Markets often tend to reward those who have the right temperament rather than just intelligence. The challenge, however, is how to avoid the temptation and stay calm when the entire market is in a frenzy. Franklin Templeton’s Anand Radhakrishnan has mastered that fine art.
During the famous tech bubble, when he was managing a fund at Sundaram Mutual Fund, Radhakrishnan underperformed his peers for almost two years. Most fund managers had bet heavily on the tech sector. In fact, some funds even had an exposure as high as 60% to the sector while Radhakrishnan had capped the fund’s exposure at 30%. “We chose to remain invested in quality tech companies. It was a difficult thing to do when the rest of the market was doing well. But my boss kept telling me not to worry, these valuations are not sustainable. It is okay even if you manage the funds conservatively, but do not take the risk,” recalls Radhakrishnan. Once the tech bubble burst, the Sensex fell from 5,500 to 2,900, a fall of nearly 50%. His fund fell by about 40% which was still reasonable considering most other funds fell by more than 70%.
At Sundaram, Radhakrishnan’s boss Shreekant Pandey came from its then joint venture partner BNP Paribas. “Pandey was a pension fund manager at Bell Canada. He used to talk to me about the Japanese market bubble and what kind of mistakes people made. He had the experience of investing in global markets and had seen many bubbles bursting,” says Radhakrishnan. Japan went through a big boom from 1982 to 1990 when the market hit a high of 39,000. At 19,000 today, the index is a far cry from its all-time high. “He used to say if you are stuck with the wrong stocks in a bubble, you may never be able to recover your money even after a long period of time. Those kind of examples were really useful. He was a great teacher and I was very lucky to have him as a boss for almost seven years,” adds Radhakrishnan. In 2004, Radhakrishnan left Sundaram to join Franklin Templeton. As CIO, he now manages some of their flagship funds such as Bluechip, Prima Plus and Infotech Fund.
Radhakrishnan considers himself to be a conservative investor who stays away from taking undue risks. Not without reason. All through his investing journey, he has seen how greed had destroyed many a portfolio. He started investing when he started to work at ONGC right after completing his engineering in 1992. Post liberalisation, the market was on an unprecedented bull run. The Sensex went up from about 900 in 1990 to a peak of 4,500 just before the Securities Scam broke out in 1992.
He used to largely invest in IPOs rather than the secondary market. His colleagues at ONGC used to invest in the secondary market and talk about the money that they had made. One of his colleagues had invested in a company called Mazda Leasing, which went up from 100 to 10,000 in no time. But eventually all those gains evaporated when the market crashed. “Thanks to my first experience with the market, I am very conservative. I do not want to lose too much money. I do not invest, if I do not understand the business,” says Radhakrishnan.
Apart from being conservative, there are a couple of rules he always sticks by. For instance, he never chooses a less expensive stock over quality. “Investors often go for the next best idea while selling some of their existing quality stocks once they turn expensive. This cycle continues till you are at the peak of the market with stocks that are ideally not the best picks in the industry. The problem comes when the market corrects and you pay a huge price for choosing a relative trade over quality since the fall in these stocks is the steepest,” he cautions.
He believes that sticking to quality companies is what will drive outperformance across market cycles. “One of the biggest top-down themes that has worked over 20 years has been IT services, thanks to the outsourcing story. About 10-15 years back when the global outsourcing model was shaping up, you could have actually bought a lot of good companies and many of them would be lemons today. Many of those second and third tier companies are nowhere today. But if you had held on to the better managed companies in the sector, they have managed to generate good returns even after the bursting of the tech bubble and other ensuing market turmoil,” points out Radhakrishnan.
After two years in ONGC, Radhakrishnan went on to do his MBA from IIM, Ahmedabad. When he passed out in 1994, he had the option of joining Asian Paints or SBI Mutual Fund during his campus recruitment. “To be honest, I initially didn’t want to be in the capital market. In IIM, I did multiple courses on marketing and operations research. It was only towards the last year in campus that I started gravitating towards finance. There was a lot of excitement about liberalisation, decontrol and opening up of the economy. We used to discuss a lot and that led to an understanding of the macro developments at that point in time. Against this backdrop, I felt working in the financial markets will give me a better perspective compared to sales and marketing,” says Radhakrishnan.
So he began as an analyst at SBI Mutual Fund, tracking sectors like automobiles, FMCG and Pharma. “It was at SBI Mutual Fund that I learnt to analyse companies, understand businesses and sectors in detail. Actually it was the time when I realised that investing is not just about markets but it also has lot more to do with other things like the business model, how the industry operates, the kind of management decisions that are taken and their implications,” says Radhakrishnan.
One of the earliest bets in auto that they made was Hero Honda which worked really well for the fund. “The company was launching a four-stroke engine when only two-stroke engines were available in the market. No one knew back then about the importance of a four-stroke engine. But after speaking to the company, we understood its advantages and how it drives fuel efficiency. They were the first to do it. We knew that certain technologies are hard to replicate quickly and that gave the company a significant competitive advantage. We also realised that its focus on technology will be one of the long-term value drivers for the company,” says Radhakrishnan.
Not all his bets worked, he remembers investing in a synthetic yarn manufacturer whose IPO was hugely oversubscribed. Those days there was a great demand for textile stocks given the government incentives. “Eventually most companies turned sick with the emergence of China as a leading global supplier and the internal misuse of funds. An NBFC that I invested in went bankrupt within two years of its existence. So, I also made my share of mistakes early in my investing career,” says Radhakrishnan. “What it taught me is that even if you have identified a good space like textiles and finance early, if the quality of management is not good, there is no point holding on or buying those stocks from a top-down perspective.” He points out that it was the same case during the infrastructure boom of 2005-2008. “From a top-down perspective many investors saw a huge opportunity in the sector but in reality, no one made money. Today many of the infrastructure companies are out of business or struggling for survival as they have piled on huge debt,” he says. This time around Radhakrishnan saw the signs early and turned contrarian on infrastructure and real estate stocks during 2007-08, a strategy that worked well for him when the market crashed post the financial crisis.
Art of investing
Excessive diversification or concentration, according to Radhakrishnan is a bad idea. He believes that a portfolio should be diversified such that it reflects all the risks such as higher crude oil prices, exchange rates, government policies, politics etc. “I think the trick is in knowing those risks and constantly checking if the portfolio is exposed to any such risks,” says the fund manager. For example, in the event of a crude oil spike or an interest rate hike, Radhakrishnan would want to know which part of the portfolio is exposed to that development and how much weight it has in the portfolio. “But that is only limited to the knowable risks. You can always have one-off events such as demonetisation. We reduce exposure to any stock that is disproportionately adding to risk without any proportionate return expectation,” mentions Radhakrishnan.
He says fund managers can generate alpha by two ways. One is by sticking with the best businesses which can grow and generate profits over a long period of time. Second is by being contrarian to the market, which he calls as behavioural alpha. This calls for being bearish when others are bullish and vice versa. In practice this is quite difficult. But Radhakrishnan believes it is quite doable and that’s where his past experience comes in handy.
According to him, the market keeps throwing up many such opportunities. “When the market is excessively bearish or pessimistic that’s when you generate a higher alpha,” he says. Today he remains cautious and is turning contrarian on the mid and small cap space, where he is trying to reduce his exposure. “I think the mid and small cap stocks are a little over-valued. In the mid and small cap space the institutional ownership is very less. Lot of domestic speculators have become big investors in this space. FIIs now want to own some bit of small and mid-cap companies. So there is growing demand and not enough supply. Retail investors are buying at every rise adding fuel to the fire. So the stocks have run-up in the recent past and valuations are stretched. There is definitely some cause for concern,” he says.
Businesses never stay the same and some companies come through the evolution process much better than the others and as a fund manager, Radhakrishnan believes, one has to constantly look for ideas that can get bigger over the next 5-10 years. Citing a few examples, he mentions how Reliance ten years back was seen as a petrochemical company but now is also a telecom major. Maruti started out as a small car company but now has a presence across segments. On the contrary companies such as Tata Power, Century Textiles and Reliance Communications have really not gone anywhere. While finding winners on a constant basis is never easy, having a disciplined approach like Radhakrishnan’s, does bring a method to the madness.