Bulls Interrupted: Indian Investors Don’t Realise We Are In A Low-Rate World, Says ICICI Prudential AMC’s S Naren

Bulls Interrupted is an effort to understand how top investors recalibrate portfolios and investing strategies when a bull market pauses. Because that’s what happened for several months this year. And while markets may have more recently resumed their upward climb, portfolios now face the problem of stark polarisation.In short - when the going gets tough, what do these veterans do?Here’s the second chat in the series with Sankaran Naren, who manages money for India’s largest asset manager.Name: S NarenKnown For: Being a contrarian and value investorWhat He Does: Executive director and chief investment officer, ICICI Prudential AMCWealth-Creating Idea: Bet on metals in 2016 and telecom in early 2019Key ExcerptsOn Polarised Markets.“When markets become polarised, people say that the polarised markets will last and last. I remember in late ’90s. You didn’t need cement or steel or any other sector. In 2007, people felt that all you needed to construct was roads and there was no need for cars, and today people believe that there is need for only the top 10 companies in India and nothing else is needed. These things can’t last.”.On Changes In Portfolios.“I call it the switching model. At some point of time, you don’t talk about selling decision alone. You talk about selling X and buying Y. You switch. Once you move the conversation from selling to switching, the process becomes easier.”.On Return Expectations.“People don’t realise we are in a low-interest rate world. The returns from the market have switched to the risk-free rate currently. But somehow, Indian investors can’t understand lower returns.”.Here are the edited excerpts of BQ’s conversation with S Naren:.You have seen multiple cycles and have seen multiple interruptions in bull runs. Approach the current time, what’s your thesis on how you have looked at the last two years wherein a select band of stocks would have done well but a large portion of market is bleeding or not performing.Actually, if you only have bull markets then, there won’t be any need for fund managers. They can all retire. In the late 90s in the U.S., there was an unprecedented bull market. And in an unprecedented bull market which bordered on irrationality, many rational fund managers lost their jobs. So frankly, you need periods in time when the market cools off. Otherwise what happens is, in the fourth or fifth year, I find that people forget the word risk in any bull market and that leads to problems. If you look at small caps in 2017, people almost forgot the risk of small caps. That was a problem. So, I believe that such interruptions are welcome. In fact, we welcome it with open arms because it is only through those corrections that we realise that there are risks and there is something called fund management..The question out here is this: it’s great for fund managers, people understand the importance of risk management, money management etc. But individual portfolios for a lot of people who take pride in their stock picking abilities, devote time to pick up ideas as well and still have been caught on the wrong foot not because of any other fault but because of the fact that the market has really lit only those few names. It’s something which a lot of people have not seen in the past, but you may have. How are you viewing what’s happening in the past 20-odd months compared to what you would’ve seen in the past?Initially, it was fine. But in my opinion, polarised markets do cause stress and the more and more time the markets remain polarised, the stress goes up on an exponential basis. So, I think, as fund managers, we go through stress at this point in time. Because of these polarised markets. Very often, people say that polarised markets after they become polarised, they will keep on continuing. So, I remember in the late 90s, people used to think TMT steel was the only sector. You never needed cement steel or any of the other basic sectors. You go back to 2007, people felt that, all you needed to construct was roads. There was no need for cars. Today, people believe that there is only a need for the top 10 companies in India and nothing else is needed. So, these things can’t last but while they continue, they cause an agonising stress to fund managers, rational investors, and that’s a part of the job otherwise, investing would be very easy..How do you, as somebody who has seen a lot of these, deal with such situations? How do you approach such a period of time? I am not saying your portfolios are underperforming but say, if a portfolio is underperforming, how do you approach your investing and your mental traits in such a scenario?First, our portfolios are underperforming. The reality is, in 2007 if your portfolio was outperforming very handsomely, most of the persons who outperformed very handsomely they lost their jobs. So, I believe that when markets are irrational, you have no choice but at some point, to say no, I won’t participate in these kind of valuations. So, I think it’s very stressful and the only hope is, in all asset classes, irrationality doesn’t happen at the same time. So if you look at what has happened to me as a CIO, in 2017, we were pretty careful in many of the NBFCs and housing finance companies on the credit side. That madness ended. This year has been this period where we are taking happiness not out of quality stock investing, but we take happiness out of the fact that we stayed away from a lot of absurdities in credit markets and that has helped us a lot. So, 3 years from now, 2 years from now, we will take happiness out of the fact that at the peak of quality cycle, we stayed cautious and we would have stress at that point of time that we were too cautious on credit in 2022. So, I think that’s the beauty of cycles. You have cycles operating in different asset classes at different points on time and that gives you hope that you don’t have irrationality in all the asset classes that you are involved in. For example, the small-and mid-cap irrationality ended in 2017. So we are taking happiness out of the fact that the absurdity is gone and now we have moved to the other model of recommending SIPs in small-and mid-caps because they are no longer are very overvalued and they know they are fairly valued and they justify accumulation at this point of time. So, I think that’s how we balance it and having said that, I don’t have reading glasses, I have full glasses and that’s the stress of diabetes, maybe the diabetes came out of the stress of dealing with these markets..Bulls Interrupted: How Motilal Oswal’s Raamdeo Agrawal Deals With A Polarised Indian Market.One thing is because you are a seasoned investor you know that market is series of crest and troughs and at some point, of time you know that this will end. But for some people that pain hasn’t ended. What do you tell yourself in such scenario, do you tell yourself that this will end at some point of time and therefore be patient or is it difficult for you as well?See, number one, it is difficult for me as well. Number two, everyday when you are going home you ask yourself is this the way you would manage your personal money and since I believe that this the way I would manage my personal money and I say that what my guru James Monteir says, “To do what you would do with your own money with others people money”. But the fact is that you are dealing with other people money and other’s money means stress on you and there are questions we are exposed to. But that’s the part of the job. In 2007, I had funds which were underperforming very substantially. At that point of time I have tried to answer a lot of questions and I believe that, similarly we have to answer a lot of questions because finally, in the long run markets are rational. It is just that whether you are able to handle period of irrationality and periods of irrationality will always come, otherwise there are not markets..In earlier conversation I was talking to Ramdeo and he mentioned a point on which I will take your view as well. He said that no matter what you do as an investor, all the precautions that you take, market is a beast where risk will find its way in your portfolio and punish you. You can at best try and mitigate some of those loses and try and deal with these rationally. So, because you have done this so many times what did you in 2007 to the mental framework, are you doing it slightly differently 10-12 years hence?I think, what happened is ICICI gave me this opportunity to be CIO so due to that now I am involved in wider variety of things. I have also encouraged many of my colleagues to have more than one fund so that it helps them to handle these irrationalities better. So, if you look at dynamic asset allocation category, markets have been beautifully volatile in the last 2 years that if you look at all the dynamic asset allocation category funds and hybrid funds the returns have been very good. So, that is something which does reduce my stress. I believe that one of the advantages that we have is that we are not focused on one style, we are not focused on one category. We are present in all the categories and we have categories where we are doing very well at this point of time, despite the quality outperformance and there are some categories where we are not doing very well because of the same problem. I think, you widen your universe of what you are looking at and hope that you don’t have irrationality in the entire universe and that is what has happened at this point of time. In 2007 also, I was having trouble with many of my funds, but infrastructure was doing very well so that showed that you have to actually widen your universe then you are able to handle public money much better. In fact, if you look at what the Warren Buffett does, he is running a closed end vehicle. Because he is running as a closed end vehicle, he doesn’t have people exiting and the money that is left with him, it doesn’t go out in any bear markets. So, that’s why in 2017-2018, we had many closed end funds that was also something which was there at that point of time. I believe, you have to do number of things. If you look at it, certain things work, certain things don’t work. If you do many things at least few of them should work..How easy or difficult it is to one, recognise not necessarily a mistake but something when market is not rewarding despite fundamentals being at place and we have had number of cases like this in last 18 odd months. And then how easy or difficult it is to take the call to replace that because may be the fundamentals may tell you that this has to work at some point of time, but due to whatever reason it is not working. I am not talking about your portfolio, I am talking about in general portfolio, how easy or difficult it is to take that decision?I call this process buckling. That at one point of time you say I have to buckle and sell off this mistake or I have to buckle, and I say I have to buy this stock. It is never easy, and I always say that it takes more stress on you. I try my best to buy a stock where I was wrong after recent underperformance. So, what I say is I forget that this stock has done well in last 3-5 years, but in the last three months it has done very badly so we can actually use that opportunity to buy or vice versa. So, I do try somethings, but investing is not that easy, it doesn’t come with zero stress. The best way to reduce stress is what we came up is dynamic asset allocation but otherwise stress will remain. I don’t think that you can completely remove the role of stress in investing unless you have a very long-term approach or else what I feel if you are unemotional about investing, then handling stress is bit easier. It is not easy to be unemotional about investing because finally you have to recognise that we are managing other people’s money. So, if you are sounding very unemotional, it sounds like that you are not caring for their investment and that is not true. But the best way to invest is to be unemotional. So, when Warren Buffet in 2008, invested in Goldman Sachs and GE, he was unemotional. If he was emotional, he would have been caught up by entire bearishness and turmoil which was there at that point of time. So, the tough job for us is that we have to act unemotionally, but at the same time we have to clearly communicate that very much concerned about all the other people money that we are managing at that point of time..One is that maybe you identify that there is a mistake that has happened and find and correct that. The other thing is when a call for a theme for example that you embarked upon doesn’t work not because the thesis is wrong but because the markets for whatever reason in its wisdom is not rewarding it. What do you do?You are right and for that I believe in a switching model. That at some point of time you don’t say that I am selling share ‘X’ and buying share ‘Y’, you don’t talk about the selling decision only. You look at I am selling shares of ‘X’ to buy shares of ‘Y’ and I evaluate the switch. So, we have discussions, can I do this switch and once you move this conversation from selling to switching, I feel that you have a more balanced approach and that enables you to take better decisions. So, I think, there is an agonising process which is happening at this point of time. The agonising process is not so bad because right now investors haven’t lost money. They have actually not made money. The bigger problem is when you have years like 2008 when investors have lost money that becomes much more agonising. Here, now people come and feel okay that we have not made enough money. So, frankly, that is the kind of challenge that people have. One of the big challenges is that people don’t realise is that we are in a lower interest rate world. People don’t realise that the amount of return that you get on the bank FD, which is the safest way to invest, is much lower than before and the returns that you should get from the market is linked to that particular risk-free rate which is the state bank FD for example and against that is what you have to consider returns. People still think that they are in 90s where inflation was in double digits, but we are not there we are in much lower return. So, there is lot of challenge which in my opinion as a company we try to communicate because communication is one the best ways to actually communicate this data to people and continuously communicate. So, we keep doing monthly calls without fails for long periods of time because the process of communication is one way of handling the stress..Would you believe that if the markets reward investors, the rewards have to be measured in the line of what we said the lower risk rate and therefore a return which may not be as good as 2003-2004 but lower than that should also be accepted as a roaring bull market?Absolutely. I think, it is one of the biggest tasks at this point of time that unless the government /RBI say that we go back to older inflation model to reduce the return expectations of the investors is one of the biggest challenges we have at this point of time. Today also there is a set of IFAs from Karnataka who had come. To tell them that you have to forget 2003 to 2007 that is a superb dream, but that dream is not there, but you have to believe in lower return world. In other parts of the world you have negative interest rates. Indian people can’t understand lower positive rates. So, just imagine if you are in Japan and Germany and you have negative interest rate what you would be in. So, I think, there is a lot of challenge and that is the part of the job and that gives me the thrill because I have to explain it so many people that the world is different from 2003 to 2007 and we are in a different world and how to communicate to the different people, how to make people understand that. These are all big tasks which I find interesting but not easy..What do you think should be a base case or acceptable rate of return for an equity investor for the next five years?I think, you will be surprised what is 10-year Nifty return today. It is 9.7 percent including dividend, I think. So, that is the kind of return which has been achieved in last 10 years by Nifty. If you talk to any investor in the market and tell what was the 10-year return they will talk about 12-15 percent automatically. But the reality is that the large cap index has given, including dividends, less than 10 percent per annum over the last 10 years. And the fact is that it is easy to talk about high returns, but you know when you can talk about high returns, when you have valuations in comfort, and you have blood on the streets. If you have this combination, I am comfortable talking about high returns. If you don’t have these two it safer to actually talk about last 10-year return. I don’t think that the last 10 year is something that people intuitively think that is a number. If I would have done a blind-folded guess, they would have all given different numbers none of them would have been close to 9.7 percent..You spoke about having taken bets on telecom; I don’t think too many people took bets on telecom. Now in hindsight the moves that have happened despite blood on the streets, the stocks have given good returns. But how do you handle going public with a bet and then seeing it not go according to plan, but having conviction that it will go as planned at some point?Actually, in telecom it is much easier. If you know that you are so dependent on your phone and without WhatsApp you cannot handle your daily routine, so you know you don’t worry. Frankly, it is such a basic product, so I believe that as I mentioned to be successful as an investor you need to know when to be unemotional..So you are unemotional about it?I would not say that, there are people much better in this. But I am trying my best. I believe that you have no choice but to be unemotional if you want to make very good long-term returns. You have no choice. For the last, I would say almost two years we have been telling people that you have to invest in ICICI Prudential Debt Fund and at that point of time people would actually say invest in small-cap. But the reality is if you look at two years returns on ICICI Prudential Debt Fund they are far superior than what you would have got into the mid-cap fund or small-cap fund. The challenge of investing is to be unemotional and practical asset allocation and if you are able to do that in the long run you will be able to make good money..What happens in that intermediate period wherein you are convinced about the bet. You would have taken that bet and you would have thought that at some point of time they worked beautifully, and it probably will but for that intermediated period. What do you tell yourself? You tell yourself to exercise patience because it will come at some point of time or will some doubt creep in for some time as well?No, doubts don’t creep in. Stress will creep in, but doubts don’t creep in. That’s why I like part-time investors. In fact, Warren Buffett says, “I have been a better businessman because of my investments, and I have a been a better investor because I have spent more time managing business.” Because the reality is that if you immediately buy a stock and you keep looking at that stock and I am into full time investing, what happens is that you are tracking every day. Whereas if you invest and if you are busy let’s say in making software programmes or producing news programmes, you are possibly in a better shape because you are not tracking every day. The day you are over-focused on looking at your profit made on your daily investment that becomes a bigger problem. That’s why historically day traders have never made money because they are too focused on what they have done whereas the best people are the long-term investors who do not look at their investment. Because it is not that all that their investments get right but the few investments where they have got right, they have made extraordinary sums of money..What about spaces which do typically very well. You take a bet and it worked out better than you thought. How easy or difficult is it then foot off the gas saying it has run its course.It is not very difficult. In fact, I would say that I have moderated my style of booking profits and doing it in much more in steps. But for me to book a little bit of profit in something which has worked for me is not at all difficult. In fact, I went through framework where I was worried that I was booking profits too quickly that is what I have to curb, so it is not the reverse. And even today I have noticed in my portfolios, I have booked profits and I believe that I have a model which says that if you book profit you never go broke. So that is why I never had that worry. The reality is, if you look at it even some of the quality stocks that I don’t have in my portfolio, I had bought them. But today in retrospect, the selling discipline, I have actually sold them earlier and after I have sold them, they have gone up..You are saying that you have taken profits off but may be what happened in 2017 and beyond could work this time as well. Because at that time it felt that not being in NBFCs was painful but two years out it is actually proven wrong?Yes, I hope so, but it was based on my 90s experience. Back in 90s there was a long bear market in all the stocks except technology stocks between 1995 and 2003. And in that bear market I actually realised that if you don’t sometimes book your profits, they may go away. After that I had a model which was always book a little bit of profits. So, that’s why for me I will say that the challenge is never that of booking profits, challenge is whether I booked profit too early. That’s what my colleagues whom I do joint fund management with, they basically ensure that they keep saying this is the fair value we have to wait till then actually my co-fund managers help me..What is your favourite bull memory?Two bull memories which I will remember as long as I am in good shape. In 1989, LMW was trading at Rs 400 at one-time cash earnings per share and it went from Rs 400 to Rs 14,000 in 1994. When I met a person and asked him why this trading is at 2 price to equity ratio, he said this stock always trades at 2 P/E. And to watch it go from 400 to 14,000 was something which gave me a lot of happiness. The second was late in 1989 when I had worked on sponge iron industry and at that point of time all iron ore sourcing was done through a mine called Bailadila in Chhattisgarh. In 2001, I was very amused to find that the company which owned a mine was trading at less than cash, which was NMDC. It meant the mine which supplied the iron ore to the entire sponge iron industry was available free of cost in 2002 and from there the shares went up 500 times. That’s why if you ask me, post-2008 thanks to internet and thanks to all the work that all of you do, I read Howard Marks and realised that there is something called cycles. I realised that you have always have an extreme bull cycle and an extreme bear cycle. And to gather the guts to invest in extreme bear cycles is what leads you to maximum profit. And it is important to be cognisant of the cycle. So, each cycle doesn’t operate in the same way. If you look at 2013, small-and mid-cap were at a very attractive part of the cycle and real estate was in the very dangerous part of the cycle. So, I believe that different asset classes have different cycles. That is the reason why asset allocation works very well. So, you focus on cycle and asset allocation you have made substantial part of the money. Will you always go through frustrating period? Yes, you will go through frustrating period but at the end of the day you will make money in the long run that’s why we all are in the market for..One bearish move which have taught you most important investing lessons?I think, in 2007 I knew something was going wrong, but I did not have the capability to explain why I was feeling uncomfortable. And when 2008 happened I realised that there is a role for top down and bottom up and you can’t be just bottom up. Because bottom up sometimes doesn’t explain all the problems that are happening in the market. They are all bottom up and top down. Look at 2017 and look at all the aggressive NBFCs you won’t have realised the problem unless you said that there is a cycle and people around you like what Warren Buffett said, “People around you are taking risk that they should not be taking and therefore you should be cautious.” Otherwise in 2017 it felt that the most aggressive financial services companies will take over the world. But that didn’t happen. The challenge is that you should be unemotional, you should be able to handle the cycles better. It is not something which is easy but if you keep working on it may become easier. But still you have to remember you are handling other people’s money and when you are handling other people’s there is a certain responsibility which comes with it and that challenge will always remain in the job that we do.

Bulls Interrupted: Indian Investors Don’t Realise We Are In A Low-Rate World, Says ICICI Prudential AMC’s S Naren

Market veteran S Naren explains why you need to manage expectations in polarised markets.

Choose a plan