In this series of Coffee Can Investing, Saurabh Mukherjea talks to “bubble analyst” Manish Gunwani, who reveals his mantra for identifying good companies at reasonable prices. Gunwani, CIO of Equity Assets at Reliance Mutual Fund, also talks about his journey into the market and how he managed to master the art of investing.
Saurabh: Welcome to Coffee Can Investing and our interview with Manish Gunwani, it’s great to have you here.
Manish: Thank you.
Q: Yours is an interesting career because you are one of the few people who graduated from the IITs and IIMs in the mid 90s when the IT boom was in full throttle. Despite graduating from premiere institutions during the IT boom you chose not to go into that industry. Instead you chose the financial services industry. Would you talk us through that period, the initial period of your career and why you entered the world of finance?
A: This goes back to my family in fact. We were growing up in Hyderabad and my father is a doctor. So when I was in IIT, during one of those long summers, I was just looking at some of the shares he had bought. He being a doctor, in 1977 when MNCs were going public, he was given shares of Glaxo and I think he paid a nominal price. He paid Rs 170 and when I was looking at it somewhere around 1992-93, it was worth Rs 3-4 lakh. So, for me it was a kind of bulb going out, it’s that easy to make money! Since then, I was one of the few guys who went and did a course on stock markets while I was at IIT.
Q: This was before IIM?
A: Much before IIM. It just intrigued me that making money could be so easy. It was then, that engineering was dead for me and I was attracted to finance. I was lucky enough to study a finance course at IIM. There too from the first day it was more about going into investments than anything else. So much so, that I was lucky to have done whatever I wanted to right after campus.
Q: During your stints with brokerages through the early 90s, you had a start-up. Where did that impulse come from?
A: When I started off in research I happened to be in that bubble sector of the late 90s, which is software services, and I was covering all tech companies and it looked so easy to make money, I mean just do something else and export to US and then couple of my IIT batch mates had started this company in Hyderabad again which already had some contracts from US. So, I just thought let’s join and create another Infosys or whatever. It looked very easy to do that.
Q: You quit your brokerage job in Mumbai and went to Hyderabad to commence a startup.
A: Yes, and then when we started doing that business we realised that we are probably the 700th NASSCOM company. We then went into products just to differentiate ourselves. So, I was there for four years. Unfortunately, the company did not scale up all that fast. Then, I came back to investments because one of my friends Ashish Kacholia had started a portfolio management service (PMS). So, I joined him in 2004.
Q: While the dot com bubble had an influence on your life, you are one of the few people who had managed to sell a business to Lehman Brothers, others got sold by Lehman Brothers. But then they went through the unfortunate events of a decade ago. What was it like being part of this roller-coaster of the 2007-08 bubble going up and then seeing the other side?
A: Maybe it is my destiny. I was called the bubble analyst because I was in software in 2000 and in 2007, I was doing real estate. I have seen weird cycles. I was covering DLF, Unitech around that time. In that crash, I wanted to go back to the document management startup we had because that got a round of funding in 2007. So for one-and-half-year, I went back to that start-up.
Q: Remarkable. So, the startup continues to this day.
A: Yes. They are going pretty well.
Q: And you are still a shareholder.
Q: I had no idea about this entrepreneurial streak in Gunwani, but that leads me to the aspect of your career which has interested and fascinated me the most. You consistently had the desire and ability to spot turning points in the cycle whether they be around economic growth, interest rates or currency. Is this something you have consciously cultivated over time? How did this analytical ability to time cycles and position your portfolio accordingly come from?
A: First of all, you are being very kind. It is not easy to spot these turning points, but as I said my experience has been in fairly sharp cycles whether it is a tech boom of late 90s or the real estate boom of 2006-07. What’s important is to keep expanding your circle of competence. When I was with Ashish Kacholia, we were doing mid-caps, which were really small in 2004. At that point Marico, and Blue Dart were trading up 12-times PE and I remember discussing whether it is too much paying 10 or 12 times from Marico and Blue Dart.
Q: And this was 2004-05.
A: It was 2003-04. At that time the entire investment process had nothing to do with macro. I mean, we would read about inflation the next day in newspapers and probably not pay any attention to that. In 2008, I got interested in macro because there was no way you could have got the 2008 crash without macro. At the bottom, earnings growth was there 20 to 25 percent, you could say PE was high, but it was not obnoxious of 50 percent. It was 22 or 23 percent. If earnings remained at 26 percent, maybe that was not so bad. But then I did go through that whole process of understanding macro and then you read people like Howard Marks. Then you start appreciating the whole thing about cycles because you’ve seen industrials trade at 100 PE, trade at 10 PE, you have seen software services trade a 100 PE and go back to 12 PE.
Q: Given the emphasis that you placed on turning points, what are the two or three metrics that you would use to either time the sector or the macro cycle as a whole, two or three favourite metrics?
A: After doing whatever work I have done in micro, a good thumb rule for me has been that when you look at a country there are broadly only three output variables of the economy which matters which is current account deficit, inflation and growth. The first two, are actually checks on macro imbalances. It’s like the blood pressure and heart rate of the patient. Now what causes it? To my understanding it is very difficult to go deeper than that because the economy is such a complex black box that whether fiscal deficit is causing inflation, female labour participation is causing inflation, technology. So, I have really stopped bothering to much about that.
The point is if inflation and current account deficit (CAD) are under control then you look at growth as a capacity utilisation variable. So, if unemployment is very low you have to be very careful about investing. So, we were a bit contra on growth because things do tend to mean rewards.
Q: So, things like interest rates, capacity utilisation those are not as central to your diagnostics?
A: Those are three-four variables which come under that growth dimension. So, the first two are kind of filters. I mean if CAD and inflation are out of control just leave it.
Q: If you were to sort of just apply this framework — CAD, inflation and growth — is this what helped you figure out in late 2017 that small and midcaps the rally is overdone and there is going to be a rotation out or small and midcap because you are very emphatic. When I thought late 2017 that people are just going bonkers about small and midcaps. I was one of the people who was thinking like that and I saw your interviews and you were saying pretty emphatically that rotate away. What led you to make that very early call?
A: To be honest India was fairly stable on the macro side in 2017. I also have this theory about the dollar. Whenever the dollar goes down, emerging markets do well and India does well. And it did look to me that, obviously the valuations were frothy, but the dollar [index] had come from 103 to 88 and usually nothing falls in a straight line, so it seems like since Donald Trump’s victory, when dollar [index] was 103 at the end of 2016, in 2017-end it reached 88.
Now, a 12-14 percent kind of fall, in the reserve currency usually you would expect a pullback at some point. But I have this funda that you can do macro or whatever, but valuation is actually the starting point. Macros are not very easily predictable. So, if oil will go up $20 or go down $20, India’s macro will change. There is some empirical evidence to that as well that in stock markets the biggest correlation is to valuation and not to interest rates, GDP growth etc.
Q: When you talk about valuation, your favourite valuation matrix would be PE, PB?
A: I don’t think very simplistic structures work because obviously in a cyclical, PE will not work. Sometimes you have to do a profit pool analysis. One of our better investments in ICICI Prudential was in general insurance, and it was not like these companies were very cheap or very visible. But the point was if you just looked at any developed economy and see the size of the general insurance industry, you could figure out that these companies will become very big.
What was happening was due to some regulations on third party pool, initially all these companies were loss making, because the tariffs were there… Sometimes it is not just PE of one year forward, I think it is good to have a long-term profit pool analysis of that sector and if a company has X market share and then you see if that profit pool ten years later is Y, X percent of Y if it is big enough then you probably are fine paying a higher valuation figure.
Q: I remember S Naren telling me that one of the ways you got the 2007-08 cycle right was the market cap of DLF was more than the pharma sector in its entirety.
A: I was not there but yes.
Q: I think this profit pool and the market cap pool, you are giving us very interesting matrix to time a sector beyond PE, PB and the usual stuff. So, that brings me to another subject where you know you have sort of said something publicly which I found very intriguing. So, there was an interview last year you were saying that contrarian investing is as much about psychology as it about economics. Now. Unfortunately or fortunately, most rest of us as many books on economics and valuation and accounting but there are very few good books on investing psychology. How have you gone through your journey of getting you head around on the psychology of investing?
A: I have worked with S Naren. He is a great behavioural investing person. Clearly a lot of that learning came when I was in ICICI Prudential. Again, if you read authors like Howard S Marks, you can do linear investing — identify good companies at reasonable prices — and you can achieve a certain amount of excellence. But that good to great happens with catching these cycles, because clearly there will be a set of companies and you have read a lot about where you can just compound earnings, and you can be a bit disciplined about valuation, not overpaying for them and make decent returns. But clearly the exception about shorting tech in 2000, shorting Infra in 2007, buying FMCG, IT, pharma in early 2000 – for all this, you need a perspective on the cycle and as Charlie Munger said, multiple disciplines go into that as also macro.
Q: One of the less appreciated facts of Warren Buffett’s career, especially in his prime, has been his ability to get the cycle right. So, whenever you read Buffett’s career through the 60’s, loading up on American stock 67, at the height of the boom getting rid of them, 1973 - 74 with the market roughing out, picking up stocks, mid 80s picking up stocks and then that being the driver of his wealth. So, it’s just it is very hard to do this right.
A: Yeah, if you read about Buffett, he has played at the silver cycle. He has bought Goldman in 2009 which are not traditional GARP investing.
Q: If you look at Warren Buffett’s almost only successful financial services investments have been the ones that he has bought in stressed circumstances, Goldman being the most memorable one which in turn I suppose reminds us that those were buying Bank’s and NBFC’s at 4, 5, 6, 7, 8 times price to book today. Maybe they have got some other mental framework of investing which is not known to most of us. But let’s move on to the subject of influences. Clearly, Naren and Kacholia have been an influence... who else has sort of influenced the way you have seen the world and you have taught yourself this trait.
A: When I started my journey in the sell side, Ashish Kacholia was my boss in Prime Securities. Obviously I have worked with him as well so he has been very influential. He is more of the GARP kind of investor. I have a friend called Kaushik Shekhar for example whose vigour in accounting and thinking about business models, clearly has been a big influence for me.
Q: So, Naren has indoctrinated many of us over the years, the three gurus that one should look up to his Marks, Mauboussin and Montier are three M’s as he calls it. Are you too worshiping at their altar?
A: So, what has happened with this digital thing that reading gets more diffused. I have read Marks and [Michael] Mauboussin, I have a lot of respect. I think recently Viktor Shvets in Macquarie, his writing is very interesting, plus you have a lot of these strategists globally but it’s much more diffused. I don’t think I can remember one or two names who I intensely like or dislike.
Q: Any other suggestions as to your other sources of intellectual enlightenment that we can look forward to?
A: I think Credit Suisse’ Global Strategist Andrew Garthwaite. I think he is very interesting. I think Morgan Stanley the Economist team, their team is good as well.
Q: You have spoken repeatedly about how much you have invested in your own funds in your previous avatar. Is that something that came because you felt comfortable putting money in your funds or is that something you feel ideologically that a fund manager should really eat his or her own cooking.
A: At some point, it is good to have a fair percentage of your net worth in your own funds. I think at a seniority level I would like to see that. Now clearly when you are young and you have starting out and growing up the ranks that’s not so important because you obviously need to buy a house and all that. But if you follow people like Seth Klarman, almost their entire saving is in their own funds and that’s something that is good to see.
Q: Do you think that practice is as common in our country as it is in promoter driven shops in the West?
A: To be honest I don’t know. I haven’t seen the data.
Q: Because you are one of the few people I have heard who are very vocal on this subject and whilst a lot of the US endowment funds and pension funds insist that fund managers do it, I don’t think in the mutual fund community or in the Indian investor community.
A: I think our industry is still in a nascent stage. I think as people manage larger amounts of money and obviously you reach a point where your balance sheet is okay and I think incrementally your savings going to your own funds is a nice thing.
Q: Right. And then moving away from the world of investing. I heard from your colleagues that you are a keen sportsman who plays multiple sports.
A: You are being kind again.
Q: Some of your college mates have commented on your sporting prowess. So, from the world of sport or entertainment. Any role model or idol that you look up to?
A: I’m a jack of all trades, I play badminton, cricket, but somehow I don’t watch too much of sports. If you ask me my role model, they go back very long time when I used to watch a lot of sports. The likes of Steffi Graf whose poster was there in my hostel room.
Q: So, I think there is plenty of us who go back a long time. She really was a formidable sports woman and she married another formidable sportsman, but I suppose the enduring image that I have of Graf’s career is that the Grand Slam.
A: Yeah, the Golden Grand Slam.
Saurabh: Olympic gold and the Grand Slams, I don’t think that will be emulated. And it is remarkably rare because she got to do it once in that Olympic year. So, I hope you have an equally successful career.
Thank you very much for your words of wisdom today. That was very interesting.
That’s it from us today. That’s it from Manish Gunwani, CIO of Equity Assets at Reliance Mutual fund.Saurabh Mukherjea is the Founder of Marcellus Investment Managers and author of best sellers 'Gurus of Chaos' and 'Unusual Billionaires'.