Quality Works In Bear Markets

Sivasubramanian was part of the original equity team at Pioneer ITI of India in 1994, which was subsequently acquired by Franklin Templeton in 2002. He has been in the investment industry since 1988. Prior to joining Pioneer ITI, Sivasubramanian was Industrial Finance Officer at Industrial Development Bank of India. He earned his Post Graduate Diploma in Management from the Indian Institute of Management, Calcutta in 1988, specialising in finance and marketing. He obtained his bachelor of engineering degree, specialising in mechanical engineering in 1985 from REC, Jaipur.

When you buy a company, typically how long do you plan to hold it to realise its potential?
In theory, when you buy a company, the intention is to hold on to it for as long as the underlying thesis plays out, and the company has the potential to keep delivering. So if a company is doing well and has the potential to grow in future, we hold on. We don’t buy a company with the intention of getting out, unless we have made a mistake. In that case we try to get out as soon as possible based on a re-evaluation of the underlying fundamentals. Apart from fundamentals, relative valuations also play a role in portfolio construction — a company might score well on many parameters, but if other companies with similar potential have attractive valuations, we might look at them.

What are your criteria for selling a company’s stock?
The right reason for selling a company is if your expectations and objectives in terms of return potential and growth path have been met. Also the stock price has to reflect that.
But in some cases you tend to hold on even if your objectives have been met because you believe in the long-term potential of the company. Even if the company looks over-valued, you ride out that period of over-valuation because it is a quality company and you would like to have such companies in your portfolio.
Another case is where the valuation is out of sync with current fundamentals. Even when it is a good-quality company you may have other opportunities where you think there is better risk-reward potential . In such a case we tend to book profit and move on.
Sometimes you realise that the rationale underlying a particular investment was wrong. That has happened in the past and will probably happen in the future as well. The objective of portfolio construction and investment process is to reduce the number of mistakes, but mistakes do happen. So if the basic premise behind making the investment is wrong, then obviously we sell the stock.
If there is a significant deterioration in fundamentals or when corporate governance issue arise we may choose to exit even if there is still some value in the stock.

You have seen both the tech rally and the recent rally of 2006-07. What are the challenges in managing a fund during such bull markets?
A bull market is always a big challenge. Just as a rising tide lifts all boats in the sea, so also in a bull market the demarcation between good and bad companies gets blurred. Higher-beta stocks do very well in a bull market compared to quality stocks. So it is definitely a challenge to focus on long-term goals and not be distracted by bull market trends. Obviously, this may mean that we don’t do as well as our peer group or we are not as nimble in catching certain short term trends and don’t focus on moving in and out of stocks.
While managing our funds, we have always focused on long-term value creation. Our aim is to deliver over market cycles. The challenge in a bull market is to not be taken in by fads or to chase higher-beta stocks just for the sake of trying to outperform the competition or peer group. One of the critical components of a portfolio manager’s job is to manage downside risk.

How challenging is it to manage a fund in a bear market?
A bear market, I think, is relatively simpler because normally in such phases quality stocks hold up better than the broad market. A portfolio that focuses on better-quality stocks holds up well in a bear market as compared to a bull market. Of course, in a bear market there will be a fall in the value of the portfolio. As a consequence, we have seen at least in India, even if you do better than the broad market or peers, it is difficult to attract money in a bear market.

Bear markets are also associated with large outflows of investment. How do you deal with that?
During a bear market, the correction is generally so sharp that assets under management also fall very sharply. But outflows are muted because retail investors don’t like to take losses on their investments. So they wait for break-even to happen before they take out their money.

What are some of the core convictions that you have developed about stock investing over the years?
Based on the mistakes and also some of the better investments made over the years there are three key learnings. The first thing is to avoid businesses which we don’t understand. Real estate is a good example. We luckily made the mistakes early enough and found that it is not our area of strength, so we stay away from this sector. The second is to play to our strengths. Always deploy more money in those areas where your understanding is good. Just because somebody else is buying stocks in X sector, we shouldn’t be going in there unless that’s an area where we have demonstrated strengths in the past and are comfortable with the business fundamentals.
The third is to always focus on the downside. Normally one looks only at the potential upside without looking at the possible downside. We have to look at both.
Of course, it is not that the learning has stopped; we continue to keep discovering new things as we go along.

Since you mentioned real estate, can you elaborate on the difficulties in understanding the real estate sector in India?
The real estate industry’s potential seems to be huge. There is huge unmet demand and it is the aspiration of every Indian to own a house. With such a potentially large demand, you would expect a company that caters to this sector to do well. Unfortunately, there are issues in the way the real estate business is structured in India. It’s extremely opaque, and it is very difficult for somebody who is not an expert in the business to understand its nuances. As a result, we tend to make mistakes. Having realised early enough, we thought it better to stay away from such a business.

Who are the people that have inspired you the most and moulded your investment approach?
A lot of people — colleagues, industry experts, analysts and other portfolio managers. One of the most inspiring figures is obviously Warren Buffett. His thought process is extremely clear. He makes the entire investment process appear so simple by focussing on the key issues that impact the business and shutting out all the noise.

Your favourite investment books?
The Essays of Warren Buffett which is a collation of his annual letters to shareholders. This is an investment book that I like immensely.
I also like Jim Rogers. He’s a bit of a maverick, but he is somebody who looks at different things in life and uses that as inputs in his investment decisions. There is a book by him called ‘Investment Biker’ that I really enjoyed. His life is not limited to sitting in the office and looking at investments. He is somebody who has travelled the world, and has used the experiences gained through his travels to mould his long-term thinking on various investment ideas. His investments are not limited to stocks and he has been a bull on commodities for a long time. That has made him a lot of money. So, he is not confined to just one investment theme. The great thing about him is that he is open to fresh ideas.

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