MC Exclusive: SBI MF CIO R Srinivasan says illiquidity could command premium; negative on stocks down the Mcap curve

You are being cryptic. Please explain why you are not worried when you look the worst on an important risk parameter.

We’ve always been cognisant of liquidity issues and there is no reason to be worried. There are two aspects to liquidity: the asset side, thinking through the prism of the portfolio, and the liability side, which is the kind of investors we have and the likelihood of redemptions in case markets turn bad.

Our liability profile is highly distributed. The top 10 investors own just 0.61 percent of the fund. This is very important because this forms the basis to assess the extent and probability of redemption we could potentially face.

But let me get to the asset side because that is what everyone is worried about. We think and manage liquidity at a portfolio level and not based on individual stocks – this is not captured in the way AMFI has designed disclosures. AMFI calculations assume pro rata selling down of portfolio assuming a certain market participation and trading volumes. Which is by and large a theoretical exercise.

If redemption is tackled based on available liquidity, meaning I use the cash first, then unwind my index futures and then the liquid component like some of the large-cap stocks and so on, 25 percent of our Smallcap fund’s redemption can be met in four days flat as against the AMFI formula-based reported number of 30 days.

50 percent of the portfolio can be redeemed in 17 days as against the reported 60 days. And mind you, 25 percent is a large number. The AMFI disclosure also does not capture the liquidity gradient between a 0 to 25 percent redemption which is the more likely redemption scenario.

Also Read | MF stress test: Check whether your smallcap fund has these illiquid stocks

That number sounds better. But Sebi’s concern with the kind of methodology you are suggesting is that existing investors will be saddled with junk stocks if the liquid part of the portfolio is disposed of first.

I am sure they have their reasons. But it depends on whose lens you are viewing this from. I don’t see the illiquid part of my portfolio as junk – far from it. Ironically, illiquidity has been commanding a premium over the last many years which seems irrational but makes sense when there are more buyers than sellers. Also, liquidity may be low not necessarily because there are no buyers but because there are no sellers.

High-quality stocks in small-caps are hard to find, especially in big blocks. Today, if we were to sell some of our holdings, investors, for all you know, might line up to buy and even pay a premium. I would do the same for many stocks I am eyeing. Right now, one of our key challenges is that we are unable to find good-quality businesses at reasonable valuations because of liquidity constraints. When we get them, we like to lap them up.

But we are not talking about normal circumstances. We are talking about a stressed environment when market falls and everyone wants out…

If you look at past market cycles, you will realise that quality holds value better in a falling market. It’s only rational to assume that price elasticity for a higher-quality business and management will be lower. Besides, the markets work on a constant feedback loop, meaning liquidity increases when the price falls especially if the relative fall in price is not related to fundamentals.

Sebi’s concern about having adequate liquidity to meet redemptions is legitimate. We’ve always been prepared for it. But remember, price risk in equities is inherent to the asset class and investors need to contend with this. If everything falls and there is generally fear on the Street, prices will fall, you can’t help that.

What is the probability of large scale redemptions in your fund?

Never ask a barber if you need a hair cut!

We don’t have detailed liability data, so no option but to ask...

Very low, I would say. To be fair, our Smallcap fund has been closed to one-time inflows since 2017. We opened for a small window of Rs 1,000 crore when the market fell into COVID and then closed it again. We are probably the only fund where all existing investors are happy.

Coming to SIPs, it is restricted to just Rs 25,000 per PAN. Our registered SIP book for the fund is Rs 691 crore spread across 2.7 million investors which implies an average of just about Rs 2500 per SIP. Do you really think these small investors will all redeem at one go when the market falls? I’d say they’ll probably increase their SIP ticket size.

These are real retail investors who are saving every month for the long term. Redemptions can happen and will happen, just unlikely it will happen at a large scale in a few days.

It’s not the first time we are seeing a fall in smallcaps. AMFI data shows that the worst net redemption in the worst small-cap fund across the sector was less than 2 percent monthly cumulative in the last 10 years. Note, monthly cumulative!

Also Read | Stress Test results of top 10 smallcap mutual funds

Are you saying this whole stress test exercise is futile?

Not at all. Given the noise around this, I’m glad we are doing it. We should’ve done this way before. Investors need to be aware of the risks however improbable they may be. These are, after all, known black swans.

But in the end, it is about what you are looking to optimise. There is a golden mean or a desirable middle across most things: growth v/s inflation, active v/s passive, concentration v/s diversification and the like. In this case, it’s about liquidity risk v/s potential returns which the investor needs to decide on.

Sebi has been using the term ‘froth’. Do you think we are in overheated markets? Do you think a major price disruption is waiting to happen?

Hard to say. Market timing is tricky. We do run an asset allocation strategy which is presently underweight equities on account of valuations. This model works on large-caps. Relatively, we are more negative down the capitalisation curve.

You have a great performance track record but performance over the past year is lagging behind peers and the category average. What’s going wrong?

We go through our phases of underperformance. It is tough to perform consistently like on a yearly basis over the benchmark when you are running a high active share and targeting absolute-type returns.

Our conservative philosophy also makes it tough to outperform a highly buoyant market. I’m confident we’ll come back sharply as valuations normalise.

I don’t think there’s anything wrong with our philosophy or with the portfolio picks. It is, however, pertinent to note that our past performance has been on a smaller size and it is wrong to extrapolate similar returns on larger AUMs.

Are you revisiting any part of your investment approach given the recent underperformance? Do the liquidity disclosure norms in any way impact the way you construct your portfolio going forward?

No, nothing changes. But a few things I would add.

Firstly, liquidity is a matter of fact and is what it is. It needs to be considered in conjunction with other parameters such as the liability profile, portfolio-wide liquidity, the likelihood of stress, the extent of the stress, stock price elasticity, valuation attractiveness if the fall is due to technical factors not related to fundamentals, etc.

Two, we are small-cap in the spirit of the category, our weighted average market cap is just about Rs 12,000 cr (excluding cash and Nifty futures), far lower than the small-cap cut-off. Last but not least, we have and continue to discourage inflows into the fund except for small ticket SIPs.

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