“You got a temper. I like that,” he winked. “I get where you’re coming from, Changez. You’re hungry, and that’s a good thing in my book.”
I did not know how to react. But I was impressed with Jim; he had after all seen through me in a few minutes…I could understand why he could be effective at valuations….and why by extension his firm had come to be highly regarded. -From Mohsin Hamid’s The Reluctant Fundamentalist
Temper and hunger – attributes Jim liked in Changez before picking him for the job – may well be the attributes a fund manager would like to have in a mid-cap company before picking it for his portfolio, to ‘spot the potential early’.
Chirag Setalvad, senior fund manager with HDFC Mutual Fund, loves reading books. But, he feels it is important to look for some application in what you read to what you are doing. “Otherwise it becomes recreation,” he says. Chirag is currently reading The Reluctant Fundamentalist. He loves going scuba-diving in Lakshadweep once a year. He likes travelling a lot. And these days, he’s busy as his fund house has launched a new scheme called the HDFC Midcap Opportunities Fund – the first one in 18 months – that he would be in charge of. Setalvad spoke to N Sundaresha Subramanian and Khyati Lodaya on mid-cap scene, his approach to fund management, his experience with a hedge fund, his favourite books and his plans for the new scheme.
How do you see the mid-cap scene now?
It looks very interesting as right now, the mid-cap part of the market is being ignored. Keeping aside the last one month, when they have come back a little bit, in the last two years, large caps have done very well, as a result of which valuations in the mid-cap segment are a lot more interesting. Also, we find mid-cap companies are growing faster than large-cap companies. If you are stock selective, you can find high quality mid-cap companies. There is a perception that mid-cap companies are weak and don’t have sufficient market share. It is interesting some of India’s strongest companies are mid-cap companies. India’s largest AC company, Blue Star, is a mid-cap company and so is the largest battery company, Exide. We are all familiar with the big names… we know Maruti. We sit in our Maruti car and think only Maruti. But, if you look around the Maruti itself, you will see a lot of mid-cap companies. Asahi India makes the glass, Exide makes the battery, Subros makes the AC. We don’t realise so many other components are manufactured by these companies. A lot of mid-cap companies are incredibly well-run. They have strong business characteristics – the managements who run them are also very good. They are growing faster and are available cheaper.
What is your strategy for the mid-cap fund? Will you have a concentrated allocation?
We are hoping to raise more than Rs 1,000 crore. The scheme wouldn’t be excessively diversified and we will have 40-45 stocks, of high-growth companies growing at a decent rate and available at reasonable prices.
Do you think the money you raise will be of the optimum size, considering some of the larger mid-cap funds are finding it difficult to deploy the money they have?
At Rs 1,000 crore, there will be no issues with respect to size. We have created a model portfolio. What we have done is for the companies in the portfolio, we have seen what the trading history has been in the last six months. We see the average traded value in the market; we assume a market share say 30% of the trade value. We see how long it will take to build up a position. So, assuming you are taking Rs 1,000 crore, it cannot be done immediately… may be over a couple of months. It also depends on market conditions. Is the market running away? Is the market collapsing? If the market is collapsing, it may be easier to invest from the mindset point of view, but difficult from liquidity point of view. If the market is running, it may be easier to invest from the liquidity point of view and difficult from the mindset point of view. So you got to balance those things out. Ultimately, I feel Rs 1000 crore is fine, there won’t be much difficulty in deploying it.
Are you looking at the unlisted space for your new fund?
We will look at all listed entities only. Investing in unlisted firms is a very different style of investment. The private equity requires lot of involvement in the management of the company. It’s a very hands-on style of investment. We find it very difficult to mix the two.
What are the parameters you look for when you are picking a stock?
Three or four things, basically. We are looking for businesses that are easy to understand. We are trying to stay within our circle of competence. We are looking for businesses that have strong underlying characteristics in terms of the industry they operate in, cost positioning and market share. It’s a combination of looking fundamentally at the business in terms of people who are managing the business and what price we are getting it at.
What stage do you decide to meet management of a company?
It depends. In certain companies, more information is available, and some companies are not transparent. Now, if you look at an IT outsourcing company, it’s a well understood business model and so you can invest without doing much incremental work. But in IT product companies, the business model is not very simple. We need to speak to the management to try and understand it. In all cases, you want to speak to the management. If it’s easy to understand, it’s only easier to make the decision.
Fund managers can’t resist quoting the Bharti example when selling the mid-cap story. Who do you feel the next Bharti is?
All large-caps were mid-caps at some point of time. I do not think we have to find the next Bharti, if you find a good business which will grow at an above average pace fairly consistently for a long period of time. It is very difficult to identify the next Bharti because companies which have the potential tend to be fully valued. What happened with Bharti was that people did not realise that it is going to be next big thing. The IPO was priced at Rs 45 and people were hesitant to buy as you don’t know what exactly is going to happen to the stock at the time you buy it. Given this, you don’t have to get multi-baggers all the time. If you populate your portfolio, put 45 stocks and are thorough with your research on those 45 stocks, some of them will end up being multi-baggers. But it’s difficult to say at the beginning itself which one of these will be the multi bagger.
So how do you spot potential early?
You don’t start off thinking this firm is going to go 10 times. It’s just that you buy a really high quality firm and it continues to surprise time after time. The idea is not to buy dirt cheap. Because very often, such firms face inherent problems, structural problems, so we are happier to pay a little bit more for a high quality business. Even internationally, some of the great investors like Warren Buffet have moved away from the idea of buying dirt-cheap, deep-valued to buying higher quality firms with higher growth rates that tend to surprise you positively, and realising that if the surprise compounds over a period of time you make lot of money.
You have worked with both hedge funds and MFs. Which one of the two do you like better?
You can see me back with HDFC MF. That should answer your question. Hedge funds have a different mindset than MFs. You are looking at absolute returns vs relative returns. You are supposed to hedge a portfolio considerably. You are not looking at a benchmark. Hedge funds tend to be more short-term oriented in their investment philosophy, which is what I was trying to do when I was there. You also have much more US-centric approach to investing and driven by quarterly estimates, mini consensus etc. That kind of approach – there are good and bad things in that. It’s not all bad. I learnt a lot there and I’m trying to apply that in the MF context. But, the fact that it’s short-term oriented and trading-oriented, that’s something I see as a negative and that’s the reason I decided to leave the hedge fund.
Are you glued to the market day to day?
Not at all. How does it matter what happens on a day-to-day basis, except for the fact that you can take advantage of short-term volatility. There is a saying that market in the long-term is a weighing machine and in the short-term a voting machine. The market will constantly vote back and forth. It can go up and go down. So, you can get too bogged down and involved by that.