One of the central tenets of modern macroeconomic thinking has been the emphasis on following a counter-cyclical policy — raise interest rates during the boom phase and lower them during a slowdown. This counter-intuitive idea lies at the heart of Sailesh Raj Bhan’s investment strategy. Bhan vividly recalls, how his ability to spot sharp distortions in relative sectoral valuations across different business cycles since 2004 enabled him to spot the right opportunities and earn a 10-year return of 10.79% compared with the Nifty’s 5.54%. Bhan ranks ninth in our survey, based on his past 10-year performance and currently manages assets worth over 16,000 crore.
Born in Hyderabad, Bhan acquired his graduation degree in genetics (1993) from Nizam College. Given the limited opportunities in geneticsresearch at that time and with the equity market in Indiapresenting immense potential, Bhan went on to do his MBA in finance from Osmania University. He also holds a CFA charter from Institute of Chartered Financial Analysts of India, Hyderabad. Bhan recalls, “My first brush with the stock market was in 1995. It’s not a job with a finite framework, it’s a job with a framework that is too large, you have to make it finite, or else you get lost in the whole system! And that makes it exciting.”
Before joining Reliance Capital Asset Management — as it was formerly known — in November 2003, (which then had assets under management of 700 crore) Bhan was leading the research team at Emkay Share and Stock Brokers for one and a half years. This was after he had worked as a pharma and technology analyst for five years at Shah & Sequeira Investment, a Mumbai-based brokerage house.
He attributes his analytical rigour to the experience he amassed as a sell-side analyst before becoming a fund manager. “The equity research stint helped me build a hypothesis, which allowed one to take decisions, but now as a fund manager, you have to live those decisions. It is one thing telling someone to invest for the long term, but actually making money by investing in companies for the long haul is another thing altogether.”
Bhan first joined Reliance as a pharma analyst and has been managing the Reliance Pharma Fund ever since it was launched in June 1994. He has also been managing three other funds since their inception — Reliance Equity Opportunities Fund (March 2005), Reliance Top 200 Fund (August 2007) and Reliance Media and Entertainment Fund (September 2004).
Bhan believes that he was fortunate to enter the asset management space at a time when the Indian equity market was on a dream run. “It’s more than interesting; it just consumes you. And so many things you think are right, are actually not right. You can learn about various sectors and companies in different stages and can virtually grow with them.”
Against the tide
The ability to spot relative distortions in valuation across different sectors early on has been one of the key factors, which guaranteed his success. Bhan recollects one such cycle in 2007-08. “In the heady days of 2007, during the real estate and infra boom, IT and pharma had become touch-me-not sectors. For instance, the market cap of one real estate company was equal to the market cap of the entire IT services sector or the market cap of one telecom company was equal to the market cap of the entire pharma sector,” he says.
For instance, DLF was commanding a market cap of 2.1 lakh crore in January 2008, and the stock was trading at trailing 12-month (TTM) P/E of 506.5x. Infosys, on the other hand, had a market cap of 87,459 crore with a TTM P/E of 19.82x, during the same period. So, Infosys was first bought in the Reliance Top-200 Fund in September 2007, and to this date commands a weight of 4.4% in the fund, making it the second largest stock. The price of Infosys at that time was about 455 and since then it has multiplied 2.2x. It was also bought in the Equities Opportunities Fund in April 2009, and currently is the fifth largest stock, with a weight of 4% in the fund.
Bhan also invested in the pharma sector as valuations were equally attractive. “We were massively overweight on the pharma sector in 2007-08 till 2013. In our Reliance Equity Opportunities Fund, we were holding 18-19% in pharma sector in 2008, when the Nifty 50 Index weight was 3-4%.” In early 2013, Bhan decided to exit companies focused on the US markets. “The US-focused companies were generic players at that point in time and the valuation seemed too high, since generic products typically witness steep price correction every year and so the yearly 30% earnings growth seen till then seemed unsustainable. They were in a sweet spot till end of 2013, as gains from currency depreciation significantly improved their profitability. But we chose to exit early, rather than late,” he explains.
It was only in 2017 that Bhan started looking at generic pharma again. The renewed focus came from the fact that their valuation had seen a significant correction and the stocks were available at disproportionately attractive valuation compared with the domestic pharma players, such as Cipla, Glaxo Pharma and Ajanta Pharma. Bhan also expects their heavy expenditure on R&D over the last two to three years to bear fruit in the near future as they foray into specialty generics. “These are businesses operating in around 100 countries with product registrations in place. Some of them are just going through a bad phase,” adds Bhan. So stocks such as Aurobindo Pharma (February 2017), Sun Pharma (December 2016), Dr Reddy’s Laboratories (February 2017) were added to the fund portfolios.
Engineered to gain
In 2013-14, after making stellar returns in the pharma sector, his search for value distortion lead him to the engineering sector. While the TTM P/E of Nifty Pharma Index was 46.5x in July 2013, the Nifty Infrastructure Index was trading at 14.6x. The engineering sector was collapsing, with surge in oil prices and interest rates, and a depreciating currency. “With India being the most under-invested infra opportunity, given the scale of our economy, the valuation distortion was apparent. So we ended up holding large stakes in the engineering companies. We went for companies with a clean balance sheet and with some product or technological advantage. If you look at power sector, there are about three to four power companies without which power transmission and distribution cannot happen. So it was a no-brainer to invest in them,” he says. Bhan bought stakes in ABB, GE T&D India and Siemens.
He bought into ABB in February 2013, which has gained 122% since then and GE T&D India in May 2012, which has appreciated by 206%. Bhan also bought into MNC engineering companies, which were witnessing offloading of stake by their parent company to conform with the Sebi norm of minimum 25% public-holding. Nevertheless, these firms were in a position to dominate, when the cycle turned. He invested in firms such as, Honeywell Automation and Kennametal, which have gained 661% and 97%, respectively, since then. “The order book had dried up and some of the engineering firms were operating at 60% utilisation. These were not debt-heavy firms, so we knew that a small improvement in growth outlook would significantly improve their prospects. The idea was to invest in those players who will not miss out on the opportunity,” he says.
Another point which Bhan repeatedly harps on is sticking with the leaders in the sector, who have a moat, which is relatively difficult to attack. “You cannot generate returns without taking risks, if you are taking risk, please take it with leaders!” For instance in banking, Bhan believes that the leadership position of the major PSU players is difficult to challenge despite the recent hiccups. “Smaller banks, which had no longevity or any material competitive advantage, were getting valuations 3x-4x more than the larger corporate banks,” he quips. He believes larger PSU banks focused on corporate lending are likely to do better in the next three to five years compared with private sector banks. So, SBI has the largest weight in both his funds.
Bhan owes a lot of his investment philosophy and strategy to reading, and the valuable lessons he has learnt from colleagues, over the past two decades. Being an avid reader, Bhan boasts of a collection of 1,000 books, curated over the last 20 years. Besides Buffett and Lynch, his favourites are Seeking Wisdom — From Darwin to Munger by Peter Bevelin and The Only Three Questions That Count by Ken Fisher. He is currently reading The Hour Between Dog And Wolf by John Coates, which explores how people cross the lines between trading and investing, in good and bad markets, and describes it as a phenomenal read.
Apart from looking for value distortions while evaluating businesses, Bhan places extensive focus on promoters’ stake in the business. For him, a frequent dilution by the promoters is a clear precedent to value destruction. “The right business model, quality management and high capital efficiency is reflected in a high RoCE, so it is important that the businesses do not keep getting diluted, as return also gets impacted proportionately. So, the idea is to find a business with a market opportunity that structurally allows you to grow without frequent equity dilution. If the market is not expanding, even the leaders cannot grow,” he explains.
The themes Bhan is betting on over the next few years are retail and consumer discretionary, financial services and engineering & construction segment in infra. “We are in an environment where interest rates are benign and the capex cycle is starting to see some momentum due to increased government spending. The whole EPC cycle will play out in the next three to five years, as private spending also starts to kick in. We have already seen few steel companies announce new projects,” Bhan points out. Betting on the revival of the capex cycle, Bhan invested in stocks such as Engineers India (October 2017), ABB India (March 2017), GE Power India (August 2017) and Vesuvius India (September 2017).
He is also bullish on the hospitality space, a sector that he bought into more than three years ago. Indian Hotels, bought in May 2014, is the fourth largest stock in terms of weight in the Reliance Equities Opportunities Fund, at 4.6%. The stock has gained 43% since his purchase. EIH was another addition to the portfolio in July 2014 which has gained 58%. While he may have been ahead of the market in placing these bets, he feels that given the favourable demographic dynamics and improving purchasing power, spend on travel and leisure is only bound to increase, and both these hotel chains are set to be major beneficiaries of increased spending. “The sector is coming out of a significant downturn. Over the past two years, occupancy rates have moved up and it’s a matter of time before they regain their pricing power. Once that happens, given that it is a high operating leverage business, their profitability will see a significant improvement,” he predicts.
The insurance business is another segment that has caught Bhan’s eye. “The insurance business is a large investment opportunity. It is an area, where a lot of product innovation is possible. Also, in the past ten years, the mindset towards insurance has undergone a change, so insurance is part of everyone’s budget now. The cost of distribution is also declining, which was previously their biggest challenge.” In the past one year, he has bought New India Assurance, ICICI Prudential Life Insurance, Max Financial Services and HDFC Standard Life Insurance.
Bhan’s ability to spot the most favourable sectoral trade-offs in the backdrop of business cycles and his unflinching commitment towards the leaders in these businesses has ensured his success. Does his investing style make him a contrarian then? He is quick to disagree. “It’s not about being contrarian. You are not purely buying a company because there is value. You have to ensure there is growth but you are buying into that growth at a reasonable price, and not over-paying for it. Sustainability of the underlying business is another important factor. Often, investors tend to write off sectors very quickly, but that is where you get a bargain,” Bhan signs off.