`Stock valuation is both art and science' -- Mr. S. V. Prasad, President, Zurich Asset Management Co.

Suresh Krishnamurthy

Bl Research Bureau

Mr. S. V. Prasad has been the President of Zurich Asset Management Company (India) Private Limited (ZAMC), the asset management company of Zurich India Mutual Fund, since August 1998. He is an active member of the Regulation Committee of the Association of Mutual Funds of India (AMFI) and is Chairman of the AMFI Accounting and Valuation Committee. Business Line recently spoke to him on a range of issues.

Excerpts from the interview:

How do you rate the performance of Zurich's equity schemes?

I think they have done well. I think the return has to be looked at not in isolation but return vis--vis risk. And return vis--vis what the product stands for. Like a balanced fund should be a balanced fund. That I think is critical. In that sense all our funds have done well.

What is your opinion on Sensex and Nifty as benchmarks for evaluating the performance of equity schemes? Do you think these indices are reflective of the markets?

We have three equity funds, one tax saver fund and a balanced fund. Out of three of our equity funds, one is Zurich India Top 200 which is benchmarked against BSE 200. As for our other two equity funds, Zurich India Equity Fund and Zurich India Capital Builder Fund -- our benchmark is S and P CNX 500. In our case we have used a broader index. There is nothing wrong in taking a smaller index. Except that there was a fair degree of convergence among all indices till about a year.

Of late, it has not been happening because of the New Economy stocks. The indices are now diverging. Therefore, we believe a broader index is more relevant because that is the way you have defined our fund. I believe when an investor comes into a general equity fund, he wants advantage of an equity portfolio and at the same time, does not want to be so volatile. Tomorrow, we may launch a fund that is benchmarked to sensex or nifty. But I believe a general equity fund should be benchmarked against a broader index.

In recent times, do you think the evidence has been against a greater degree of portfolio diversification and therefore, narrower indices, better benchmarks?

There is a danger in looking at short-term trends because it can some times be misleading. What I believe is there has to be a balance in the case of diversification. Over-diversification does not make sense. Under-diversification also does not make sense. And I do not think there are any right or wrong answers. Yes, the point of optimal diversification has come down in recent times. The reason is that the number of stocks that are actively traded are also coming down because of mergers and also because the markets are getting more and more ruthless in assessing performance. And SEBI has also tightened the listing agreements, the tax advantage for listed companies have also come down. So, the investment universe of FIIs, mutual funds have also come down sharply. So, I think it is a function of market development.

How have these developments affected your portfolio investing strategy?

We believe the fund management process has to be a philosophy across the company. We have a core list of companies and within this core list the fund manager is given full freedom. We continuously look at the core list, add or delete from it. This core list is not a function of market price or PEs. It is a function of the company's fundamentals and also the qualitative factors of the company. Within this core list, the fund manager is given full freedom. And exposure in companies is allowed. But we put a cap on exposures outside the core list.

There are a few stocks that appear in all your equity portfolios. If you decide to sell those stocks, would it be on a fund basis or across all funds?

No. Not at all. I would like it underlined that the reason is: We have fund managers who are fiercely independent. Therefore, there is no question of buying or selling across all funds. If at all it has happened, I would say it is more of a coincidence than anything else.

What is your opinion regarding sectoral funds?

Sectoral funds have their place in the scheme of things. As long as investors are made aware that the entire portfolio of investors cannot be only sectoral funds plus stocks in the sector fund. And at least now, people have realised the volatility in tech stocks is pretty much high. Certainly, there is a place. Very clearly, the Indian companies have shown their mettle in the world market place. So long as these guys are vigilant and continue to do what they do, there is certainly a place for sector funds.

What about long-term investing by mutual funds? Are mutual funds swayed by short-term investment trends?

I would say we certainly do not do that. We are clearly not swayed by the momentum or the flavour of the day. The issue is more of investor getting educated. Unfortunately, in India people go to extremes. When the market is bullish, people are deaf to bad news. When the market is bearish, people are deaf to the best of news. I think investors are getting educated. More and more mutual funds are seeing investments coming in through systematic investment plans (SIPs).

The logic behind SIPs is that an investor should not attempt to time the market. What about your fund managers?

The same logic applies to us. I would not say we never succumb to it. It would be false to say that. There are times when the fund manager may succumb to it. And then he realises. Let us admit one thing. The market works on the psychology of so many people. So, it is very difficult always to distance yourself from the market. The trick is in minimising it. The idea is to be aware that timing the market may work some times but not all the time.

What about `stock timing'? Would you stick with a stock for a considerable period or based on technical indicators exit and enter a stock?

I will put it this way. A fund manager should not get emotionally attached to a stock. When you enter a stock with a target price, you should not shy away from booking profits. Tops and bottoms are only for fools. So, you start selling at every rise and on an average, you are almost at the top. And when the stock comes down to reasonable levels you start buying it.

As long as you are conscious and are as dispassionate as possible and do not make a habit of timing, you are fine. There are irrational exuberances in the market on both sides. Look at (Ashok) Leyland and Telco. In late 1998, (Ashok) Leyland was going at Rs. 20 per share. Obviously, the stock was a bargain. Suddenly, every body discovered the virtues of Leyland and it took off.

So, you emphasise on contrarian investing?

To some extent. I will not say it is always that. We have an aggressive equity fund and we have to do momentum investing there. But as for the capital builder fund, certainly yes. There, valuation is the issue. I would not like to be pigeon-holed into contrarian or that. All I am saying is that it has to be sensible investing. If you think the price has moved up, get out and come back into the stock again. And the other thing is, there is no substitute for experience. The fund manager has to be seasoned over two, three cycles if not more. We have four fund managers and each of them has between seven-ten years of experience.

In March, most technical indicators were pointing to a sell on stocks? How did you react to these indications? Did you rebalance your portfolio?

Most of our funds went out of IT much earlier. That is again a lesson for us. The fundamental factors, the PE valuation that you went by, conventionally or historically, felt that the share was peaking. But, then, the market was valuing the shares higher. Maybe we should not have got out when we did, which is second or third quarter of 1999. It was a lesson to us. Therefore, we did not get the full benefit of these March indicators. To some extent, we did. One has learnt.

Can an investor say that you are learning at his cost?

The way I see it is we are not wet behind our ears. I will not take a fresh chartered accountant or a management graduate and put him in the market. That would be learning at the investor's cost. Those guys are not the decision-makers. The guys who decide have solid experience. But at the same time I cannot say I have stopped learning. In IT, the whole market has learnt. That is the difference I would like to make.

How has your approach to valuation of IT stocks changed after March?

Valuation is both an art and a science. Why was Infosys considered a buy at Rs. 13,000 and within a few months, there were no takers for it at Rs. 5,500 levels. There is no logic to it. It is depends on the fund. A momentum scheme up to a certain part of its corpus, would still go for a bet. While a fund such as capital builder, which is certainly driven by valuation issues, will not do that. Therefore, it entirely depends on the fund. Take a large cap fund.

You cannot take too much of an underweight on some of the heavyweights in the index. That means you are taking a huge bet that some of the other stocks are going to outperform so much better. Therefore, you need to balance. It cannot be purely a fundamental approach. If HLL is x per cent of the index, how much of an under weight on HLL can you take. If Infosys is x per cent of the index, how much of an underweight can you take. If it is zero, then it is a major danger. Under-weighting, you are minimising the danger.

So, one fundamental issue is in terms of PE growth rates. The other is a function of what is the index weightage of these stocks. We have internally fixed certain limits in terms of what kind of over- or under-position we will be willing to take. We are going through that exercise constantly.

Have you participated in the futures markets?

No, we have not. There are certain systems issues to be resolved first, in terms of software. This is more an internal issue. Second is the issue of accounting. We are talking to our auditors on the accounting to be used. There are some institute guidelines, there are some SEBI guidelines. Third, we are now getting ready in terms of our prospectus enabling our participation. The fourth is the whole issue of whether index futures is the right hedging mechanism for our funds.

You must have already done some studies. What is your assessment of the hedging efficacy of Sensex and Nifty?

We are looking at it. I would not say we have completed the study. There are some market environment issues. For instance, FIIs have not got in. Most of the institutional investors are waiting and watching. All of us are very keen. Again, it is a zero-sum game which people should not forget.

Purely as a hedging mechanism, do you think Sensex and Nifty are less efficient, compared to other indices for mutual funds?

It has to do more with what your benchmark index is, ultimately. If your benchmark index is Sensex, then there is nothing wrong in using it. But if your benchmark index is neither Sensex or Nifty, then these issues do come up. The other aspect is you have the circuit-filter problem. ow at 16 per cent, life is a bit easier. But it is also an aberration.

So, the circuit-filter inhibits trading in futures?

That is not the only factor. I think the inhibiting factor is more of system issues. I read somewhere that UTI needs to sort out its offer documents. And UTI is the largest player. As far as the mutual funds are concerned, it is the system issues and the accounting issues. And again, FIIs are the unknowns, lot more used to dealing in the domestic markets compared to a lot of the domestic funds.