the CIO feels that between 2002 and 2008, corporate profitability tripled with a CAGR of 20% and the equity market went up six times. That was because driven by massive recession in 1999-2002, no company set up capacity. When the economy started to revive, companies were able to utilise idle capacity and operational leverage came into play. Also, interest rates fell very sharply in 2002-03. From 9%, the 10-year yield came down to 5.5%. So, financial leverage also came in. “We are in the same kind of scenario today. In 2008-14, India had capacity but no demand. Interest costs went up. So, operational leverage became a headwind and profit growth was hardly there. Right now you are slowly seeing operating leverage coming into play and with interest rates also falling, financial leverage too will play out. Though the current earnings recovery will take another two to three quarters, our view is that by 2020, earnings will clock a CAGR of 17-18%,” opines Singhania.
Against such a backdrop, Singhania finds it thrilling to run the small-cap fund, modelled to deliver pure alpha for investors. “In small and mid caps, the sense of achievement and satisfaction is much higher because the work you do is more proprietary. I wouldn’t be reckoned extraordinary if I invest in HDFC Bank and generate the same return that is common to just about every other investor,” says Singhania smilingly. That approach could well keep him on top of the pecking order in the times to come.