Our approach is to find the next Titan, sustainable growth is important: Sundaram Alternate Assets

Vikaas M Sachdeva, Managing Director, Sundaram Alternate Assets

The Chennai-headquartered Sundaram Alternate Assets manages assets of around Rs 4,200 crore across PMS (portfolio management service) schemes, and Category –II and III AIFs (alternative investment funds). Its products include a PMS scheme focused on small and mid-cap stocks and AIFs that extend credit to emerging corporates and real estate companies largely based in South India.

In an interview with Moneycontrol, Vikaas M Sachdeva, Managing Director, and Madanagopal Ramu, Fund Manager and Head – Equity, Sundaram Alternate Assets, talk about their views on small and mid-cap stocks, and why their 5-year PMS returns lag that of mutual fund returns, among other things.

Edited excerpts.

What's your view on small and mid-cap stocks? What is looking attractive in this space and what's not?

Madanagopal Ramu: If you want to play the India growth story over the next 5-10 years, there is a lot of opportunity only in mid and small caps. The best way for a fund manager to create alpha is to invest where the next leg of growth is happening. A lot of this is happening outside the large-cap space. And, there are growth concerns across various segments of the large-cap index.

We have a 40 percent-50 percent allocation to large caps in all our portfolios. But another 50 percent to 60 percent allocation is to mid and small-cap stocks, which is how we think we can create a consistently compounding portfolio for investors. By only sticking to large caps, can we create a compounding effect for the investors purely from an earnings point of view? I think those opportunities are fairly limited. If you look at the mid and small-cap indices, you need filtration. Out of the universe of 200 -300 mid and small-cap stocks, our universe is 50 stocks and of these, we end up investing in 15-20 stocks.

Right now, based on valuations, the mid and small-cap index looks a bit stretched from a short-term perspective. Two to three months down the line, we'll have a lot more opportunities.

You can see some opportunities emerging in areas such as consumer discretionary and QSR (quick service restaurant). The QSR companies have delivered good results despite high inflation but the stocks have not gone anywhere or have corrected by 20 percent. With this correction and earnings growth of 15-20 percent, you are getting them at a 40-50 percent discount from the peak.

In manufacturing, valuations were very high last year, and correction is already happening in specific pockets. Auto-related stocks have corrected because of some slowdown, and private equity exits. We are seeing value in auto ancillaries, though not in all companies.

Last year was a period of war leading to supply shocks, resulting in high inflation and subsequently high-interest rates. So it was an easy strategy to just go and play dividend yield and defensive stocks. But these stocks turned out to be the greatest underperformers in the last 5 to 10-year period. As we move into 2023, in the second half, inflation will start cooling off because all commodity prices have gone down. And when interest rates go down, the market cycle will shift towards growth and value, not defensive stocks.

Both your PMS schemes – Sundaram India Secular Opportunities Portfolio (concentrated multi-cap portfolio) and Sundaram Emerging Leadership Fund (invests in small and mid-cap stocks) have given returns close to or lower than many flexi, small and mid-cap mutual fund schemes, respectively. Why invest in your schemes then?

Madanagopal Ramu: We are at a period where we have seen many passive funds do well. Why? Because post-Covid, a large amount of money came in. When globally liquidity increases, it chases mid and small-caps and does not differentiate between quality companies and not-so-good companies.

Actually, it chases low PE stocks, even if there are temporarily better returns to be made. Many companies benefitted from Covid-related supply shocks. So the number of mid-cap and small-cap companies that did well expanded tremendously, and that lifted the returns of diversified stock portfolios.

If you had checked the returns, say one or two years back, you would have got a very different answer. So today in terms of 5-year returns, there will be a difference, because we have fallen this year. Over a 10-year period, we will be among the first quartile.

Mutual funds got this tailwind of large flows that helped their diversified portfolios do well. You give it another two to three years and you will see very different five-year returns. It happened in 2017 when PMSs were in question. In 2018, 2019, and 2020 PMSs stood out – our portfolios beat the benchmark, and we used to be in the first quartile.

Last year, our performance came down. People wanted to play more defensive stocks, so people exited growth stocks. That phase will change. And as growth comes back, our returns will pick up momentum.

Our approach is to find the next Titan, which has given you a return in five years. Obviously last year, the ITC stock doubled. Now looking at last year, we might look like we have not delivered returns. Now ITC looks like a great story. But it is only short term. In our opinion, sustainable growth is important.

Given so much uncertainty at the global level, investors are seeking safety. Are you expecting a reduction in investor inflows?

Vikaas Sachdeva: This (those investing in PMSs and AIFs) investor segment is very savvy. They understand the virtues of flows coming in when times are bad. So we've seen consistent flows.

Having said that, people do get affected by sentiment and some of them might want to pull out money. And also, when the markets are down, you will suddenly see opportunities elsewhere, in debt, real estate, and in equity, which is the most liquid. So those reductions (in inflows) will keep happening. But by and large, incrementally we are getting more people than those leaving. This is private capital, and people will stay.

With SEBI proposing tighter regulations for AIFs, do you feel this space is getting more difficult to operate in?

Vikaas Sachdeva: I think what SEBI is trying to say is whatever you are communicating, communicate it in a format, whatever you're selling, sell with checks and balances. Now, there are some things that you may like or may not like as an industry. We are a very young industry – alternatives are just about 10 years old. The first 10-year product is just getting redeemed. So at times, one does feel it's a little excessive for an industry that is not even a teenager. But this is part and parcel of the game. The sheer amount of innovation that SEBI is allowing in terms of AIFs is phenomenal. The next big idea will more likely than not be in the AIF space because it has a flexible structure.

Will stricter rules on distribution commissions impact the business?

Vikaas Sachdeva: It’s too early to tell. I think businesses grow because of two things – one is pushing and the other is customer demand. When it happened in mutual funds, I think it coincided with this whole ‘mutual funds sahi hai’ campaign, which is when demand exploded.

You find a bottle of Bisleri even in places where you don't find drinking water. That is because there's a distribution push and somebody's making money. So it's not bad to do that, mis-selling is the issue, which I think has been more or less covered by a variety of other regulations.

AIFs are definitely a very complex product. So you need distribution but whether the commission should be paid upfront or over a period of time, the jury is out there. If you ask us as an industry, we will always believe that you let us decide.

And to say that upfront commissions will lead to mis-selling in the context of AIFs may not necessarily be true here because this is a sophisticated product. You will always have exceptions. But an exception cannot make a rule.