The best investment decisions are taken during bubbles & bursts, said S Naren, CIO, ICICI Prudential AMC.
In a CNBC-TV18 special series ‘Unplugged’ Anuj Singhal caught up with S Naren, CIO, ICICI Prudential AMC to get his insight on the way forward for the Indian equity markets and the sectors where he sees value.
If you want to make big returns from the market, Naren said: “Normally you have to have some panic, and from those panic levels you can have big returns.”
Currently, we are in the phase of normal returns and so to expect abnormal returns at this point of time is not right because you need panic levels for that and you also need extremely cheap valuations. However, now you neither have panic nor do you have extremely cheap valuations, said Naren.
We are in the middle in the pendulum. The pendulum will go towards the positive side and at that point of time, we have to see what to do, but we are exactly in the middle, he added.
Talking about the non-banking financial space he said some of them seem to be overvalued at this point of time and maybe over the next three years the good quality NBFCs will get separated from the weak ones.
According to him, the best investment decisions are taken during bubbles and bursts; for example, during the 2007 bubble, they took a call that pharma was very attractive and infra stocks were costly but almost for a year pharma stocks underperformed infra stocks, but the house stuck to their investments. Going forward, between 2007 and 2012, pharma stocks gave huge returns for them.
Similarly, during bursts whatever small caps that were bought in 2008 second half, gave phenomenal returns in 2009.
Talking on the global fixed income market, he said it is in a bubble and due to global fixed income market being in a bubble anything which has certainty of cash flows in not cheap.
Therefore, even in India there are sectors like banking and infrastructure which over the next 2-3 years have to deliver returns because those are stocks that people are scared to buy since there is no guarantee of cash flows at this point of time.
So, “I would believe that cyclical sectors are the best opportunity on a 2-year basis, and one has to invest in them at this point of time, especially when people are doubtful of their earnings and on whether the capex cycle will take place etc., but that is the time when you can invest in these sectors.
Below is the verbatim transcript of S Naren interview to Anuj Singhal on CNBC-TV18.
Q: I just first want to know, I was looking at your background. You did your engineering from IIT Chennai and immediately after that you went to IIM and chose finance. What happened between your engineering and your MBA that you decided to go from mechanical engineering to investment as a profession?
A: I come from a traditional South Indian family. So, a traditional South Indian family back in their 80’s they were three career choices engineering, CA and medicine. When I did get engineering my father obviously told me you have to join IIT. However, when was in IIT it was very clear to me that engineering was not something what I wanted to do in my life.
Clearly I was always interested in finance so when I got the opportunity of getting MBA at Indian Institute of Management (IIM) Calcutta I just joined immediately. So, I am one of the person who has not actually done engineering although I have study at government expense for four years in a premier engineering college.
Q: Was your father okay with you then moving from engineering to investments, financial world?
A: Absolutely, he said that the moment you joined engineering I knew you have a safe career ahead. So, he said now you can do what you want. Now that you have got an engineering degree you can do what you want. He was always supportive of this.
Q: You started your career with some of the brokerages or financial services companies like Refco Sify Securities India. Tell about your transition from sell side to buy side?
A: I was running a stock broking firm in different way in between 1994 and 2000. In that phase very clearly I wanted to do buy side and I was very keen on doing a fund management job. However, when I came to Mumbai it was very clear that given my past track record it wasn’t possible for me to get a job with a buy side firm. So, I did do institutional research as a platform to getting a job as a fund manager.
Q: Let us talk about your key learning’s in financial market. We were just discussing this before the show how you recently met two of your guru’s. Relatively unknown names for a lot of our people, you want to tell about both these guys and what you learned from them?
A: I think 2008 was a clear, an event for me as fund manager. I had never seen a year like 2008 when I am managing other people’s money. Once 2008 happened it was very clear that we had to improve our theoretical foundations of what went wrong. Thanks to internet it is very clear you could look for gurus and there was a person called Howard Marks who has written, whatever he has written is free to read on his website called oaktreecapital.com and Michael Mauboussin at that point of time was in a buy side firm and he had also written a lot of books.
These people and there is a third person called James Montier who leaves in London these people actually helped to understand what was going wrong. So, in 2008 there was a very nice research report written by James Montier which showed that it was a bottom of the market. Despite it being bottom of the market I could not convince most people to invest in 2008.
So, that got me thinking and I said what we have to learn is from any negative event like 2008, we have to improve our theoretical foundations and work for it. That is how got me to Howard Marks, Michael Mauboussin and James Montier.
Q: I have a book of Howard Marks -The Most Important Thing Uncommon Sense for the Thoughtful Investor, have you read this book and what does this book tell you?
A: I read this book and as I said I got an opportunity to meet him last month one on one in New York. It basically argues that investing is common sense. However, it is not that simple because there is nothing called certainty in investing. So, in fact everything he writes he doesn’t use financial jargon. He talks about market has a pendulum; it is a pendulum which at some point of time can be at the middle and at some point of time it can go to an extreme optimistic situation and on the other hand the other side of the pendulum it can go to the extreme pessimistic situation.
See, he argues the market has a pendulum and you have to recognise where you are in that pendulum. He says if you recognise where you are in that pendulum you can take the right investing decisions.
Q: Where are we right now?
A: I think we are in the middle, when you meet people there is scepticism at the same time you know the markets are not as cheap as they were in 2008 or 2013 or 2002. So, clearly you are at the middle because the sentiment factor is in the middle. The valuation factor may be slightly on the optimistic side and the economic cycle is something which is going to improve significantly. If I put all these three factors valuation, sentiment and economic cycle I think we are right at the middle.
Q: In terms of valuations, we are probably now trading at levels we haven’t traded. We are trading at may be historically high valuations. Earnings while they have picked up, this quarter have disappointed. Do you get a sense that there could be some disappointment post the earnings season and there could be reversion to mean?
A: First look at financials, go one year back, the non performing loans (NPLs) all of us knew there were a lot of NPLs in infrastructure area, they have all come out and due to that earnings have got downgraded. In the last one year the markets have not given big returns particularly in largecap, why are people worried about earnings? It is because of three reasons, one reason is because you have a situation where most of the oil and other related areas the stocks have actually fallen, the prices have fallen and due to that earnings have actually fallen. Is it good for the country? It is very good for the country. Do we need to bother that oil is at USD 45 per barrel and due to that earnings are lower in a set of companies? Certainly we shouldn't bother.
Secondly due to NPLs a lot of bank earnings have come down. Is it better now and safer now than one year back? Certainly because the earnings de-growth has already happened.
Third is you had two bad monsoons and on the other hand you have a phenomenal monsoon this year. So, these three factors are actually showing up in these earnings and there is worry about valuations. I don't worry but having said that, are we dirt cheap valuations? Certainly not. We are certainly not that cheap but at the same time from an economic cycle point of view clearly we have a few years where things can be better.
Q: Since you spoke about financials - NBFCs have had a remarkable run, something like a Bajaj Finance. You could argue that the return on equity has been too strong and they continue to grow their book every 20-25 percent every year or you could say that things have got too overheated, in which camp would you be purely for the NBFC names?
A: If you look at the benchmark, the benchmark has such a high weightage in financials and a number of people don't want to invest in certain financials. So, they go and choose some other stocks in the same sector. So, you could have some over valued NBFCs at this point of time which is clearly the case at this point of time.
However over the next three years I think the good quality NBFCs will separate from the weaker quality NBFCs. Finance is one of the areas where today's mistake shows up in financials three years later. In the first year you actually get net interest margin, in the third year or in the sixth year you get NPLs.
Q: You have been a contra investor in the past. I remember you had bought Sun Pharma or couple of pharma stocks when real estate was at its peak and you turned underweight on some of the pharma names when some of these stocks hit record highs. What goes behind this process of being a contra investor because contra calls can go horribly wrong?
A: Seth Klarman the investment guru says, you have to be a contrarian but you should have a calculator and that is what I believe in. You look at contrarian opportunities, contrarian doesn't mean buying every stock in the market. You try to assess what the outlook is, what the companies are doing and then you look at it. So, essentially when you are managing large sums of money there is not much of a choice but for you to be partially contrarian.
If you look at Warren Buffett, when did he invest? He invested large sums of money between 2008 and 2011, that was clearly the best period because that was a contrarian period. In 2007 did you hear him making big acquisitions? The answer is no.
I would say that as the sums of money that we manage become larger we have to be contrarian in our approach. Having said that we can be contrarian in our approach but we have to do the right work, it doesn't mean you go and buy a junk infrastructure stock. So, that is something we have to do as a continuous process and that is what we do.
Q: Contra thinking does not work always. You have to arrive at a particular time where you go contra?
A: You have to do research on the sector where you are going contrarian. If you are not willing to do enough research on the stock that you are buying as a contrarian buyer or on the company and the sector then you will go horribly wrong.
Q: What is the contra call right now?
A: Right now as I said we are in the middle in terms of everything. There are no super strong contrarian calls but when I meet people, I tell them this is not a market top, it could be if you ask me but global fixed income looks like a contrarian opportunity to exit. If you have 40 year Swiss bonds yielding you negative returns, I think that is one area where the pendulum has become excessively optimistic. The recent quote that most global investors tell us, today you buy equities for yield and you buy fixed income for appreciation. When a quote like this comes you have to worry about that pendulum. I think the pendulum in India is exactly in the middle whereas the pendulum in the global fixed income clearly seems to suggest that, that is one area where you have to be very careful.
Q: In stock market we keep talking about the Gujarati market cult. However, I believe there is a nice Chennai cult as well which you are part of and you have a nice group in Chennai called Chennai Angles if I am getting it right?
A: We don’t have a formal group; we used to call ourselves the investor group. I think 1994 to 1997 was a fairly big bull market followed by a big bear market. I have noticed once you have a big bull market and a big bear market you have a lot of losses. Once you have a lot of losses there is a lot of understanding you have to do to know why you lost money. So, I think the group got formed by the bull market of 1994 and the subsequent bear market. It helped, what I believe is investing is a psychological kind of subject. So, if different people have gone through the same experience of making money and losing money you tend to get into a situation where you need psychological support.
Group helps you to actually share your thoughts and that led to a situation where finally to make money in investing you need an investment process. If you have a group and you are able to sit with different people’s strengths and different people’s weaknesses you actually get that process.
Like even in my investing team I have different people with different investing styles in ICICI Prudential Mutual Fund. By having different styles and different strengths it helps to create a good investment process.
Q: How often do you meet?
A: The group meets every two weeks on a Saturday afternoon. I get to meet them now once a year and otherwise some of them have a conversation with me and tell them what is going on in the group. However, otherwise on an average I get to meet them once a year.
Q: Any interesting titbit or anything that you can share with us from that group?
A: If you look at it the group’s first success was in handling the tech boom of 1999-2000 and by avoiding stocks in those days which were very favoured like Himachal Futuristic Communication, Global, Silverline Technologies etc so, in that particular bull face we avoided looking at these stocks.
Q: We spoke about Howard Marks and his books, any other book that has inspired you that you would recommend young investors to read?
A: Clearly, if you look at how Peter Lynch his books are concerned I think that is the easiest way. Because what he says you go to a super market you look at what is happening in the super market you go and see what is happening around you, he said you will know where growth is increasing and where actually deceleration is happening. That is easy for a common investor to do because it is not connected to numbers or complex balance sheet analysis or something like that.
I would actually recommend Peter Lynch books for investors who are entering investing because this is a book which says think based on what you see around you and it is very easy for any person to know what is happening. Everyone knows online is peaking up, everyone knows that if you are in a travel agent business it was going down.
So, these kinds of trends are very easy for you see. You know tablets are peaking up, you know landline is going down. So, these are things, you know that mobile is peaking up, so all these kinds of trends come through by just thinking of what is happening around you. So, I recommend Peter Lynch book Beating The Street and One Up On Wall Street.
Q: You manage so many funds, you are the CIO of course, what is the best thing that you enjoy about running a fund and what are the qualities required to run a fund?
A: More than the qualities required, what makes me come to office as I keep telling my CEO is that you have the advantage of being able to manage other people's money from Kashmir to Kanyakumari, from Dwarka to Guwahati, so you get to manage money of a wide variety of other people. If you are able to give them a good investor experience which is what we have tried to do particularly through our dynamic asset allocation products, it gives you a very good feeling because when you meet people you know that you have helped them to achieve their life objectives when they have invested in the mutual fund. So, that certainly keeps you very happy.
If you are asking me what are the requirements of a good fund manager, I think he has to have a good temperament, he or she has to have a good temperament. In the initial years you have to be willing to work very hard to understand much more about many companies and if these two are there I think managing money is simpler than what it appears at this point of time.
Q: I was talking to Nilesh Shah and he gave me some interesting anecdotes about how he made couple of investments and how he made couple of exits. You have any interesting anecdotes to share in terms of any interesting investment decisions that you made?
A: There have been many but what I believe is that the nest investment decisions are things which you take in bubbles and busts. In bubbles for example we took a call in 2007 that pharma was very attractive and infrastructure stocks were costly. For almost a year pharmaceutical stocks had underperformed infrastructure stocks but we stuck to our guns. However between 2007 and 2012 we got huge returns in the pharma stocks that we bought.
Similarly in the bust you tried your best to collect but whatever smallcaps you bought in 2008 second half all the way to the elections, the kind of returns that they gave in 2009 was phenomenal. So, the most interesting opportunities come in bubbles and busts. It is not easy because in 2007 to buy pharma was not easy. In 2012-2013 I got a chance to recommend investing in international schemes to a number of people. At that point of time people said how can you make money in international schemes? However if you look at the kind of returns that a market like US gave between 2012 and now, it has been phenomenal.
Q: How do you distress, fund manager is a stressful job, specially you are managing both equities and debt. What is your key mantra to de-stressing yourself?
A: My son has a rare genetic disorder called Fragile X. So, I distress by understanding more about the brain, more about the disorder that he has. What type of treatment can be done for him, what kind of things will help him to be better. You will be surprised that these are areas. So, this is how I distress myself. I found that brain despite all the developments we have seen, treatment for brain related problems haven’t happened. I have seen lot of other people who have autism, they are also going through the same process. I find that very fascinating because it is an area where lot of work is required and we have not been able to find a cure to Alzheimer's, we have not been able to find a cure to Parkinson's, we have not been able to find a cure to Fragile X or even Autism. I attended a medical conference in San Antonio on this disorder, so it is an area which I look at and I find it interesting.
Q: In fact I have been told it is your dream to someday help in getting some kind of solution to this problem?
A: I am not a scientist but this is an area where if things improve I think a lot of people will have success. If you look at it the extent of Autism for example in America is almost 1 percent. The Fragile X syndrome is very similar to autism. So, if you look at the combination of Autism and Alzheimer's and Parkinson's, I think a large number of people are affected. I hope the American scientists and scientists across the world find a cure for such disorders.
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