Money Masters | In conversation with Kenneth Andrade

Dhirendra Kumar: Welcome to Money Masters. I'm here with another master, Kenneth Andrade, whom I've known for 21 years. He has been managing funds in some form or another. And right now, he runs a portfolio management company and is about to get a mutual fund licence. So, soon, you will have an Old Bridge Mutual Fund available to you.

Kenneth Andrade: Thank you, Dhirendra. Thanks for having me on the show.

Dhirendra Kumar: Welcome, Kenneth. And I have a long list of questions for you, though. Some of the answers I know! But I thought of asking them all over again so that your answers are all in one place. So, tell us about your beginnings in the world of investments.

Kenneth Andrade: I've been around since 1990. My formal fund management experience has been around since 2002. That's when I first joined Kotak, and subsequently, it's been quite an incredible journey up to Old Bridge, which is 21 years of fund management experience and almost 30 years of capital market experience. Hopefully, all of this experience culminates in the next leg of the journey, our asset management/mutual fund, which hopefully should be launched by the end of this calendar year.

Dhirendra Kumar: What got you interested in this? In the 90s, when things were, you know, pretty crude. It was before Harshad Mehta - The Great Indian Scam!

Kenneth Andrade: A little bit, and then greed takes over us. Right? We are in the business of managing money or trying to deliver a higher return on investment over longer-term periods. And that inquisitiveness and how companies demonstrate their ability to make more profits and survive. Put them both together and that creates great companies over the long term. I think that's what the most interesting part of it is. The only way you can participate in the journey as an individual is to participate with those companies.

India has seen a great number of companies that have come through. So I think that's what got me started, and that's how I found that sweet spot of how to choose some of these businesses. And here I am today. So it's just an inquisitiveness that turned into a hobby, which just turned into a profession, and now it turns into entrepreneurship.

Dhirendra Kumar: So being curious actually has taken you in all these directions?

Kenneth Andrade: Yes. I love what I do.

Dhirendra Kumar: Was there anybody who influenced you?

Kenneth Andrade: I think right through the journey, there've been a number of individuals who put pieces of this puzzle together. It's my initial association with Capital Market - the journal, and that was my first job.

Dhirendra Kumar: Capital Market, the magazine.

Kenneth Andrade: Yes, the magazine. They used to run this large scoreboard, as they used to call it, with financial parameters of over 500 companies dissected by sector. And that was the only place to get all the financial numbers. And I think that was the best part of learning.

Dhirendra Kumar: So you started as a publisher or working in a publishing game?

Kenneth Andrade: Yes, I started working in a publishing company. That was the phase of accumulating data. So you looked at companies - you had an IPO boom, you had a bust, and you accumulated a lot of data. The next assignment was how to utilise that data. And that, I think, started off in the late 90s all the way to 2002-2003, and then the portfolio management experience.

So, there's a gentleman who used to work as a manager in SRF, and I used to track SRF, and it was Rs 17 of stock price. His name was Sanjeev Pandiya, and he was also associated with you.

Dhirendra Kumar: Yeah, he has been writing for our magazine since its beginning.

Kenneth Andrade: And he introduced me to the fundamentals of how companies survive through a down cycle. We always used to have very long debates about how the sugar cycle would last, how Bata would come through, and the reasons why.

Dhirendra Kumar: When was this?

Kenneth Andrade: It was the late 1990s. Then, through the 2000s, I met a gentleman who also became a boss and now a good friend of mine, Vetri Subramaniam. He actually helped me practice what I did. So, I moved from theory, data collection, and theory to the interpretation of all that data.

Dhirendra Kumar: As a portfolio manager?

Kenneth Andrade: Yes, as a portfolio manager since 2003. And that was when Kotak Mutual Fund happened. Now, a significant aspect of those small three years spent with Kotak Mutual Fund was that I was given a fund called Kotak MNC to manage. The stock universe was 51 companies.

Dhirendra Kumar: Multinational company, that itself was an attribute. And maybe in India, it was being considered a quality filter at that time.

Kenneth Andrade: Yes, but the universe was 51 companies, and you had to create a portfolio out of that. You couldn't work outside the box. You had to work inside the box of 51 companies. That helped me optimise the box. That was the process that started.

Dhirendra Kumar: Just for the sake of, you know, understanding the context at that time.

Kenneth Andrade: It's a small fund. I don't think liquidity was such a big challenge. The second thing is that it cleared, or kind of cleared, corporate governance. It ticks the boxes in terms of governance. The third was market share, market dominance and performance.

Now, you had to choose, and every business went through multiple cycles. So I used my little bit of experience with cycles and then tried to optimise: Out of 50 companies, how many do you run? If I remember correctly, I would be running 15 companies in that product. And that's how the concentration of the portfolio set in. And with 15 companies, I think we did fairly well. If I'm not mistaken, we were pretty much in the top quartile amongst all diversified funds in the entire industry. That's how the optimisation got through.

So, in a learning cycle, data collection and learning how to pick survivors in this cycle and then implementing, all of that led through in 2003. And if it weren't for Vetri, I probably wouldn't get the chance to do what I do today.

Dhirendra Kumar: How do you judge value in a business and how difficult it has been to find value and quality together all these years?

Kenneth Andrade: Quality is often understood as a company with a ROE of 15 per cent or more. But when you go down that path of an established business around for a long time, you usually get it at an extremely exorbitant price. So you have to shell out a lot of money to buy great businesses, right?

What if I just step back for a minute and try to address how to buy quality at a price? Take an industry that is going through a down cycle and buy the largest. In all probability, you'll get it free of cost. When I say free of cost, you'll get it at pennies to the dollar.

So what happens in a down cycle? Today, the biggest story in the marketplace is capital goods because everyone's talking about the expansion of infrastructure and capex actually taking place. But none of this was there between 2015 to 2019 or 2020. And how many of these companies were trading below the book. Half or more were trading below the book. Now, it's a patience game. Everyone wants growth, but you have to pay the price for growth. But if you have to pay the price for value, you're getting it for pennies to the dollar. That's the space that we try to optimise.

So, when we choose a business which is out of favour, we usually buy the best company in that entire sector.

Dhirendra Kumar: Ahead of the curve while it is still depressed?

Kenneth Andrade: Way ahead of the curve and probably participate every time because that's the only time you get a high-quality business at a price that you want it to be. And then you ride the cycle with it. Now, it may be a patience game, but if I just step back into my career and some of the businesses that we bought in 2006-2009, a lot of them were in the consumer franchise business. You take Bata, GlaxoSmithkline Consumer, Asian Paints, Page Industries.

The names of them all were similar, and then all of them were available at a 10 per cent cash flow yield. That's value. Today, they're all available at 50 times, 100 times earnings. That's growth. So, the market shifted from value to growth with the same names.

Today, all the names, which in 2015-2020 or some time back also, were all capital good names. If you go back to 2019, the CAGR on Larsen & Toubro is 1 per cent. Over the decade, it was 1 per cent! And that wasn't true for the last three years.

Okay, so that's all you try to do. You try to anticipate it. And if you have anticipated that and try to pick the cycle right, in probably all formats, you really get a great business, and at a price. At different points in time, even today, you have a business hitting a 52-week low. A good quality large business hitting a 52-week low. That's where the focus and attention has to go. To value being valued, look for 52-week lows.

Dhirendra Kumar: Okay. So the time you buy is the most important.

Kenneth Andrade: Yes.

Dhirendra Kumar: That is the critical thing?

Kenneth Andrade: It's always the price.

Dhirendra Kumar: Okay. So you buy it at your price? And how do you arrive at this price?

Kenneth Andrade: So, my job, and I transition this down to my team. Our job is to buy high capital efficiency at a price. And that's the way we do it.

So, if I have to look at it, buy a business which has got low margins. Buy a business which has low ROEs. Exit the businesses which have high ROEs.

Dhirendra Kumar: Okay. Those companies themselves will actually move the path.

Kenneth Andrade: Take a large business at a low ROE. Either the business closes down, the industry closes down, or it revives itself.

Dhirendra Kumar: How often have you been wrong with this?

Kenneth Andrade: A couple of times, but I wouldn't say I was wrong with it. I was very early into the cycle.

Dhirendra Kumar: So, it didn't work out at all?

Kenneth Andrade: It didn't work out... I wouldn't say it never worked. I probably missed the opportunity to wait for the right price. So, as it corrects, I just waited a little too long, and then you don't get it right.

Dhirendra Kumar: Hmm, That's the justification. So, all your ideas don't come from any screening or any such thing or of another fund manager's portfolio? You have your own universe, and you have your own watch list.

Kenneth Andrade: We have our watch list, and it's fairly easy to put it together. But I think formal portfolio management or formal funds management, after three decades of doing the same thing again, you learn to make fewer mistakes. So you just wait for the price. And our job is to buy low and sell high. So, where do you look for businesses which are at the lower end of their industrial cycle or their business cycle and wait for the time you will get it right?

Dhirendra Kumar: So, you know, in this whole investment decision, is it all a logical number or is there even some gut feeling or instinct that plays a role here?

Kenneth Andrade: I think experience drives the gut.

Dhirendra Kumar: Okay, okay. But if numbers are not supporting it, you'll be off it completely? Are there any such exceptions that come to you?

Kenneth Andrade: No! So, if you had asked me this question 15 years ago, I would have said the gut plays a big role in it. Simply because there was not as much experience to establish what you did wrong at that point in time.

But today, I think we've been through multiple cycles and multiple market cycles. From a valuation cycle to an industrial cycle, you've got 2008, you had 2019-20, and you had 2013. 2013 was a blinder. At the beginning of this financial year and at the end of last financial year, 700 companies were making 52-week lows. This year was a no-brainer!

So, there was science. This is all established science. Basically, history reinvents itself, and we just have to wait for our time.

Dhirendra Kumar: It repeats. Or it rhymes. You're known to invest in cyclical, down and attractive sectors. So, which sector is the most attractive today? We are trying to get some tips for the audience.

Kenneth Andrade: I think somewhere a lot of it is mid-cycle to what people perceive to be a large capex cycle in the marketplace.

Dhirendra Kumar: We're in the middle of the cycle?

Kenneth Andrade: We are somewhere at the beginning or in the middle. I wouldn't want to choose the point, but this thing has legs to go. It's because it's not about India going through a capex cycle, but globally, the world is going through a capex cycle. You have the US, which is 23 per cent of the world GDP trying to do that. Middle East, with all the US dollars that it has got, is trying to do that.

This capex cycle could be bigger than what you saw in the last round. And somewhere, the entire commodity was not falling into that logical space. Now, it might sound intuitive that commodities do well, but I look at it in the other format. A lot of commodity businesses are still at one-time price to book.

Dhirendra Kumar: Even now?

Kenneth Andrade: Even now.

Dhirendra Kumar: Can you be a little more specific about this? Any example?

Kenneth Andrade: You take some of the large steel mills, one-time price to book. You take some of the large aluminum businesses - one-time price to book, not only in India but globally also. And you can't have a rollout of any infrastructure without the base primary metals.

Now, if they are trading at a one-time price to book, everything in that lifecycle of those businesses is also trading reasonably cheap, which is basically the mining businesses, etc. They're all paying a dividend. Now, I don't know the future of that business, but I know for sure that there's no downside to it.

You can't lose money. And that's what establishes a portfolio. First, you've got to protect your downside. Your upside will come because the marketplace gives back. And I think that's around the corner.

So, the way we are looking at it and when you ask me which stocks look valuable or which stocks have reasonable value, I think the entire commodity cycle has it. Now, metals could be just one part of it. If you look at agro commodities and processors, they're the second leg.

So, right through the chain, what is happening in India, and somewhere we've been looking at a lot of these businesses for the last 30 years. The commodity companies in India today are adding 10 per cent or 15 per cent of incremental capacity without recourse to debt. Plus they are debt-free. Now, put it together. I am adding 15 per cent of incremental capacity with my own cash flows.

Dhirendra Kumar: Own cash flow. You don't need to go for debt anymore.

Kenneth Andrade: I've taken financial solvency out, so I am solvent as a business, and I am waiting for the cycle to come through.

Dhirendra Kumar: When you'll add to the capacity?

Kenneth Andrade: Yes. So this is what is currently present. You have a company with X amount of capacity, currently - debt-free and making profits.

Dhirendra Kumar: Have you ever seen a balance sheet this deleveraged?

Kenneth Andrade: Never.

Dhirendra Kumar: Never in the past?

Kenneth Andrade: The last time it was 2005, 06, 07. This time it's better.

Dhirendra Kumar: This time, it looks like nobody is willing to borrow.

Kenneth Andrade: It's not that no one's willing to borrow it. The problem is, and I wrote this in the last newsletter to our investors - in 2015, all Indian investors looked at the corporate balance sheets and said too much debt. 2023, you look at the corporate balance sheet, and they said too much equity.

Dhirendra Kumar: Okay. It has diluted the earnings.

Kenneth Andrade: It has diluted the ROE, which is the biggest risk to the marketplace.

Dhirendra Kumar: So, where do we go from here?

Kenneth Andrade: So you are not wrong when you say that there will be a corporate cycle or a capex cycle in the environment. India might have it for sure, not because of anything else, but we still have a huge cash balance in place. The thing is, whether you use it productively or we use it unproductively. Now, I'm creating a scenario in the future. Productively means we chip in with incremental capacity.

Dhirendra Kumar: Infrastructure, businesses?

Kenneth Andrade: Yes, the problem is that we've got too much cash with the banks and with the corporates to be material for a very large capex drive. So then you do it unproductively. You go out and buy assets.

But when that starts, it starts with a very logical framework for the first few assets that will get acquired, will get acquired at a reasonably good ROI, and then it starts deteriorating.

Dhirendra Kumar: So you're referring to the time when Tatas went ahead with their global acquisitions?

Kenneth Andrade: They did it at the end

Dhirendra Kumar: They did it at the end. Okay.

Kenneth Andrade: So if I take you a small journey back to 2003 and 2004, or a little earlier than that. Gammon India, a company that no longer exists in its original format, had got three BOT projects at an IRR of an unbelievable 29 per cent.

Dhirendra Kumar: Okay, 29 per cent!

Kenneth Andrade: Yes. But then the cost of this funding was 15 per cent. So it didn't look very great.

Dhirendra Kumar: I was looking at, you know, one fixed deposit of BHEL, which was available at 14 per cent in 1981.

Kenneth Andrade: Yeah. There were bonds at 17 per cent.

Dhirendra Kumar: And the government of India tax-free bonds of 11 per cent.

Kenneth Andrade: And when the cost of financing moved from 14, 15 per cent to 6 per cent and 7 per cent, the value of the asset moved up. And the final couple of road contracts (the BOT projects) went in with an IRR of eight, nine, and 10 per cent.

So you see the difference between the first mover and the last mover.

Dhirendra Kumar: Yeah, we have seen many projects actually falling through. The biggest example is while coming to our office, you would have travelled through the DND. Its a toll-free thing now. That was a BOT project.

Kenneth Andrade: Yes. So, all this is basically a mathematical simulation in which you keep your return on capital employed higher than the cost of capital and remain solvent. But unfortunately, things move the other way around when you continue to keep projecting your cost of capital is falling and make all the mistakes.

Dhirendra Kumar: And go about just mismanaging the things.

Kenneth Andrade: Yes. So, I think this is what will eventually happen with India. The cyclical part of it is playing out, with too much capital on the book that is going into some logical investments out there, but it's going to get into illogical territory.

Dhirendra Kumar: That is also cyclical?

Kenneth Andrade: It's extremely cyclical. Too much money drives people to do abnormal things. But that's some time away, and you need that to get outsized gains in your equity markets.

Dhirendra Kumar: Now, I have a question which has come from our equity person, Ekram. How do you assess whether a company's decision to either invest in capacity or payout dividends to shareholders is the right decision? And which sectors do you see these scenarios playing out today?

Kenneth Andrade: So today, they've got a lot of cash on the balance sheet. They don't know what to do with it. If I look at historical returns on equity, it has been 15 per cent to almost 25 per cent. This 25 per cent was in 2006, 07. Now, if I'm a shareholder of that business, I would want the company to reinvest that capital at the same ROE. If it doesn't have the opportunity, it pays it out.

But the problem with paying too much of dividends is that you get valued at bond valuation.

Dhirendra Kumar: Hmm. Nobody factors any growth.

Kenneth Andrade: Exactly.

Dhirendra Kumar: They stop giving any credit for any potential growth.

Kenneth Andrade: Yes, because even the company is indicating the fact that it will take away all the cash flow because they do not know what to do with it. So when you get into that kind of matrix, it becomes a little difficult to quantify or substantiate that you will trade at an X amount of valuation. And these are all physical assets which are on the ground.

We're not a very big proponent of companies paying us capital back, and dividends are the wrong way to reward the shareholder. Buybacks make much more sense because the simple reason is that when you buy back stock, you reduce shareholder capital. So, it influences my return on equity.

Dhirendra Kumar: It improves.

Kenneth Andrade: Yes.

Dhirendra Kumar: And dividend actually signals a negative thing?

Kenneth Andrade: Dividend says, I don't know what to do with capital.

Dhirendra Kumar: But that is just a form. The real situation hasn't changed at all. A buyback or a dividend is the same thing for the company.

Kenneth Andrade: Yes, but as a dividend, my return on equity remains static. In a buyback, I'm returning shareholder capital, and I am increasing my shareholding in the company itself.

So, in both cases, both can hit cyclical highs in the next cycle of the business, but the one with the lower equity benefits more.

Dhirendra Kumar: So, how can an investor use cycles to improve their investment return? You know, you will be doing this in the portfolio. Can you explain some examples and a couple of parameters to watch out for here?

Kenneth Andrade: So, when we talk about cyclicality and when we talk about value investing and on the other extreme, we talk compounding. So, what is value investing? Everyone says it is to buy cheap. And that's what value investing is, but everyone has different parameters about how to define it as cheap.

Our format is when you try to buy a business which is right at the bottom end of the industrial cycle, and you're waiting for a cyclical recovery. When the cyclical recovery comes, you have earnings growth.

Now, bring compounding. Compounding happens when you have earnings growth and you have price-earning multiples steering up. You have two parameters working for you. If I'm buying a business at 30 times or 35 times earnings, one variable is fixed. Only earnings growth is the variable. So that's how we try and compartmentalise ourselves and look for a cyclical business on the down cycle.

And like I said, every business is cyclical. There's nothing structural about a business.

Dhirendra Kumar: 'Every business is cyclical.' Are you saying this in the context of the stock price in the marketplace, or you're talking about the underlying business?

Kenneth Andrade: Underlying business.

Dhirendra Kumar: Excluding the consumer?

Kenneth Andrade: No, I'm getting there.

Dhirendra Kumar: Okay, so not even consumer business?

Kenneth Andrade: So in the last three years, when consumer companies are talking about inflationary pressures and inability to pass on pricing hikes, they're going through a cyclical down cycle.

Dhirendra Kumar: Their pricing power is gone.

Kenneth Andrade: You take 2000 to 2009. India's largest FMCG business gave shareholder returns of 1 per cent. And look at its earnings growth during that period. Very similar.

Dhirendra Kumar: Right, earning was also growing at 1 per cent.

Kenneth Andrade: Why did you get GlaxoSmithKline, BATA, Page Industries, and Asian Paints, between 12 times earnings and 18 times earnings? Why did you get it? And why did you buy Tata Motors at 40 times earnings and L&T at 60 times earnings in the same cycle? What is structural, and what is cyclical?

Dhirendra Kumar: The early days of a revival of the earnings for those companies.

Kenneth Andrade: Yes, so what are structural and what are cyclical? So, every business has to redefine its marketplace to grow into the next cycle.

Dhirendra Kumar: In past interviews, you have talked about investing as buying at low margins and selling at high margins or buying low ROEs and selling high ROEs. Exactly what you said at the outset. Can you elaborate on a recent example which we can relate to?

Kenneth Andrade: So, step back, I mean, the most obvious ones were the entire metal cycle. They just flew through us. The other one that always plays out is the automotive cycle.

During COVID, everyone's margins collapsed and everyone's ROE was hit.

Dhirendra Kumar: But Covid was an outlier, no? Everybody's earnings disappeared.

Kenneth Andrade: No, so go prior to Covid, and automotive wasn't coming through. And look at post-COVID. I think you're catching up for three or four years of a down cycle that was coming through, and everything is coming back again. Well, automotive is one.

You had the chemical market for a 12-year-old, 15-year period, it was going through a down cycle because of the enormous amount of capacity creation outside the world. And it all came back and formed a big, gigantic bubble in Indian chemical businesses.

But the most recent was the pharmaceutical cycle. 2015 was the peak, the patent peak. Everyone rushed into saying the generic market is the next best thing. All Indian companies put in capacity. All US companies bought out generic capacities all over the world. And in 2020, 2021, and 2022, you see all of them hit the 52 weeks or four, five-year lows.

Dhirendra Kumar: It coincided with the FDA mess that was also on.

Kenneth Andrade: Yes, but what happened with the Indian company was very simple. You had Indian companies which are solvent. The US companies had an enormous amount of leverage, plus they had a lot of fines that were coming through. So balance sheets got stretched in the US, and Indian companies were sitting pretty with cash on balance sheets. Now, who has the opportunity to scale back?

So, this is the Indian context of pharma consolidating their global footprint.

From 2000 to 2010, IT did the same thing. You had one or two companies there in all orders or bidding for most orders. But after 2005, the US companies didn't exist. EDS was a very large brand. It no longer exists. Compaq and HP had a very strong services brand, along with digital equipment, it no longer exists. All the services business had gone offshore.

And they shut down there, and they set up shops here, and the Indian companies went out and got more market share. So, all you need to go through a cycle is to remain solvent.

Dhirendra Kumar: Being alive is the most important thing.

Kenneth Andrade: Always the case!

Dhirendra Kumar: The most important thing in your experience - which are better long-term investments, structural or cyclical?

Kenneth Andrade: I think one leads to the other. And as I say, you have long-term cyclical journeys in every industry. So, I'll try and put it in a very simplistic way. Every industry grows at the GDP growth level. To grow faster, you have to leverage it.

So watch the banks. Figure out what they're leveraging, and that industry will grow faster. So, that ends up being structural till it hits another cyclical patch.

Dhirendra Kumar: So they will go through their own cycle?

Kenneth Andrade: They will go through the same cycle because the banks across the world go and leverage the fastest growing business because the fastest growing business needs capital to grow. And incrementally, as they continue to keep growing, more money gets channelled out till the banks create their own competition. And that turns cyclical all over again.

Dhirendra Kumar: That reminds me of Jet Airways, you know, it was in the news today.

Kenneth Andrade: So if you just step back, at least from my framework, I don't think there is anything which is structural in nature. There are survivors of the cycle, and those businesses get larger with every transition that keeps coming back, every industry cycle that keeps coming back.

So through our investment footprint, when you look at larger investors that are there across the world, they will always look at companies which have longevity. So if you have a company which has got a longevity of 50 years, undoubtedly, you've made money.

So all focus, irrespective of whether you're buying growth businesses or value businesses, you have to stress the point that you have to buy longevity. It will help you go through a cycle, and in that cycle, you'll also get a structural piece of the action.

Dhirendra Kumar: But in this case, when you have to buy such companies, have you ever gone wrong? You know, you've heard of a company which has existed for 50 years. Tata Steel, at one point, looked like it was going towards bankruptcy. And it got very close to bankruptcy, a 100-year-old business! So, how often have you gone wrong there? The cycle, if it just did not turn around?

Kenneth Andrade: There's no such thing as a cycle not turning around. If Tata Steel had gone bankrupt, then it would have taken down the entire steel industry with it. In 1998, 1999, two companies in the steel world were solid. Tata Steel made Rs 60 crore in profits during one of those years. The other one was Nucor in the US.

Dhirendra Kumar: The steel recycling company?

Kenneth Andrade: Yes, and obviously, the Russian company at that point in time.

Now, if Tata Steel went bankrupt or Nucor went bankrupt, what would happen? There would be no steel available across the world. So, yes, there are industries that do not have longevity. I have come across the colour picture tube market once upon a time.

Dhirendra Kumar: Samtel

Kenneth Andrade: Yes. You come across Moserbear at one point in time, which was floppy disks. You have a generation change in technology which happens, and some companies fall by the wayside. So it's very important to actually track a lot of those businesses' transitions.

Dhirendra Kumar: They are a dangerous business. You know, they've virtually disappeared and also because of the quality issues which came with the promoter of those times.

Kenneth Andrade: So, Dhiren, over the longer term period, I am not worried about falling into value traps. Because portfolio construction takes care of those mistakes. As long as they are not very serious. Unless you are extremely concentrated, having only one stock portfolio, you can go completely wrong. Which is what Value Research has also always influenced their investors. It is like diversifying your portfolio.

Dhirendra Kumar: Yeah, of course. You know, one can't be sure of something all the time.

Kenneth Andrade: Yes. Which is why we run a diversified portfolio. Now, the diversification for different managers could be very different. I'm comfortable with a 20- or 25-stock portfolio because at the back of my mind, I'm not playing the marketplace. I am playing my competencies. That's what I want to put forward in the portfolio there.

So, yes, there are value traps. I will get one or two. It has happened. It has happened as recently as 2017, 2018 and 2019. We went searching for value where there was none available. The mid- and small-cap markets were at an all-time high and the mistake that we made was we looked for value when there was no value to be found. And where we tiered down in terms of the quality of businesses. A company trades cheaper than the next company for a reason.

Dhirendra Kumar: It's never without a reason. It is never misplaced. Then how do you create an alpha if the market is always right?

Kenneth Andrade: So, like I say, it's always the price. And at points in time, capital around the world is like a herd instinct. All rush, whether it's money available for equity investing or money which is in the banks, they always migrate to the best-performing sector.

So step back. What do you want to do? And once you define what you want to do, I think getting an output out of it or...

Dhirendra Kumar: ...to be able to leverage that opportunity.

Kenneth Andrade: I think that's where all alpha gets created.

Dhirendra Kumar: So when do you sell? Something that was in the down cycle went up, then when do you actually say that okay, it's more than enough. Now, this is getting into risky territory.

Kenneth Andrade: So this is an interesting question because selling as a discipline doesn't come very naturally to most of us. But the data point that I use and which I also try to institutionalise, but I still have to formulate a process around that, is that if every company in an industry is making money - that's a very dangerous place to be.

It's a common sense approach to why I say that. When everyone makes money, what are those companies doing? They're reinvesting in their existing businesses. So they're bringing in more capacity than what demand exists. Then, the adjacent industries are also putting in capital, looking at their ROEs. More capacity is created.

Numerically, if you have to put it together, if an industry makes a 30 per cent return on capital employed, there's always a private equity investor who says my return on capital employed hurdle is 15 per cent. And he will fund it, and he'll fund the competition.

And then the bank will say that my hurdle rate is 9 per cent. So, in the longer run, the whole industry's return on capital employed comes to 9 per cent.

Dhirendra Kumar: Now I'm seeking some tips from you. Which sectors are at their cyclical lows?

Kenneth Andrade: So, one is agrochem. It's gone horrid this year, but my sense is it's still somewhere from bottoming. But we're getting price points, which are nice. Not very attractive, but nice.

Second is what I have spoken about commodities. I've never seen companies in India generating this kind of cash flow, adding capacity on the ground without debt.

And the third one, it is interesting, and I've been saying this for the last 18 months, it is IT services, especially the big players. Now, what gives away? That is fairly simple. One of the largest companies in that entire space has hit on with a 6 per cent margin in the last quarter. And I think that the margin is troughed. So you're close to the bottom as far as business operations are concerned.

Dhirendra Kumar: 6 per cent margin actually scares you. Because a little bit of currency movement and that can become zero?

Kenneth Andrade: Yes. Which is why it's reflected in the prices. So you get negative news, you get price play, you get positive news, you get the price earnings multiple.... So which of the two? You have to choose.

Dhirendra Kumar: But, what will cause a turndown?

Kenneth Andrade: So that's something you don't sit down and predict. These are multi-billion dollar companies. And that 6 per cent margin is for a number of reasons, apart from the fact that it also had a weak quarter. But as a whole, the whole basket of companies is hitting this kind of lower returns.

So, the functioning of this industry is never going to close down. There are questions about AI, lower growth for the business, etc. But these are large businesses that will go on to dominate your technologies. And like I said, as long as you don't question the longevity of these companies, one day, you will get a cyclical turnaround.

Dhirendra Kumar: So the turning triggers could be anything. It may not be an improvement in the margins, but just scaling up further from here.

Kenneth Andrade: It all reflects on the underlying business. So, you sell it at an all-time high in terms of margin and buy it at an all-time low margin. But, people extrapolate the top to be higher and expect the low to be lower. It's like equity investing.

Dhirendra Kumar: So, doing the reverse of how to make money.

Kenneth Andrade: So one of my ex-bosses said, and he framed it very nicely. People come into the equity markets wanting to make a 15 per cent return and leave the equity markets, trying to save the last 15 per cent.

Dhirendra Kumar: This is an interesting question based on your earlier interview. You had said earlier that, this decade belongs to government capex and which non-PSU industries tend to gain from this opportunity?

Kenneth Andrade: I think the whole value chain does it.

Dhirendra Kumar: ...cement, steel, everything?

Kenneth Andrade: Yes, because the government capex is the start of it all, so everything in the value chain will actually benefit. So for every Rs 100 that goes into infrastructure, Rs 40 goes to employee cost or labour. Only Rs 60 go into the material.

Dhirendra Kumar: Now, there is a kind of margin, there's kind of a breakup?

Kenneth Andrade: Yes, that's a breakup. Now, you can have your preferences and put a valuation chart next to it, and you've got your numbers.

Dhirendra Kumar: If consumer-facing businesses are likely to face inflationary pressure this decade, are there small niches or segments you think will continue to do well in this space?

Kenneth Andrade: Of course, I think urban consumption is a great play. Because all said and done, India is also evolving, and if you have to see India's GDP grow from 3.5 per cent of the world GDP to 5.5 per cent of the world GDP, we've got to import that growth. When we have to import that growth, we have inflation coming in, and it is very rampant in what we see as services in the services economy.

India's per capita income (especially in places which are feeding into the services economy globally) is going to move very close to the Western economy wage state. And that's how we import higher GDP growth. So, track that faction of the market.

Dhirendra Kumar: ...where earnings will actually be consumer play?

Kenneth Andrade: Yes, so track that faction of the market, and the simplest point that you're seeing across India right now is in the real estate market. So take every individual's balance sheet in the country; real estate is the largest part of your balance sheet. If you do not like buying a house, take your income statement. Your biggest expenditure line is rentals. And in an inflationary economy, that's where inflation fits into your consumer base.

Dhirendra Kumar: With the increasing competition and pricing pressure in the US, what are the prospects for the Indian pharma industry for the next couple of years? What will set the winners apart?

Kenneth Andrade: I think whether it's pharmaceuticals or whether it is IT, or whether it's services import or whether it is steel exports, it's the same.

Let me put it differently. Whether it is automotive or whether it is two-wheeler, or engineering, India's overcapacity in every single metric. We produce far more cars than we can sell into the economy. We are the largest steel manufacturers or the second largest steel manufacturers in the world with the lowest cost. We've got more people employed in services and IT than India as an economy needs. And in pharmaceuticals, it is the same.

So we've got the lowest cost benchmarks that are there, feeding into the world's largest economies. So, we could be a perpetual part of the entire supply chain. And it started off with chemicals and a number of other parameters, but it's cutting across every single industrial line.

So somewhere, what the world's largest manufacturing economy is doing, we are doing it with very different industries. And pharma is one that fits right in there. We've got the largest plants, whether it's injectables or whether it is generics. We've got companies that have invested in biosimilars. We've got some of the largest vaccine companies in the country. You name it; we have all of it.

And we've got to find a niche everywhere else in the world.

Dhirendra Kumar: They've also become a little bit more compliant with the FDA.

Kenneth Andrade: I think our compliance is there. It's not up there, but it's there.

Dhirendra Kumar: So there won't be an issue with the longevity or, you know, a disruption in business?

Kenneth Andrade: I don't think that's going to be an issue as far as longevity is concerned because we can consistently remain bottom-end cost manufacturers of pharmaceutical and pharmaceutical ingredients.

Dhirendra Kumar: Now, I have a set of questions which are going into the past. So, what are the big lessons, a big mistake and what lesson that you got?

Kenneth Andrade: So I think 2017, 18 and 19 was probably the most horrendous part of my career.

Dhirendra Kumar: Your career? And I think that was also the early days of your PMS business.

Kenneth Andrade: That's right. So we had a roaring 2017, and in the back of that 2017, from a portfolio perspective, we tried to look for value when there was none there. And quite contrary to where I would have wanted to be, we moved downwards instead of moving sideways. That's where mistakes came in the portfolio.

I think it took us about two and a half, three or four years. Today, if I look at the CAGR from the start, it's not so bad, but those two years definitely did impact how the cyclicality, or how being at the right place with the wrong strategy, impacted long-term returns.

Dhirendra Kumar: So you did what you're telling me right now that should not be done.

Kenneth Andrade: It should never be done, never tier-down from an institutional portfolio, especially if you are a very large shareholder of the business.

Dhirendra Kumar: So, what is the way to actually avoid such accidents? Because there could be another one.

Kenneth Andrade: There will always be an accident, and there'll always be a new learning cycle. But if you ask me about my past, this is probably the biggest one that was there. Incrementally, you have to make sure that you are disciplined enough to make sure your portfolio is reasonably balanced at all points in time.

So, today, when everyone's looking at a growth market for something that turned value, I think that's a mistake that you need to avoid.

Dhirendra Kumar: How, when were you able to recognise that, okay, this is something where you have gone wrong?

Kenneth Andrade: Very early.

Dhirendra Kumar: Very early? That's something which I don't see happening very often. Now, a question which has been asked already. Is it more difficult to keep holding on to your big winner or to your big loser?

Kenneth Andrade: I think holding onto a big winner comes naturally. Holding on to the biggest loser becomes a bit of a mindset block. And that is something that takes a lot of time to overcome. To answer the question straight, it's easy to hold on to your biggest winner.

And that's essentially where it comes from. So, if you step back, I'll give you my team as a reference point, and every time I ask them the same question, what's your biggest conviction? And their biggest conviction always comes with the price history of the last two years. And that ends up being your biggest mistake.

Dhirendra Kumar: So you know there will be an exit point, and there will be an entry point. You'll get into something, and then it falls freely. Say, 30 per cent from that level. Because that is what the downside of your strategy is, that you might have to wait for a very long time or you have to witness your 20, 30 per cent decline. How do you overcome this? How do you psychologically prepare yourself for this? That, too, with other people's money?

Kenneth Andrade: The entire challenge comes from how convinced you are at 30 per cent lower and at 50 per cent lower.

Dhirendra Kumar: Are you able to buy more?

Kenneth Andrade: Exactly. And that's what you have to realise because when you step into the office or when I step into the office, I've got to realise that my costing is based on yesterday's price and not on my original purchase. So, I have to build a portfolio starting yesterday because yesterday is when my last investor came in. I got to be fair to him like I believe I've been fair to everybody in the past. And that's where that further differentiation comes in.

And once you address that problem, you know which part of your portfolio is froth and which part of your portfolio you need to continue to have. And that is the assessment, and that's how we put portfolios together.

Dhirendra Kumar: So, you keep your investors in mind while you're creating a portfolio.

Kenneth Andrade: Of course, of course.

Dhirendra Kumar: And how difficult has it been managing a PMS as compared to an open-end fund?

Kenneth Andrade: So Dhiren, if I just step back into my history, I have always been a portfolio manager from 2002 to 2015 in the mutual fund space. So pool structures work wonderfully, single NAVs work wonderfully, and everyone gets what they see. And I think that's the structure that has always attracted me to what we do. So obviously, the preference is a simple structure, which is what a mutual fund structure does compared to a portfolio management product, which is all about managing that on a smaller portfolio.

In terms of customising a portfolio to individuals becomes a little bit of a process. So, over a period of time.

Dhirendra Kumar: ...all portfolios will be different?

Kenneth Andrade: In terms of weightages, yes. Because if someone walks in today and one stock, because of its historical performance, is at 15 per cent of the portfolio, which it currently is, I can't give you 15 per cent because I'm giving historical performance.

Dhirendra Kumar: But that won't be the case in an open-end fund because in an open-end fund, everybody will put their money into the same fund.

Kenneth Andrade: Yes, but then you're correcting it, correcting it as money comes into the fund. So unless I'm buying 9 per cent of the fund at a regular interval, I'm doing injustice to it. But if new money comes in and I'm increasing it at the bottom, which I'm doing as a portfolio manager, then over a period of time, that correction, of course, actually takes place.

Dhirendra Kumar: You're about to get your asset management licence, or you are going to get a go-ahead. How is your mutual fund business going to be? Have you transitioned from PMS to, you know, a mutual fund?

Kenneth Andrade: So we are an investor-led, I'd say, investment-led asset management company. And for us, an investment-led asset management company is quite simple. The product has to do all the talking. So, there are a few expectations that I think investors would expect out of us. But it's a process of taking it in steps, building a portfolio, letting it mature and making sure that you are ahead of indices and with your peer group, demonstrate and then go to them.

So it's going to be a gradual process of a build-up of how we want to do it. We're in the business of making money.

Dhirendra Kumar: Like those startups nowadays?

Kenneth Andrade: So we're not in the business of actually collecting capital. So we'll go slow. We'll build it up over a period of time. And our product has to do more talking than our advertisements.

Dhirendra Kumar: How do you look at the startups, which are continually or perennially losing money and they lose even more to grow, without any sight of, you know, a road map to make money?

Kenneth Andrade: Well, it's not very different, and if you go to very different periods of time, and in history also. And, if we go back to the US in the thirties and forties, the capital costs were very, very low. You had a lot of incubation of businesses that are not profitability-driven but idea-driven, and their cost of capital became expensive.

So what you had in India and the rest of the world was an incubation of ideas. Now, the ideas have to be profitable. So now you're seeing a consolidation of that space and the cyclicality of that business being out. They are solvent till capital flow stops, and now they have to start generating their own capital.

Dhirendra Kumar: So you think most of them will survive? Have you taken a closer look at any of them?

Kenneth Andrade: Of course, a lot of them will be there and into the next decade. A lot of them. But you just got to buy them at what you think is the relevant price because it's very expensive to create footprints that all these companies have done. And in the consolidation of that space, they're creating virtual monopolies. And when you create virtual monopolies and they are go-to businesses, then of course, we've got a business model. Now they've got to price it.

Dhirendra Kumar: Now they have to figure out how to make money. But, they might lose customers if they have to make money.

Kenneth Andrade: So maybe first they would have got that customer base. So, for paying customers, if they had gone down the path, they would know what would have been paying customers.

So, you created the customer base. Now, you have to shrink the customer base and become profitable.

Dhirendra Kumar: So you get selective?

Kenneth Andrade: You get very selective!

Dhirendra Kumar: What is your view on gold? Should savers put any money in gold, in any form?

Kenneth Andrade: I think it's an asset allocation structure that is there. And I really don't want to comment on whether it's gold or whether it's equity or whether it's real estate, etc. Every investor has made money in gold, in real estate, in equity, in bonds. And it depends upon the DNA of that investor to maximise the profitability of that particular commodity or cycle.

I mean, people have made enormous amounts of money in art, too. But you have to be selective and get it at the right price.

Dhirendra Kumar: I'm now done with most of the questions, except that I have some questions which is about you. But, one more question. This whole talk about active versus passive funds - the index funds actually becoming mainstream. Do you think, your days are over? In the sense of, you know, you owe it to active management, being selective.

Kenneth Andrade: So, look at passive management. Passive management is about polarising money into things that are doing well. Hmm. I'm doing exactly the opposite.

Passive money is about polarising money into things that are doing well. So if you have the index, which is taking all the money, they are the top 50 companies because they have done well. That creates an opportunity at the bottom end of the structure. So, passive money buys indexation. I buy at the bottom end.

Dhirendra Kumar: It creates an opportunity for you.

Kenneth Andrade: It obviously creates an opportunity at the bottom end of the spectrum.

Dhirendra Kumar: How dangerous is it? Because, you know, the amount of money flowing into passive and it's just very mathematical exercise. This much money goes into the system. And there are lousy companies, and they also get a standard allocation.

Kenneth Andrade: And that's fine. I think it's the market cycle, and that's what diversification does. And even in a passive fund, you get 50 companies in the Nifty50, 100 companies in the Nifty100, and 200 companies in the Nifty200. Not all of them are equally weighted.

So, there are companies that will get enormous amounts of money, and there are companies that will completely get no amount of money. And I am outside that basket. So, what is my endeavour? My endeavour as an asset manager is to find those companies which will go there. If I start with an index of 100, I have to reach that indexation of a 1,000 before those businesses come to Nifty.

Now, what drives 100 to 1,000 is...

Dhirendra Kumar: Growth, return, whatever...

Kenneth Andrade: Exactly! And that's how the skill set of an active manager comes into play. So we will never be out of style. We might be in favour and out of it. But that's a cycle that we would have to take. I mean, there's a risk to a business.

Dhirendra Kumar: How long have been the sad cycles in your investment while you're trying to bet on the cyclicality of investing?

Kenneth Andrade: So 2003 to 2023, I have underperformed the market about four times. Four years.

Dhirendra Kumar: Calendar years?

Kenneth Andrade: Four years, calendar years. Four years, we underperformed benchmarks. So I feel we're okay.

Dhirendra Kumar: And if you get rewarded in the subsequent years, then people don't mind that because one year of waiting is not a big deal.

Kenneth Andrade: Yeah. So, I'm having this conversation with you. I've had customers on my portfolio management and advisory, and we've had almost 30 per cent direct customers when I used to manage portfolios at my previous organisation.

So we've had this conversation also because in the last 20 years, and that's not me alone, but multiple portfolio managers and peer groups have shown the demonstration and ability to come back with performances which are significantly better or better than the underlying benchmarks.

And that's 20 years. I mean, there are investors out there who've done it for longer, but it's 20 years, and hopefully this cycle continues.

Dhirendra Kumar: Now, beyond investing, what else do you do? Do you plan your retirement sometime?

Kenneth Andrade: I plan my retirement, and I plan that around investing. And that's the good part of being an entrepreneur and having your own investment business because this is a business that has no age restriction.

Dhirendra Kumar: Yeah, Buffet is doing it at 94.

Kenneth Andrade: Yes. And the older you get, the fewer mistakes you make.

Dhirendra Kumar: So, with age, you stop doing stupid things?

Kenneth Andrade: Yes. It's like a bottle of wine.

Dhirendra Kumar: Okay. Some contrarian questions. You know, I'm forced to, you know, some of your opinions. If somebody you know is holding a gun to your head and asked to list good things about crypto, what would you say?

Kenneth Andrade: It's a fabulous instrument to do just one transaction. If crypto is available across the world in the same format, I can buy it in Indian Rupees and dig it out in the rest of the world in any currency. It's just the ability to transfer money across. It's brilliant.

And that's the most positive thing. But now, it has to prove itself as a store of value. And eliminate the volatility which comes because of regulation and everything else. If that is possible, like gold, gold has boundaries around how you can transfer gold from one country to another. And if that works out well, I think it's a very legitimate thing to have.

Dhirendra Kumar: It's a nice way of transmitting money. But otherwise, as a vehicle or the way to speculate or intrinsic.

Kenneth Andrade: No. No, no, no. It's got to be an asset. It's got to be a store of value.

Dhirendra Kumar: Lots of talk about influencers and all these people. What's wrong with the broker or the mutual fund using an influencer? Now, you would be a mutual fund, or right now, you are a PMS. And some marketing initiative, and you'll be tempted to use somebody's following to reach out to your audience. So, if it is declared, is it a problematic thing?

Kenneth Andrade: So I haven't given much thought to something like this. But I think what's necessary for the Old Bridge Mutual Fund as we get on this venture is to first look internally to see whether your product is relevant and if it meets investor needs. And then, go through the necessary channels, whether it is a broker or whether it is a fin-influencer or whether it's media.

Dhirendra Kumar: I'm asking more in the context of the SEBI trying to regulate these guys.

Kenneth Andrade: As far as regulation is concerned, I leave it to the regulator to deem appropriate what parameters the content businesses or the influencers have to adhere to for me to participate with them.

Dhirendra Kumar: Thank you very much for all your answers and for sharing your insights with us.

Kenneth Andrade: Thank you. Thank you very much, Dhirendra.