Veteran CIO warns against popular yet dangerous argument

E A Sundaram

ED & CIO – Equities

DHFL Pramerica MF

  • Even as many fund managers rationalise high PEs for high quality stocks, Sundaram warns that this is a dangerous argument – and showcases a single chart that challenges popular wisdom
  • An early sceptic of the NBFC/HFC bubble that built up through 2017 and fizzled out in recent months, Sundaram spells out what kept him away from this segment through its heady days
  • For investors grapping with the choice between equity funds and equity PMS, Sundaram offers a clear framework to guide them make sensible choices

WF: What is the core philosophy that influences your stock selection and portfolio strategy in your PMS offerings?

Sundaram: A PMS should always be positioned and sold as a product that is complementary to a mutual fund. A mutual fund would always be the first-choice capital market investment vehicle for a great majority of investors. Therefore, any attempt by a PMS to position itself as a superior alternative is not going to work, at least not sustainably.

That said, a PMS should therefore think of building an investment strategy around areas where a mutual fund would find difficult to go.

Done this way, a PMS would create a portfolio that does not have a major overlap with that of a mutual fund, and therefore meets the diversification need of the investor.

Each PMS tries to meet this need through a different method.

In our two PMS offerings, we first focus on quality of the business, its track record of the company and above all, its continued ability to compete, but purchase the shares when the company concerned is going through a period of difficulty. That way, the share price offers us an attractive entry price. Buying a good company “at any price” would not lead to a satisfactory investment return.

Our Deep Value PMS is a multi-cap PMS focussing on very well-established companies with a strong track record. Our Phoenix PMS is a mid and small cap PMS.

WF: You were very circumspect since 2017 on NBFCs and other sectors which, with the benefit of hindsight, appeared irrationally expensive. While you must be feeling very validated with the turn of events, it will be very interesting for us to understand how you try to distinguish irrational exuberance from genuine growth premium.

Sundaram: There were several points about the NBFC sector that deserve mention:

  • The valuations of some stocks in the sector had become more than 3 times the last 10-year average.
  • The valuations of some stocks had risen to levels not seen even by blue-chip banks and financial services companies worldwide
  • The number of competitors in the NBFC space and Housing Finance space ballooned in the last 2-3 years, and most of them wanted to grow their loan book by more than 20% per annum.
  • When one is excited about the demand prospects for a sector, one should not underestimate the potential supply in that sector.
  • The last few months have seen hardening of interest rates, making it potentially more difficult for NBFCs to attract lower cost funds compared to the banks.

These were the reasons that we had stayed away from the NBFC/HFC space in the past several months. Of course it was not within our ability to correctly predict when the correction would come. But we have witnessed a similar situation in the TMT space in 1999-2000, in infrastructure/real estate/power in 2007-08 and in mid-caps/small caps in 2017. “History doesn’t repeat itself but it often rhymes”

WF: Quality stocks are still expensive, even after the recent correction –at least by historical valuation standards. Are high PEs the new norm we must expect for good quality or is there need for us to remain cautious with these high quality –high PE stocks?

Sundaram: We think that this is a dangerous argument. For a start let’s look at the following chart depicting the PE history of a blue-chip stock like Hindustan Unilever since Jan 1996:


The above chart is for understanding purpose only

The HUL stock, which enjoyed a PE of more than 60 in late 1999, saw the PE slip to less than 20 in 2003-2004. Similar PE corrections have happened to other blue chip stocks like Infosys, Colgate Palmolive, Sun Pharma and Maruti, besides several other stocks. If this can happen to HUL, it can happen to the stock of any company. A belief that “high PE is the new norm” is a recipe for investor heartburn.

This is not a recommendation/an offer to sell or solicitation to buy any security

WF: What are the strategies you offer in your PMS and how has performance been over 3 and 5 year time periods?

Sundaram: Presently we offer 2 PMS strategies, the Deep Value and the Phoenix. Their respective investment performances are as follows (as of 31st October 2018):


The Phoenix PMS will be completing 3 years in August 2019.

WF: What are the themes that appear most attractive to you from a 3-5 year perspective?

Sundaram: These are the themes that the two strategies are betting on:

  • Industrials (engineering, industrial ancillaries)
  • Agriculture-related (companies that can enhance agricultural productivity)
  • Selected pharma companies
  • Better quality real-estate players
  • Utilities
  • Selected banks

WF: Are we done with the correction –can we look forward to a smooth equity journey in the new Samvat Year?

Sundaram: The equity market will never be “smooth”.

WF: For HNIs who can consider equity funds and PMS, what factors should govern the choice between the two?

Sundaram: A HNI should definitely consider both. What is important for the HNI to consider are the following:

  • Be clear about why the investment plan is made. For this, very specific goals are needed to be articulated. “Making money” is not a goal.
  • Have very clear ideas about the time in which these financial goals would need to be realized.
  • Based on the above, finalize the asset mix of debt/equity etc.
  • Within equity, take care to choose funds/PMSes that have different approaches to investment. This is vital to ensure diversification within equity, so that the client does not end up having replicas of the same portfolios.
  • A different approach to investment would mean a different trajectory of return. This means that some product would “outperform” and some would “underperform” at any given point of time.
  • A temporary underperformance is OK as long as the process followed by the fund manager is logical and this has to be verified periodically.
  • It is vital that, as long as the fund/PMS is sticking to its stated mandate, the client does not shuffle the products just because there is temporary underperformance. If everybody tries to “outperform” at all points of time, everybody will end up with the same portfolio, and this is not in the client’s interest.
  • A fund or PMS needs to be changed only if (a) the fund manager does things contrary to the stated and agreed mandate of the product or (b) if the performance is significantly below the benchmark index for three separate years in a row.

Past performance is no guarantee of future returns. Return for period upto 1 year is absolute. Since inception date stated is considered to be the date on which the first client investment was made under the strategy. Please note that the actual performance for a client portfolio may vary due to factors such as expenses charged, timing of additional flows and redemption, individual client mandate, specific portfolio construction characteristics or other structural parameters. These factors may have impact on client portfolio performance and hence may vary significantly from the performance data depicted above. Neither the Portfolio Manager, nor its directors or employees shall in any way be liable for any variation noticed in the returns of individual client portfolios. The Portfolio Manager does not make any representation that any investor will or is likely to achieve profits or losses similar to those depicted above.

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