Seeking value in fear

S Naren puts his faith in out-of-favour stocks with good long-term potential to make money

The CIO of Equity at ICICI Prudential AMC, S Naren, has had a good financial year 2009-10. Two of his five funds (Discovery, Tax Plan) have been category leaders over the last couple of years. The Discovery Fund, which focuses on value buys, for example, has been best performing fund over the last one and two-year time frames returning 144 per cent and 31 per cent, respectively.

Equity diversified funds have given an average return of 82 per cent and 9 per cent, respectively over the same periods. Naren believes that investing in stocks and sectors which have potential but are going through a lean patch is the best way to make the most when the bulls come roaring back as is the case now. This is why he has been able to move ahead to top of the charts for some of his funds. While it is easier to make money when the markets are on song what factors does he foresee will hold key if the current rally is to be sustained and what kind of strategy should investors adopt?

Spread your bets
Naren believes that the key factors are favourable monsoons, movement of crude oil prices and whether the government favours investment over consumption. Investing in infrastructure bodes well over the long-term while a strategy to boost consumption (through stimulus) is a more short-term step, he says. Further, neither interest rates nor debt on the books of companies is a case for worry, believes Naren. Compared with the situation a year ago and barring a few real estate and aviation companies the rest of corporate India, he says, has been able to raise money via the equity route. He is of the opinion that a rise in markets has meant that investors would be best served by a ‘combination fund’ which brings together large, midcaps and small caps avoiding sector and market cap biases. He says, “Go with a multi-cap conservative strategy because market is at the higher end of fair value currently.” While a multi-cap strategy could be a good idea for now, what guidelines should investors keep in mind before picking up stocks?

Seek value
Naren picks up scrips when there is fear in the market and the stock goes out of favour. He cites the example of a sector like telecom in October 2009 after the tariffs were brought down. He says, “You had a situation where the sector was cheap (and still is), there was a lot of fear and you knew three years later competition has to come down. That is the model which people need for investing.” The world’s best investors, he says, have all been those who have invested in fear. Warren Buffet, for example, had $20 billion of cash in 2007, now he has $10 billion in debt. “You have to invest when there is some amount of fear and keep the faith,” he says. Of course, he likes a majority of investors to practice asset allocation and SIP so they remain invested through good and bad times. For the remaining who believe in timing, his advice is to invest when they see value and fear. “How many have the guts to invest when there is value and fear?” he asks. He also urges investors to look at track record especially the company’s performance over a down cycle.

…and growth
But investing in value does not mean you don’t look at growth. Giving an example, he says, “One year ago, technology was available at reasonable valuations but also had growth and so it delivered good returns. Last year after the technology guidance came in it was a hated sector. But, it has delivered good returns in the recent past. According to him, “The best returns come when you can identify a growth sector available at cheap valuations.”

Beyond corporate governance
While evaluating companies he believes that business prospects are more important than management quality-related parameters. “Between 2004 and 2007, I invested in companies which had good corporate governance. While I got good corporate governance I did not get stock market returns.” He believes that the best returns sometimes come from companies and sectors which are perceived to be dogs. He cites as an example the steel sector between 2001 and 2003 which was trading at attractive valuations and nobody wanted them. The sugar companies, too, were multi baggers. He says, “The weakest ones may have gone up many times more than the best managed ones.” While management quality is important, valuations and growth have helped him reap the gains.

Past bets
In 2007, he invested in domestic pharmaceutical companies. The irony was that immediately after the investment, the sector underperformed for six months. The investment logic was that medical care was an absolute necessity and this was a defensive sector (is less affected by recession) and it was at attractive valuations. “Such has been the returns the sector has generated since then that it has made a material difference to my portfolio,” he says. Cadila Healthcare which has been touching new high of late and Ipca Laboratories are some his holdings in Discovery Fund. He also was able to cut his losses when crude oil prices touched $100 a barrel. Naren liquidated his holdings in all commodity stocks in some of his schemes and that helped. While he missed the last leg of the upsurge, when commodities finally tanked last year his funds were not exposed to the dip. He also has his share of mistakes but he has been able to limit them because he looks at everything with a sceptical eye. “Because of this there is lesser chance of things not happening,” he says.

Infra focus
Naren believes that the next one year is the time to invest in infrastructure theme. He says, “By next February you will have a situation where the stimulus will be withdrawn. Once the stimulus is withdrawn, the government will have money to invest in infrastructure. March 2011 to March 2014 will be a golden period for infrastructure. Investors took a fancy to the sector in 2007, whereas the next one year is the time to invest.” The best period to invest, he says, is after an underperformance not when the stock has given good returns because then the risks are a lot higher. Infrastructure has underperformed from 2007 till this year. For the next one year he believes that it is a theme with much lower risk than in 2007. The other theme Naren strongly backs is exports. He believes that any sector that helps bring down the trade deficit will do well and export-oriented sectors like software and to an extent, pharmaceuticals are good long-term bets.