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Aarati Krishnan

Mr Shyam Bhat, fund manager, Principal PNB equity fund

With its acquisition of Sun F&C and then PNB's fund assets, Principal PNB Mutual Fund now manages assets of about Rs.4700 crore, making it a failry big player in the industry. Business Line caught up with Mr Shyam Bhat, the fund manager for several of Principal's equity funds, for a lively discussion on the relative attractions of mid-cap stocks and the performance of Principal's equity funds. Mr Bhat served a 10-year stint with Tata Mutual Fund, before he joined Principal this May.

Excerpts from the interview:

Mid-cap stocks have sharply outpaced large-cap stocks over the past few months. Is this trend set to reverse?

We see mid-caps (stocks) continuing to do well, after a correction. Large-caps may begin their move only after December, after the US elections are over.

In the near term, we see a correction in the value of mid-cap stocks. The trigger for this correction could be the notification of the lower short-term capital gains tax (announced in the Budget), which could happen in October.

Investors have clearly been deferring profit-booking on mid-caps over the past few months, waiting for this notification. As we see it, the correction may be confined mainly to mid-caps because there has not been a very significant deferment of profit booking in the case of large cap stocks. Capital gains on these stocks have in any case, been exempt since last year.

This is why, when the correction comes, it could hit mid-caps hard.

But after the correction, mid-cap stocks will continue to do well. For one, given their valuation levels, large cap stocks are not cheap, this restricts scope for high appreciation.

Second, the reduction in short term capital gains tax from 30 per cent to 10 per cent, will encourage investors to participate in mid-caps, more than large-caps.

This is because it is typically mid-cap stocks which fetch short term gains, because they move up fast in shorter time frames. For the index to break out of its trading range, it needs big money coming in. The large-caps may begin moving up possibly from December, once the US elections are over. You may then find FIIs finding their way back into the emerging markets.

Principal Equity Fund has lagged behind Principal Growth Fund by a big margin. Why is there a gap in performance and what are you doing to bridge it?

There are two reasons for this: Principal Equity has an orientation towards large-cap stocks. Whereas the Principal Growth Fund invests about 25-30 per cent of the portfolio in mid-cap stocks and only the rest in large caps.

Principal Equity Fund also has a floor of 15 per cent on its cash component, which has impacted its performance in a rising market.

But we do realise that we need to make the fund more attractive to investors and we will be restructuring it.

If the large-cap orientation is the problem, why not invest more in mid-cap stocks?

We would not like to do that. We would like to maintain a clear differentiation between our diversified equity funds. There is a strong school of thought that believes that mid-caps are inherently risky. So only some investors would be comfortable with them.

We would like to retain Principal Equity Fund as a large-cap fund to cater to such investors with Principal Growth Fund investing in a blend of mid- and large-caps. The blend strategy has worked quite well for Principal Growth Fund and its performance is on par with that of many mid-cap focussed funds.

You have a range of equity funds- Principal Growth Fund and Equity Fund, then the Resurgent India Equity Fund and the Personal Tax Saver taken over from Sun F&C. How do you differentiate between these funds? Are any more mergers in the offing?

No, we do not plan any more mergers. We have tried to differentiate our products in terms of investment strategy and risk profile. The Dividend Yield Fund, which we are now rolling out, would be a "value" fund.

The Principal Growth is higher on the risk scale, but is a large-cap fund. Principal Equity is a blended diversified equity fund with both mid cap and large cap stocks.

The Resurgent India Equity Fund is mainly a mid-cap fund, with 50-60 per cent in mid-caps. So the dividend yield fund would be the lowest on the risk scale, while the Resurgent India Equity Fund would be the highest. But we would not like to freeze mid-cap exposures in this fund. We would like to keep the proportion fluid, given the risk considerations. We have retained the two tax saving funds separately because of issues about the differing lock-in periods of the investors in these funds.

We have restructured the Resurgent India Equity Fund's portfolio quite significantly since the takeover. We consciously did not completely load up the portfolio with mid-caps at that stage, because we wanted to put the performance back on track and did not want to assume too much risk. We have merged a couple of funds from the Sun F&C stables — the Value Fund and Emerging Technologies Fund into our Principal Growth Fund

You are positioning the Dividend Yield Fund as a fund with a lower risk profile. But do dividend yield stocks really provide downside protection? Despite being high dividend yielding stocks, oil and gas stocks have been battered over the past few months... .

You can reduce this risk by opting for a diversified portfolio of dividend yield stocks. For instance, before we launched our Dividend Yield Fund, we did a dry run on the strategy. Based on our dividend yield filters, we could arrive at a list of about 60 stocks that could be part of this fund, coming from diverse sectors.

For instance, 18 per cent of this portfolio is made up of engineering stocks, while 14 per cent is in chemical stocks and 12 per cent in FMCGs.

So, though oil and gas or banking stocks have taken a knock of 30-40 per cent, our portfolio of dividend yield stocks would have lost just about 16 per cent over the past eight months, thanks to sectors such as chemicals and engineering, which have done well.

Returns from the fund would improve further if reckoned for one full year, as dividend receipts would have bolstered the NAV. I think the last eight months gives a good picture of the worst-case scenario for such a fund, and it has not done too badly. Even for banking or oil and gas, the worst could be over. We have now come to a stage where expectations from these sectors are very low.

Would you have internal sectoral caps to prevent excessive focus on one or two sectors?

We are looking at caps of about 25 per cent for each sector.

Is it not very high?

It is not when you consider that some diversified equity funds now have 20 per cent parked in one sector. A dividend yield fund has a limited universe of stocks to invest in. Technology or pharma stocks for instance, may have to be largely excluded from this fund, because of their high valuations. So the sectoral cap for such a fund has to be slightly higher.

The very concept of dividend yield suggests a focus on low P/E stocks. But many stocks enjoy low valuations because of unattractive prospects. How do you make sure you have a portfolio which can generate reasonable capital appreciation?

A dividend yield level of 1.5 times that of the Nifty basket will only be the first filter on the basis of which we will shortlist stocks that are eligible to be included. Subsequently, we will put every stock through the same analysis that we would for any of our other equity funds.

This will centre on growth prospects, management and business prospects for each company. The 60 stocks that I mentioned will meet both our dividend yield and other growth criteria.

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