Why cheap stocks offer more safety than strong inflows, says Sundaram AMC MD

Do you reckon the market correction is on its last legs?

Even though the market peaked in September 2024, the earnings for the broader market did not peak. Typically, markets and earnings cycles go hand-in-hand. Market cycles usually lead the earnings cycle. When the corporate earnings cycle is going to come down, the market will also begin to fall six months before. Very strangely, the domestic earnings cycle has remained fairly strong this time, even as markets have declined, leading to a meaningful correction in valuations. Large-cap valuations have fallen below pre-Covid levels, indicating that much of the earlier froth has dissipated. This sets the stage for a reasonable period ahead, provided companies continue to deliver double-digit earnings growth.

For now, earnings momentum seems to be continuing. A small worry is the impact of elevated oil prices and rising global interest rates on future growth. Even if rates remain higher for longer, it may not drag down growth much. Therefore, I feel the market is now available at very moderate valuations.

What do you make of the nature of money flows?

It is important that money flows—global and local—need to readjust. Global flows are still flowing towards the artificial intelligence (AI) trade. And India is not on the positive side of the AI trade. We need to look at when the current AI trade is going to peak. Domestic flows have been largely concentrated in mid- and small caps. We saw record inflows into mid- and small-cap funds. Large-cap fund flows are very marginal. That is leading to lack of strength in large caps. It has almost distorted the entire picture. What makes an investment safer? Valuation is the primary factor of safety. When you buy something cheap, you are safe. When you buy something expensive, you are unsafe. Flows and momentum do not provide safety. Once that becomes clear, the domestic flows will reorient and market will slowly rotate.

Sundaram MF is known for its capabilities in the mid/small cap space. How are you navigating this segment amid big inflows?

Our market share of flows is very low. So, while I am generally conscious on excessive flows into these segments, I am not worried about our funds getting those flows because our assets under management (AUM) are relatively very small. We do monitor whether monthly flows are crossing a particular threshold level. If they are less than 2% of the fund AUM, I am not too worried. In fact, that is an internal policy on how much flows we have to maintain. So, because of our relatively small size, it’s not a company-specific problem. But it may bring a wider set of problems (distorted valuations, capacity constraints).

How will the global interest rate reversal impact Indian markets?

Global interest rates are at multi-decade highs—two-decade highs in the US and Europe, and a three-decade high in Japan. Fortunately, in India, interest rates and yields are around their 10-year averages, unlike in the US, where longer-term bond yields are significantly dislocated. As long as Indian interest rates remain broadly within their historical 10-year average, we should not face a significant problem.

The sources of inflation in India and the Western world are different. Indian inflation is largely driven by food and energy, while Western inflation is predominantly driven by services and wages. Labour markets in the West are tightening as countries try to relocate jobs back to their domestic markets. Wages are unlikely to decline, which is why US inflation remains sticky. Inflation in the US goes beyond commodity prices, and this is unlikely to change unless policies of localisation and deglobalisation are reversed. If inflation remains sticky, interest rates will remain elevated.

The US government is still borrowing a lot of money, running a high fiscal deficit. Traditionally, this was funded by capital inflows. Now, there is a bit of resistance to buy government bonds. That is the reason for the spike in bond yields. The term yields which people are expecting from the US has gone up. And that is a very different problem.

As long as the Indian inflation remains cyclical and not structural, I don’t think the spillover effects of the global higher interest rates will be high. But having said that, an allocation change can happen. Higher interest rates will also lead to higher discounting rates, and therefore, lower valuations. And they will have a second order effect on Indian markets.

What are the themes you are finding compelling now?

We have been positive on manufacturing sectors coming back to growth. After a decadal period of slow growth, many of the Indian companies are now getting strong orders. Today they are at an all-time high, in terms of order book. A catch-up trade in manufacturing is happening. There is a window of opportunity for Indian manufacturing to come and establish its relative competitiveness.

The second trade is on the tech space. Traditionally, tech in India is software services, which is on the receiving end of AI. They will be disrupted by AI first, before the opportunities of AI creates business streams for them. However, I believe this transition will eventually happen, with positive order flows from corporates as they adopt AI on a wider scale. But non-traditional, new age tech businesses, including fintech and quick commerce, offer innovative business models that are gradually scaling up. There is a strong pipeline of ideas in this space. In the consumption space, we have seen an upward shift from buying value-for-money to premium goods and services. Wherever premiumisation is gaining traction, with consumers willing to move up the value chain, particularly in segments like fashion and jewellery, we believe companies can deliver relatively stronger growth.

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Fourth is the financial services space. Traditional lenders have gone through a tough period. We feel that non-lending financial services, like asset management companies, capital markets and wealth management, will continue to grow reasonably well. There could also be a cyclical shift towards lending institutions over the next year, with PSU banks, private banks and NBFCs potentially making a comeback as their valuations have normalised.

In moving from Franklin Templeton MF to Sundaram MF, what changes in investing philosophy and framework have you sought to bring in?

Sundaram Asset Management has been a capable fund manager for more than 30 years, and has participated in various innovations in the market. A challenge they had was of the consistency of performance over cycles. In some cycles, the funds did very well, and in others, they didn’t do very well. So, one of my earliest goals was to improve the consistency and we worked hard towards it.

We have strengthened the team by adding more analysts and fund managers. We have also revamped certain processes, including how stocks are selected and how long they are held. We have made meaningful changes to the breadth and depth of stock coverage, how investment ideas are reflected in portfolios, and the pipeline of our best ideas, while improving the rigour behind the entire process. Ultimately, it is all about how rigorously you pivot to the fundamentals, and how quick and fast you adapt to the trends. Second, having the right balance or approach was critical. There were a set of fund managers who were excessively leveraged towards quality, another towards growth and a third set who were overpaying for quality and growth. Everyone had a different point of view. We have tried to realign and come to a common ground. We spent a lot of time in our first year trying to reorient and come to a common understanding so that we avoid divergence in style. As a fund house, we now follow growth-at-a-reasonable-price (GARP) across products. We want to buy growth without overpaying for it or compromising on quality. Equally, we want to buy quality without sacrificing growth.

The effect is that many of our funds are now improving in performance. I think the distribution community and investor community are slowly noticing it, and it is showing up in flows. Having said that, we have not achieved everything that we set out to achieve.

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As a mid-sized AMC, what differentiation do you hope to offer?

I feel there is an opportunity in the market for AMCs which are mid-size, disciplined, and consistent. People don’t want to buy very large funds, undisciplined or unpredictable fund management or inconsistent performance either. If three of these pillars align, the bulk of our battle is won. At our size, we have the ability to change our positions fast enough. A very large fund may have 120-150 names. We may have around 40-60 names in a typical portfolio. We are still compact in ideas and able to put more money in ideas which we have a better conviction on. We are also able to make changes to the portfolio, as and when our view changes.

When the view changes, you should be able to change your position in the portfolio. When you are not able to do it, you start resembling a passive fund. The size becomes an inhibiting force on being active. I think we are far away from that. That is a good headroom for any fund manager to grow into. That advantage remains for us. In some pockets we are able to convert it into better performance. In some other pockets, we are yet to show that.

With its maiden Specialised Investment Fund (SIF) offering, Sundaram AMC has chosen a different route than many others who have started with a hybrid SIF.

The regulator has provided a clear mandate that India needs to develop a very healthy ecosystem where pure long strategies should co-exist with viable, long term long short strategies, which reduces the overall volatility in the market. Historically, foreign hedge funds dominated that space. These mark our baby steps towards developing our own ecosystem of long short strategies. Long-short strategies are not necessarily higher risk. They provide better risk-adjusted return and complete that continuum in the risk-return curve. That is why we want to be part of this space.

Within hybrid SIFs, we are seeing many yield enhancement strategies, which are already available in many forms in the MF space as well as in the AIF space. We want to take the SIF route because this is more challenging and the longer term business opportunity is bigger in this space. We also see a need for being a little more focused. Many MFs have become bigger and wider. Many investors want more concise portfolios. They don’t want a 100-stock portfolio, they want sharper, crisper baskets where the tail does not eat into the return of the head.

So our Select Equity Ex-Top 100 Long Short Fund will run a very focused set of 30-35 ideas with an ability to enhance return, by using derivatives. We may write covered calls and temporarily hedge our long positions by shorting stock futures, to enhance the existing alpha. A focused portfolio is one way of adding the alpha, using derivatives is the second way. A combination of these two should add a little bit more. That is why we have launched this particular strategy. Using ex-Top 100 basket was partly because under-valuation, over valuation opportunities are bigger in that space. The ability to make active choice is little higher.

RAPID FIRE

Q.A previously held belief or theory that no longer holds true?

Information and analysis are the key to generate alpha. It is actually market insight and behaviour that matter more.

Q.To return as MD at Sundaram MF after moving on as a fund manager, how do you see your evolution?

Challenge has moved from picking stocks to picking people.

Q.If markets could talk, what would they say to investors today?

Remember that I have been written off before, in 2003, 2008, 2013 and 2020.

Q.If your portfolio were a Bollywood movie or song, what would it be titled?

All is well from 3 Idiots.

Q.A trend or theme you think investors are underestimating?

The power of brands and consumer resilience.

Q.Any recent market narrative that makes you cringe?

Nvidia’s market-cap is higher than India’s.

Anand Radhakrishnan

MD, Sundaram Asset Management Company