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Business News›Mutual Funds›Analysis›Focused strategy is not as risky as it seems, says R Srinivasan of SBI Mutual Fund
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“As a fund house, our stock selection process depends on quality and growth. As much as possible! As a style, ‘quality and growth’, I think, often over weak markets.”
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ETMutualFunds.com recently came out with a list of fund managers who have made big fortunes for investors over the past five years. Read this story here: These mutual fund managers have generated the highest returns for investors in the last 5 years.
R Srinivasan, Head of Equity, SBI Mutual Fund, is one of the leading fund managers who have created huge wealth for investors in the last five years. SBI Small Cap Fund and SBI Focused Equity Fund, two flagship schemes of the fund house, are managed by him and both the schemes have performed well in their respective categories. SBI Small Cap Fund is at the top with a return of 17.24% in the last five years. Srinivasan shares his strategy in an interview with Avneet Kaur of ETMutualFunds.com.
SBI Small Cap Fund has been a consistent performer in the small cap sector. The scheme has significantly outperformed its benchmark and category four over the past five years. This scheme is at the top in the last five years with a return of 17.24%. How do you know this? As a fund house, our stock selection process is biased towards quality and growth. As much as possible! As a style, “quality and growth”, I think, tends to overcome weak markets. Perhaps, that partly explains why we have exceeded the benchmark in recent years. The lack of opinions, especially those with high conviction, also led us to be more careful. It should also have helped me overcome a very low standard. Before that, we had a size advantage and few stock options like Grafite, for example.
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SBI Focused Equity Fund, another managed fund, has also outperformed its index four times in the last five years. What is the secret? The reasons are very similar to what we talked about in small caps. At Focus, we manage a fund portfolio that aims for total return (long term only) and is largely benchmark agnostic. Due to the liquidity limitations and the lack of ideas to believe, we tend towards quality and growth and this style, I think we have done very well. We also have a strong investment philosophy. It is buying a good business managed by excellent people at an attractive price. It may sound cliche, but it works.
It must be qualified here if the portfolio is not built for a short period of time (say, less than 3 years) to match the absolute or relative performance.
Small businesses are unknown and very little information and data is available about them. Since, your choice of small companies paid well in this scheme, can you please share your investment strategy? As mentioned above, our stock selection is very simple – buy a good business, managed by excellent people at an attractive price. In other words, we are looking for three characteristics – a good business, great management and an attractive price (reasonable learning). A good business is something that has a competitive advantage or economic pitfall. Second, it must or should be able to generate a reasonably high return on capital. Third, it must be paid. The ability to generate high returns on capital and at the same time grow at a fast pace. Fourth, financial strength is low. Fifth, high turnover. Sixth, the power of prices. Seven, long-term or low risk of business disruption.
Directors can be admired for integrity, energy and vision through their history; We seek transparency, accountability and clarity of thought in our interactions and analysis. A good price is something that gives you a margin of safety. This is not only in terms of PE ratio and book value, but also in terms of the sustainability of the business model and previous mergers. We try to think of these not in black and white, but in different shades of gray. You will never find the perfect situation; it’s about weighing the different variables for their depth or proximity to where you want to be and choosing the best combination.
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As you have been managing SBI Small Cap Fund for a long time, what is the most definite thing on your ‘don’t do’ list while managing these plans? Typically, stocks or companies that have corporate governance issues or that do not pass our court filters, stay out. In addition, due to its abundance, the number of small businesses is not proven and little developed, so we need to be careful. We do not have a negative inventory concept, but our emphasis on high return on capital, growth and responsible management automatically eliminates low quality. The fact that we don’t focus too much on errors of omission and spend more time on business quality issues also narrows the universe significantly.
SBI Small Cap Fund has managed the downturn well while generating the best returns in the sector. How do you manage the risk involved? We have made no effort to reduce risk or volatility in the portfolio. In fact, we don’t even think about volatility risk. The risk, for us, is the risk of being wrong with our thesis and in this context, our insistence on a consistent standard has probably helped.
How is managing a mutual fund different from managing a general equity fund? Is it a challenge to do with a limited amount of stock?
If it weren’t for liquidity constraints, I would manage all the cards as concentrated portfolios. It is a myth, an Indian myth rather, that a intake of 20-30 is restrictive or concentrated or harmful. Diversify Google portfolios and you will find plenty of evidence showing risk removal beyond 15 stocks. So no, it’s not a problem. However, the humidity is the same. Our markets are very illiquid beyond a few top stocks and that makes it very difficult to drive the bottom line of possible decisions.
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Since these two plans offer high returns, these plans tend to attract new investors. What do you want to say to new investors?
Mutual fund investments are subject to market risk. Past performance is not indicative of future results. As a fund house, we believe that generating consistent returns is more important than generating high returns because long-term returns are always better than volatile short-term returns. Investors should choose funds according to their objectives and time frame before investing.
These two funds will fall into the high risk, high return bracket. A small plan is clearly smaller than a concentrated one and is therefore designed for investors who are comfortable with flexibility and do not need to say that they have a long-term perspective (read 5-7 years).
Focus, surprisingly, is not as risky as it seems. I mean there are significant quality risks to active allocation, but because the portfolio is biased toward quality and growth, you should be more concerned about portfolio underperformance during strong capital markets than otherwise. I want to ask my father to invest in it.
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The BSE Mid cap index rose 10% and the small cap jumped around 8% in the last two months after losing 27% and 38% respectively between January 2018 and August 2019, do you believe this rally will continue?
I hope so, but you can’t look at these things while investing and focus only on things that can be managed like the companies / companies that we are looking to invest in or are invested in.
This interview is part of a series of interviews with leading equity fund managers over the past five years.
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