Coffee Can Investing | Navneet Munot feels investing in equities is more about EQ than IQ

Saurabh:  So, welcome to Coffee Can Investing.  We are in The A today with Navneet Munot the CIO of SBI Mutual Fund, one of the largest mutual funds in the country. Welcome to the program Navneet.

Navneet: Thank you, my pleasure.

S: So, let us begin at the very start. Urban legend has it that you started investing when you were 11 or 12 years old. Now, most of us are trying to figure out our football and cricket career at that age. How come you were investing from such an early age?

N:  Downside of that is, I am not good at any sport, physical sport.  So, I grew up in a small town in Rajasthan in a place called Beawar.  It’s in Ajmer district in Rajasthan and the family was into small business, some agency businesses and in those days in early 1980s, we booked a scooter, LML Vespa.  It was a new product, a very interesting product.

S:  Right.

N: And in the market, there was a huge premium for that product. I mean if you get the allotment this was like a lottery. We thought that if the company’s product is so good and it will make so much of money, I ended up investing in the stocks and then I saw in the newspaper the prices like Rs 60 or Rs 70, I was like what a great way of making money.  You can multiply your money six or seven times but in the small town those days there was no TV, no internet. We used to listen to BBC everyday. That was like a ritual, on the BBC World Service Radio and had huge interest in like global macro out of like pure academic interest.  There was no global business there.

S: Right.

N: And there used to be this newspaper called Vyapaar. It is a Gujarati newspaper, a biweekly where I used to read about Manu Manek, Nimesh Shah, Alkesh Dinesh Modi.

S: You know how to read Gujarati as well?

N: Yeah, because we used to get that Gujarati newspaper there and then you read about markets. My father used to say “Har price kuch kehta hai.” Every price says something. So whether you are dealing, not dealing but I think you should keep looking at various prices and why different markets are moving. So I think that kept the interest on. I used to write a daily diary about what happened in market. I think in like 1980s, early 1980s when I started and I still remember several of those companies, several of them do not exist now.

S: This is when India is winning the World Cup in 1983, Asian games.

N: In 1984, Indira Gandhi got shot dead, Rajiv Gandhi in 1985, and 1985 was the first Big Bull market in India and I have those memories etched in me what really happened.

S: So from, I suppose that sort of background led you naturally to Chartered Accountancy and then I suppose came the big sort of formative stage of your career, Aditya Birla Group. How did you end up joining the behemoth that is the Aditya Birla even today?

N: So pure luck, I got a rank in CA.  So actually in a small town in Rajasthan, I mean you have no other option unless you want to move out to the city, you can do CA from there.

S: I see...

N: Luck had it that I got a rank which was the 50th rank.

S: 50th all India...!

N: Yes, 50th all India. They only gave merit to 50 people and I was 50th and just that pure luck. Because of that you get lot of letters for interview letters from companies.

S: Amazing.

N: Aditya Birla was the least paying but I thought that in financial services Birla Group wanted to be a large player and I choose that and then worked there for 14 years.

S: Which year are we talking about here?

N: I think it was 1993-94.

S: So India has liberalized, Harshad Mehta was in full flight.

N: Absolutely.

S: So from what I know you spent a good 14 years in Aditya Birla Group in various roles. Just talk us through that - what we are very keen to understand is the influence that it had on your subsequent development as a fund manager. 

N: So you know this book Outlier by Michael Gladwell, so all of us were very lucky.  We were at the right time at the right place. So in the early 1990s the markets were opening up. I started as a market maker in an exchange called OTC Exchange. It does not exist today but that was the first electronic exchange in India to trade in several small companies.

And then NSE came, Demat. There were various new markets (components), derivates and all of that and I was like part of the financial services group, one of the early employees and it had like from a purely learning perspective worked in the bond market, in equity. 1997-1998 was very interesting. I was part of two-member foreign exchange advisory cell. I used to write a daily on foreign exchange market and advice the group on that.

S: …entire Birla Group?

N: Yeah and there was a time on the Asian crisis, Russian crisis, LTCM, I mean that was a great landing, and all these years, I was quite involved with the insurance company.  When the insurance company got set up, I was there on their investment committee, drafted the investment policy for them and of course large number of years in the AMC. Also, worked on the sales side. So I think across financial services, it was a great opportunity to learn a lot of things.

So, I saw lot of cycles during that time. I saw the 10-year bond is falling from 14 percent to 5 percent during that time period and I remember 2000 to 2003 when my gilt fund delivered 20 percent per annum, almost, when equities were negative. So the big boom and bust where stocks could go up 100 times and they could fall 99 percent in few days’ time.

Saw big boom and bust in NBFCs where most of our competitors who are pretty large - I was initially in the Birla Group, NBFC Birla Group Global Finance Limited and then they did not exist. Saw huge boom and bust in several other industries during 1990s and there was a big boom in 1994 with the GDR money and all — both in the equity and credit side — and several of those companies don’t exist.  So I think I have had a lot of phenomenal learning experience over the years.

S:  One of the most interesting facets of your career is your experience at Birla as a debt fund manager and you ran a bond fund there successfully. You also ran a hybrid fund there. Given that most of the CIOs have come to this program have been from equity backgrounds, we have an exceptional chance here to understand from you how a debt fund manager uses investment. Can you give us a sense as to what is the difference between how a debt fund manager views the world and how an equity fund manager would view the world?

N: So the debt guys look at a couple of things from a top-down perspective. You have to take a duration call. You have to take a sector call which is like between government bonds and corporate, high grade or high yield within that sectors and you have to take a call on the yield curve which is like big top-down calls that you need to take and then security selection is very much bottom up, credit is very much bottom-up and then of course you apply a lot more quantitative analysis relative to equity and it’s slightly different than the equity. Otherwise, a pure credit is very, very similar to the equities. I mean, you are looking at the cash flows. You are looking at the business.

On a lighter note, I keep saying that debt guys always look at what can go wrong, equity guys look at what can go right. I think they make a good combination when they work together.

Also, debt in India is a lot more, I would say, relative to equity, transactional in nature. You have to worry a lot about liquidity. A debt fund managers spend a lot of time in the dealing room because you are fighting for every basis point, you have to look at multiple sources of alpha. You look at several different kinds of arbitrage within the market to generate alpha. So, it is slightly different. There is a lot of structuring which is involved. Again to repeat the same point that there is a lot more about numbers. I think equity is a lot more about narrative. That is another difference between the equity and the debt guys. Also, I think the debt guys do not get much invited in Coffee Can Investing.

S: We are delighted to have you.

N: Also, in terms of benchmarking, so in benchmark, people look at equity returns.  They look at what benchmark is given, but particularly in India when you look at the fixed income return, people still have absolute returns or what you have delivered relative to your peers.

S: Right. So in a way the debt mindset and the equity mindset, you could argue, are complementary.

N: Oh absolutely, no doubt.  In fact, if you look globally, I mean, Paul Singer, Howard Marks, Seth Klarman, Ray Dalio I can just go on. They are investors.  It is all about discounting cash flows and then the certainty and the probability of it and it is across structures and as the markets evolve in India, you have the REITs.  What is a REIT, is it equity, is it bond? Or a combination of both?  I think we are going to have more and more, I think, the people who have the skill set in both, I think they will do well.

S: Fantastic. Now talk to us about the transition to Morgan Stanley, how did that opportunity come about and what did you learn in those years?

N: So, interestingly, I mean, I probably could have ended up with more management responsibility. I had this huge dream of becoming a global macro hedge fund manager and global macro fund manager and Narayan and some of my other friends who were there in Morgan Stanley, they convinced me that, you want to be a global fund manager then this is the platform and I joined there but maybe after sometime I thought that probably they are not the platform like SBI was better, but so, deep in me somewhere, because I used to be big fan of people like George Soros, I used to follow Bill Gross and I thought that maybe you need a platform where you can actually manage money from a global perspective.

S: So, you certainly got a platform and built more than a platform over the last 10 years. As we get into the SBI narrative, there are various facets of your SBI career which I think are very, very interesting but let us start with the first piece of your career which I find very interesting which is your ability to understand credit cycles. So, if you look at the world outside India, someone like Howard Marks has written extensively about how to understand credit cycles, where are we in a credit cycle today, are we at the top, are we at the bottom, and is loan growth going to take off, is it going to die down. How do you read credit cycles?  What metrics, what markers and indicators do you use to understand where we are in a credit cycle?

N: So this guy, Paul McCulley, at that time he was in PIMCO. He made this term very famous, Minsky moment, that lead me to read Hyman Minsky, the famous economist, who said that the period of stability or prosperity leads to instability or the distress in market and there are five stages of these cycles. So it starts with the displacement, boom, euphoria, profit taking and panic. And markets go through these stages. It starts with a period where there is an innovation or there is like this time it is different.  For example, I mean let us say that the supply market in US and then it leads to more and more easier lending to the sector.

Over a period of time, it becomes euphoric where the LTV, the loan to value ratio goes down, the lending standards go down substantially, underwriting standards go down, money is easily available. It becomes euphoric.  At some point in time, cash flows are not enough to pay the debt and then it leads to little bit of profit booking asset sell and then finally it leads to a situation like panic and I do not call it a greed and fear cycle, I call it a fear and fear cycle where there is a fear of losing the deal and then you move to a fear of losing money. So at one extreme you do not want to lose the deal at any price, another extreme where you do not want to do the deal at any price.

S: Let me now focus on your SBI career which I find very interesting. Most successful fund managers are characterised by insecurity.  You could argue the insecurity itself makes them very successful, they work very hard driven by insecurity and yet you are a CIO in a megafund house who does not run a fund.  How have you managed to reconcile these two elements of success in fund management?

N: You are touching a sensitive nerve (laughs).  I manage a team, work on culture, governance, processes, philosophy, client relationship, etc., and do everything other than managing the money directly. I joined Morgan Stanley from Birla because I wanted to just manage the money over a longer period. The interesting aspect is that we are a very analyst-driven fund house. Everyone in the 50-member team at SBI is an analyst first and a fund manager/head of equity/CIO later. So, I am one of those analysts working with extremely talented people and the most enjoyable time in office for me is when I sit with other analysts in our company. I think not managing a fund with a name attached to it is a big deal for me. But being a part of that team of analysts is a great joy.

S: It takes a lot of character to do that. It also takes a lot of character to do what your fund house has seen do repeatedly over the last few years. Most fund houses in India are reluctant to pick fights with promoters, with powerful companies. I suppose they worry about their business being in jeopardy if they were to take on corporate governance issues with any major promoter. Yet, SBI MF, correct me if I am wrong in this regard, took a stance on the way Suzuki was treating Maruti’s minority shareholders. I remember you taking a stance on the Satyam-Maytas deal all the way back 10-11 years ago and recently on Vedanta and the Niyamgiri episode in Orissa. Where does this spine come from in an industry in India not known for displaying it?

N: I would not use the word fight. Maybe, in case of Satyam, it was kind of a fight, but otherwise, I would use the word constructive engagement. I strongly believe that as a minority shareholder, we should have this continuous constructive engagement with companies to ensure that our interests are completely aligned. Historically, mutual funds or institutional investors voted with their feet.  They were not as large. If you did not like a company, you just get out of the stock. But as you become larger and larger, that becomes very tough. We also manage a lot of passive money where if the stock is there in the index, then we have to buy the stock, and I realised that over a period of time, it is better to engage proactively. I think the companies have also realised that by engaging constructively and proactively, it is helping in value creation in a better manner. So, I think it has been a good journey over the last few years but I am sure we have a long way to go.

S: So, that brings us to the next topic -- ESG.  So, we have got to a juncture in India where there are several ESG funds being launched. We could argue after large cap and small cap investing it is almost the most popular theme going at the moment. There are ESG matrix and indices which have been launched by the global index providers. And yet at SBI, if my memory serves me right, you launched your ESG funds several years ago, three to four years ago. What led you to spot the potential of this theme well before the rest of the world woke up to it?

N: So, we started on ESG integration into our investment process several years ago, almost five to seven years ago, though we launched a product on the PMS platform around three to three and half years ago.  This is not only ESG but a very strict socially responsible investing. Then, we converted one of our flagship large cap fund into an ESG-focused fund last year. It is completing a year and it has done well.  The idea was companies that are focused on ESG which are good, in terms of their environmental footprint, social impact, better governance would end up generating better value over a longer period of time. It is part of a value system and I believe that over a longer period this is important. Also, from a risk management perspective this could be a source of alpha if you are investing in companies that score higher on ESG front. But if you don’t do that then there could be several mishaps; look at the news flow over the last few years on how market has treated companies that ignored the environmental factors, companies that ignored social factors, companies that did not score high on governance factors. Still, it is in infancy in India. Globally, as you rightly said, investors are asking for ESG-focused funds. In India, it is the other way round where as managers we are going and creating awareness within companies at various forums including for investors on why ESG is important.

S: One of the things I have seen with my clients outside India is that there is far more desire on the part of global institutional investors to see ESG investing. Correct me if I am wrong, but I am not aware that Indian investors are that obsessed. N: It was the other way round. So when we put this large cap ESG-focused fund last year, we actually lost money in first few months because lot of investors thought it would come at the cost of returns. But we have a very strong belief that over a longer period this will be a source of alpha. Also, thinking back on that the same point I made earlier, as we become larger and larger as an asset manager, we have a huge stake in the economy and unless the growth is sustainable and equitable even a little impacts the overall beta and market return. So, it is our responsibility that we do the right things through our investments which increases the economic return and the overall corporate profitability that is sustainable over a longer period of time.

S: So, let us come to another element of sustainability which is our investment profession. Both of us are CFA charter holders. You are the leader of the CFA community in India and also a chartered accountant. Most youngsters in India tend to be very confused as to what exactly they should study.  Should they be a CA, MBA, CFA. What would your advice be to an aspiring investor? Someone who wants to be like you 10-15 years on. What should he or she have focus on in her late teens, early 20s?

N: CFA surely helps, simply because of the good body of knowledge which you do over the three levels. Also, I think tremendous focus on the ethics which is an aspect that is quite ignored several times. I think it is a part of a lifelong learning and the networking opportunity that you get with likeminded people over a long period. So, CFA surely helps. I think any background in accounting or if you understand financial statements then that surely makes you a better investor. Otherwise, I think investing is a lot more about common sense than pursuing those degrees. Several of those things which are taught in particular courses can also be learnt on your own. Today, I mean, there are so many sources including the Coffee Can Investing series that you do.

S: You mentioned an interesting book by Hyman Minsky’s titled, Cycles, Growth and the Great Recession. Any other reads that had a big influence on your career, anything specific like George Soros?

N: I was a big fan of Soros. In fact, I used to have a screensaver of the author and I’ve read all his books. I remember in 1993 I read, The Man Who Broke The Bank of England, everyone talks about Benjamin Graham and Philip Fisher, who published books that you have to read. But since I like everything about financial history, I read Peter Bernstein, Charles Kindleberger, I like Niall Ferguson’s The Ascent of Money. It is very important to know the long term history of markets, money, finance and it helps, if you read some of the books on behavioural aspects of it.

Another example is Nassim Taleb’s Fooled by Randomness, it is a compulsory thing to read so is, Thinking Fast, Thinking Slow, by Daniel Kahneman. From an equity perspective it is important to read authors like Michael Porter. I think the competitive advantage is the most important thing you need to understand. Creative Destruction, by Austrian economist Joseph Schumpeter is a very important classic. One can also read Adam Smith, you read Keynes and people like Milton Friedman and of course going back to philosophy. I think more than finance, it is the appreciation of the role that history, philosophy, evolutionary biology and psychology play in investing.

S: That’s an amazing reading list. Let’s turn to our audience Navneet. Anybody here has any queries?

Question from audience: What are the ethical aspects that you follow, being a portfolio manager?

N: This is one of the reasons we appreciate the CFA course as 15 percent of the exam is on ethics. In financial services, the line between what is right and what is wrong is very thin, hence it is important that people appreciate the importance of ethical behaviour. We manage somebody else’s money, so we should ensure that people’s trust in the capital market is not be shaken. This can have a huge impact on our lives. There were multiple mishaps in the ‘90s and somewhere the people’s trust was broken, hence all of us in the financial services sector have the responsibility to ensure that our behaviour is ethical overall.

Question from audience: Navneet, let’s say before you really started with ESG investing, suppose if you had an investable universe of let’s say 500 companies and after you applied ESG screen how many of those 500 companies really passed that test? So, what is the kind of ESG framework specifically in the listed space that the companies follow?

N: So, particularly in the ESG focus fund there is a negative list of certain sectors which cannot be invested, which may be invested in some of the other funds and then we look at an ESG score which is based on, as I said earlier, the environmental footprint, the social impact and the governance parameters and below a certain score, we do not invest in those companies. So roughly in our ESG fund in our universe, there would be around, I do not remember the number, but I think the number that you said maybe I think 30 - 40 percent companies would not meet that high water mark to come into the ESG fund.

Question from audience: And you see that the trend is definitely shifting towards the companies because one of the largest asset managers like you and SBI, if you are not choosing to invest in those companies at least in some specific funds that follow ESG guideline then are the companies making a conscious effort to be ESG compliant?

N: So, it is a journey. Companies are also aware and there is going to be more and more regulatory nudge. There is going to be more nudge from the society. There is going to be nudge from the investors like us and all of that will ensure that companies move in the desired direction, I mean, in the right direction. That is, let’s say the carbon emissions are very high of course, there would be pressure from all sides to find ways on how do you reduce the carbon emissions.

Question from audience: Good afternoon Navneet. Two questions actually. The first question is for the investor, what would your advice be? Because at the end of the day while India is booming and markets are growing rapidly and equity is becoming a more and more popular investment opportunity. Nevertheless, it is a fairly common knowledge that most people at a retail level don’t make money when they invest in equity for reasons which one need not go into here. How do you advise investors to, you know, look at equity going forward. Because by the end of the day people get swayed by so many things. And the second question to that is, at the end of the day with the industry growing so rapidly what changes do you foresee as far as the intermediary community is whether you call them investment advisors or you call them distributors because they play a very important role and I think the role of advice, the cost of advice, how does one tackle that challenge because at the day as an Indian customer who does not necessarily want not pay for advise, you know, if one understands that.  So these are the two questions.

N: So, on the common people how should they approach investing, I think as someone likely said that investing is less about gathering more information or more intelligence, or more analysis, a lot more about common sense and I think just having the faith over a longer period that hour of compounding works in your favour if you are in the right asset class and remain disciplined on that path, it is a lot more about the EQ, emotional quotient than the intelligence quotient.

On the second questions, on how the advisor’s role will evolve, so over a period of time will move more and more from a product selling to a more solution selling. It is already happening in India, I met a large number of advisors how they have evolved over the last 10 - 20 - 30 years, it is a lot different today. It is clients first, sales later or a process first, outcome later or they are more about the relationship, more about understanding their needs, understanding their goals, understanding their risk appetite doing the hand holding during different market cycles and I think that is where the advisory profession is moving which is a very healthy sign.

S: Thank you very much Navneet. That was a very stimulating session of Coffee Can Investing. We are glad that you could attend the session and give us your thoughts. Thank you. That is it from us. That is it from Coffee Can Investing for the day.