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Surviving the bear run: down but not out

Surviving the bear run: down but not out
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First Published: Tue, Nov 04 2008. 12 30 AM IST

Updated: Wed, Nov 05 2008. 01 04 PM IST
Mumbai: In 11 of the 13 years between 1977 and 1990, Peter Lynch, then manager of Fidelity Magellan Fund, beat the S&P 500 Index benchmark, offering an average annual return of 29%. That made the rather obscure fund grow from $18 million (Rs88.2 crore today) when Lynch took over to $14 billion by the time he retired from active management.
Bill Miller, who managed Legg Mason Value Trust, is another iconic fund manager. He beat the market for 15 consecutive years, till his run came to an end in 2006.
“Of course, anyone can get lucky for a short period of time. But consistent outperformance over long periods is probably evidence of skill. Otherwise, what would skill be?” asked Miller in a July 2007 interview to ‘Money’ magazine’s Jason Zweig.
As the assets of the Indian mutual fund industry crossed Rs5 trillion, riding on a stock market that went up for five years in a row, a bunch of fund mangers gained the status of rock stars. At least five of them not only generated phenomenal returns in some of the funds they managed—in some instances generating as much as 150% annual returns—but also consistently beat the benchmark index, the Bombay Stock Exchange’s Sensex, during the bull run.
Also See Rock Stars of Bourses (PDF)
Mint reached out to the five fund managers to hear their outlook when the market is in a firm bear grip. Three of them agreed, the other two declined to talk.
We have tracked the performance of these five, across the fund houses they worked, and asked them how they are coping with the current bear market.
Mint’s analysis makes use of data provided by Icra Online Ltd, the information services and technology solutions arm of rating agency Icra Ltd, and calculates the average returns for these managers in equity diversified funds, a category which calls for maximum skill and expertise, given the huge universe of stocks to pick from.
We have calculated their returns for four years, between January 2004 and December 2007, at the height of the bull run. During this period, the Sensex gained 247.44%, and all five managers beat the index.
Now, they are down but not out. A Rs10,000 notional investment in January 2004, which we have used as an example in the graphic, still increases to at least Rs16,014 if it had been managed by any of them. Even the best of fund managers face the heat in a bear market, as they have in the past 10 months, when stocks across the world have lost substantially in a crisis that began with borrowers with a poor credit history defaulting on home loans in the US.
Indian investors have lost Rs43.86 trillion since January. Foreign institutional investors, or FIIs, the main driver of the Indian market, have pulled out $12.78 billion from Indian equities so far this year, after pumping in $17.36 billion in 2007. Brokerages say they have not seen the end of FII sales yet.
To be sure, all fund managers admit it’s difficult to manage funds in a market that’s turned on its head in such a short while.
“As someone who is bullish at heart, it is a very difficult task,” says Sandip Sabaharwal, chief investment officer (equity), JM Financial Asset Management Pvt. Ltd.
All of them, however, advise investors to stay invested as they believe that in the long run, higher returns are a given.
“The time to panic has gone,” says Madhusudan Kela, head of equity investments at Reliance Capital Asset Management Ltd, the largest asset management firm, managing Rs86,494 crore worth of assets as at the end of September.
There are, however, those in the industry who do not believe in the star culture. Saurabh Nanavati, CEO of Religare Aegon Asset Management Co. Ltd, a new fund that is launching its schemes, is one of them. According to him, systems and processes are more important for the fund house, than an individual. But this in no way diminishes the status of successful fund managers, even in a bear market.
How we arrived at these figures
We assumed that Rs10,000 was invested as the initial amount, equally spread across different funds managed by these fund managers. So, if one was managing two funds, Rs5,000 was allocated to each of the funds and so on.
When the fund manager moved from one fund to another, the corpus—the value of the investment at that time—was withdrawn and re-invested in the new funds he managed. These figures were not adjusted for exit or entry loads.
Each time a new fund was introduced during a fund manager’s tenure, money was withdrawn from existing funds and invested in the new fund. For instance, a manager was managing only one fund on 1 January, 2004, in which Rs10,000 was invested. If this amount had grown to Rs12,000 by 30 June, 2005, when a new fund was introduced on 1 July, 2005, the Rs12,000 kitty was invested equally in two funds—Rs6,000 each.
Some of these funds were directly managed by these managers while they oversaw the performance of others in their roles as head of equity or chief investment officer. Therefore, these numbers may not be strictly comparable.
Sandip Sabharwal was not managing any fund for a year between November 2005 and November 2006. His numbers for the missing year were adjusted by taking annualized figures.
Source: Icra Online, Mint Research
Top fund managers say it’s time to be greedy for good returns
In the bull market, some of your funds were top performers. But in a bear market, many of them are underperforming the market. Why?
SANJAY SINHA: Only those funds which have a mid-cap or small-cap bias are underperforming the peers. This set is made up of close to 200 diversified equity funds which follow multiple investment strategies. The lacklustre performance of mid-cap funds is in line with the performance of the index. Year to date, the Sensex has fallen by 53% while the BSE Mid-Cap Index has corrected by 66% and the BSE Small-Cap Index by 70%.
MADHUSUDAN KELA: Our funds are some of the best performing in the peer group. Reliance Growth Fund needs to be compared with other mid-cap funds, and Reliance Vision Fund with other large-cap funds. If you do that, you’ll see that most of our funds are in the Top 25.
SANDIP SABHARWAL: I had turned very bearish on the markets last year in October-November. At that time, we had increased the cash allocation in our funds to over 20%. However, the Indian markets continued to rally even as most other markets were correcting. By January 2008, we took a call that the markets will rally a bit more before correcting and deployed our cash in the markets. Just after that, the markets started correcting sharply.
Besides, most of our funds had a reasonable mix of mid-cap stocks, which corrected much more sharply during the initial phase of the market fall.
Frankly, I had expected a 30% kind of fall from the top, and not the 60% that we have actually seen.
As a strategy, nine months ago, we shifted our portfolio to companies with strong cash flows and those that do not need to raise capital in the immediate future for their growth. The companies in our portfolios are still growing strongly and we believe will outperform the markets as the situation stabilizes.
How difficult is it to be a fund manager in a bear cycle?
SANJAY SINHA: As difficult as it is during the bull phase. If you have committed excesses during the bull phase, you have to pay during a bearish cycle. One of the key elements during the bearish phase is to avoid the general condition of the market to predominantly influence your psychology or strategy. The cornerstone of good fund management is discipline, which is something you have to maintain during this phase also. Another important element is managing investor expectations and for this, you need to communicate to them in an effective manner. This also is quite a challenge.
MADHUSUDAN KELA: When the markets are going down like this, it sure is difficult. But for me, this is part of a cycle. There was a bull market, and that didn’t last forever. Similarly, this is a bear market that will hopefully not last. As a fund manager, you have to condition your mind in such a way as to be able to deal with both cycles.
SANDIP SABHARWAL: As someone who is bullish at heart, it’s a very difficult task. Specifically, when the derating of stocks is largely due to factors that might not be fundamentally linked to the performance of specific companies or the domestic economy.
Every bear cycle is unique in its own way. For example, in past bear markets in India, we had not seen the markets fall more than 25-30% in any one calendar year. However this year, we have seen a fall of 60% already. The decline in values is unprecedented—something we might not see for a long time to come. I would say that if we had stuck to our view of the markets entering into a euphoric and bubble phase late last year, we would have handled the fall much better than what’s happened now.
What’s your strategy to tackle the bear onslaught?
SANJAY SINHA: I am relatively new to DBS Cholamandalam. When I joined here, the market had already dipped quite a lot. In the last few days, we have identified stocks and sectors which are bleeding our performance and have already started pruning the portfolios. The results will be visible after some time. In my previous organization (SBI Funds Management), we had raised cash levels and reduced the exposure to metals and real estate.
We will have to adopt a twin strategy. We need to concentrate the portfolio in those sectors which are less susceptible to global recession. Secondly, we need to communicate that great wealth is created once we come out from a bearish phase. Therefore, trying to time the market bottom may not be as rewarding as a strategic allocation to equity even at current levels.
MADHUSUDAN KELA: We have created disproportionate amounts of cash in the last six months. Today, Rs5,000 crore of our equity assets are held in cash. As soon as we get a sense that sanity has come back to the world market, we will start investing aggressively. Our investment philosophy remains the same in that we will continue investing into high-growth companies. I believe that India is all about growth.
SANDIP SABHARWAL: We have tried to improve the liquidity of our funds so that stock reshuffles and redemptions, if any, can be handled easily. We are in the final stages of capitulation in the markets and the panic levels have reached unprecedented levels. An analysis of previous such panics show that from the panic bottoms formed, the next two years typically give strong returns for those who stay back. As such, we are not inclined to increase our cash levels at this stage and would like to revisit the cash strategy only subsequent to a significant pullback that will follow the panic bottom formation.
However, the economy is likely to face a tough time over the next six months and we propose to be vigilant in analysing our portfolio companies and reacting to the evolving situations more proactively.
What is your outlook on markets?
SANJAY SINHA: In percentage terms, the fall is in line with what we saw in 1992 and 2001 when we witnessed a scam in the market. I call these episodes as accidents. This time around also the market has met with an accident. The only difference is that the root of the accident is global and not local like the last two occasions.
The market is ignoring a lot of positives. For instance, crude and commodity prices have fallen; wage inflation has moderated and credit and deposit growth are in excess of 20%.
Last but not the least, while the world is confronted with recession, India is still expected to grow at 7%. Risk aversion and market momentum may push the market lower and the uncertainty surrounding the general election may make it range bound till then. We may resume a normal trajectory after that.
MADHUSUDAN KELA: The longer term India story is in tact, though in a muted manner. 9-10% GDP growth may not come in a hurry, as we are connected to the rest of the world and what’s happening elsewhere. Over the short term, corporate performance is also likely to be muted. However, interest rates and inflation are going to come down and we have already seen oil coming down. As such, over the medium- to long-term, India is still the place to be in. Stocks have to stop falling very soon, because at the rate at which they are falling, there will be no stock market. That cannot be, and I feel that in the next 15-20 days, we’ll see the end of the worst. The credit markets have already improved, and the equity markets typically improve with a lag. Once a patient comes out of the intensive care unit, you can’t expect him to be back to normal on day one. So even after the market settles down, there will be a lull for six months to a year.
SANDIP SABHARWAL: I am extremely bullish on the prospects of the Indian economy as well as the markets over the next few years. The big bull market in India is yet to unfold and will be seen over the next 10 to 15 years.
This will be very different from 2003 to 2007, where the entire world grew at a rapid pace, creating huge inflationary pressures. India will directly benefit due to lower cost of commodity imports, an improving trade balance and the most unique part of this crisis, which is that India will be among one of the only large economies where the government’s fiscal situation is actually improving due to the crisis. The government does not need to capitalize banks and oil and fertilizer subsidies are likely to fall sharply.
However, policymakers have to be proactive in realizing that inflation is no longer a concern as inflationary pressures are likely to have dissipated for the next several years. There is a need to keep the economy lubricated with excess liquidity and low interest rates. Also, in uncertain times, the government’s fiscal spending should be used to give a boost to the economy in the near term.
Your advice to an investor in your fund?
SANJAY SINHA: Hold their investments and watch our performance from this point onwards. They also need to examine their asset allocation and if underweight in equity, top up at every fall.
MADHUSUDAN KELA: If you’ve invested two-three years ago, it’s too late to get out now. Retail investors should not panic at this time. The time to panic has gone. For fresh investors, the next three-four months will be the best time to invest. We’ve always been advising asset allocation as a strategy to investors, where you invest a portion of your investable surpluses into equity. The stock market is a place, like Warren Buffett explains, where you need to be fearful when others are greedy, and greedy when others are fearful. Now is the time to be greedy. But here, it’s so far been the other way around, i.e., the higher the prices, the higher the demand.
SANDIP SABHARWAL: We would advise investors to be patient and ride out this tough phase where we have underperformed broadly over the last nine months... It will be our constant endeavour to outperform going forward. We are very optimistic that with our fund management and research skill set, we will be able to live up to investor expectations going forward and will try to bounce back strongly.
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First Published: Tue, Nov 04 2008. 12 30 AM IST