Interview with Kotak Mutual Fund – Part 1
Dec 15, 2005

Author: PersonalFN Content & Research Team

Mr. Sandesh Kirkire is a Mechanical Engineer, and holds a Masters degree in Management Studies from Jamnalal Bajaj Institute of Management Studies. He was associated with SBI Capital Markets and ITC Bhadrachalam before joining the Kotak Mahindra Group in 1994. His experience in the financial services space spans Corporate Finance, Proprietory Trading, Investment Banking, Treasury Sales, Debt Market Trading and Debt Fund Management. Mr. Kirkire has earned several awards in his last assignment as CIO (Debt) with the AMC, a position he held till May 2005.

Mr. Nilesh Shah is a CFA and holds a PGDRM from the Institute of Rural Management, Anand (IRMA). He was associated with Gruh Finance before joining the Kotak Group. Within the Kotak Group, he handled assignments in the Corporate Finance and Capital Markets division before moving into equities. Prior to joining the AMC, he was Executive Director, Equity Strategy, at Kotak Securities Ltd. Mr. Shah is President of the AMC, and guides its equity strategy, among other responsibilities.

In an interview with Personalfn, Mr. Sandesh Kirkire and Mr. Nilesh Shah shared their views on the economy, markets, mutual fund industry and schemes from Kotak Mutual Fund.

Pfn: What is your view on equity markets at present? How do you expect them to behave over the short-term (6 months) and long-term horizons (3 years) respectively?

Mr. Shah: From a short-term perspective, markets should consolidate at these levels. The markets are reflecting the positive vibes from the economy. Markets are trading at fair valuations at current year. Over the long term we believe corporate earnings will grow at 15-20%. The economy should grow at about 7%. Gong forward, equity markets should give a return of 15-20% over a 3-5 year horizon.

Pfn: Please let us know your take on the debt markets? Where do you think interest rates are headed over the short-term and long-term horizons?

Mr. Kirkire: I have seen corporates, especially ones in the manufacturing sector reduce their working capital cycle significantly over the years. At the same time, capex requirements of corporates have increased. So we are not going to see a softer interest rate regime, at the same time we do not see a hardening of interest rates. However, if the rupee continues to appreciate then we may see the interest rate rising a little.

Pfn: How do you expect the Indian economy to perform going forward? Any significant positives/negatives?

Mr. Kirkire: I think the economy can grow a lot more than what the numbers are presently showing. Over the last 10 years or so, we have seen many new industries that have not been added to the indices. So we are probably growing more than what the numbers show. Over the long term we think the economy will grow mainly from global outsourcing and consumerism.

Today there is tremendous increase in job opportunities. The purchasing power of the consumer is on the rise. Most people who are hunting for houses are in their 30s, they used to be a lot older earlier. Today when corporates talk of expansion, it is not something miniscule they have in mind.

Pfn: What is the investment/management style that governs schemes from Kotak Mutual Fund?

Mr. Shah: Ours is a combination of the top-down and bottom-up approach. In the top-down analysis we try to identify what is really driving the economy. We have identified factors like favourable demographics, outsourcing and the core sector. We believe these factors are enduring in nature and will play out over the next 3-5 years. We look for opportunities that benefit from any one or a combination of these factors. That way we manage to stay ahead of the curve.

Once we identify a macro opportunity we look for stocks trading at attractive opportunities. As a fund house we look for longevity of ideas. We are not looking for an idea that will last for a month or a quarter. We look for ideas that will endure over the next 7-8 years.

In our bottom-up approach we look for stocks that are strong on business, management and valuation, what we call the BMV approach. Then we look at the size of the opportunity, is there an opportunity that can be several times what it is now. Then we look at the economics of the business how much capital it requires, the margins, the ROCs and ROEs. We look for managements with a vision; not those who claim that they want to be the best. We look for managements that have some financial milestones. That gives us a roadmap on how the company's performance is likely to pan out. That helps us understand how much the company is likely to grow since we believe a lot of value is created in the company through growth. We also look at the corporate governance practices of the companies. We look at the price because there could be a great company with great valuation but the price has to be right.

Our funds have mandates and we stick to them. To cite an example, K30 has a mandate to invest in not more than 30 stocks; it can invest upto 20% in mid caps. At any point in time no sector can account for more than 20% of assets in a diversified equity fund. Of course, with a thematic/sector fund the sector cap is done away it. In terms of stocks there is a SEBI (Securities & Exchange Board of India) guideline that caps allocation at 10% of net assets. We of course have a lower internal cap of 8%, but we can go upto 9-10% if the opportunity beckons. In mid caps of course we have different parameters for mid cap funds because of the risk. So no stock allocation exceeds 6%, this is apparent in our mid cap fund (Kotak Mid cap Fund).

Pfn: Kotak Mutual Fund has seen a steady change of fund managers on the equity side. There is a concern that this could hurt the fund house's performance over the long term. Your views¦

Mr. Shah: We believe that over the years, Kotak AMC (asset management company) as an institution has developed a unique investment style, framework and process. Moreover, every fund has a distinct mandate that the fund manager has to adhere to. Take K30 for instance, it will soon complete seven years since inception. Over this period, there have been several financial and natural disasters in the nation and the world, but it has still managed to deliver 28% CAGR (compounded average growth rate) as compared to 14% by the benchmark index (Sensex). I think that speaks volumes for the investment process and framework of the institution.

Pfn: How many stocks should a diversified equity fund ideally hold? Also how much should the top 10 stocks account for?

Mr. Shah: It would vary across funds, but for a typical diversified large cap fund like K30, the top 10 stocks should be in 50%-70% (of net assets) range. This would be an average of 5%-7% in each individual stock. We think that the fund manager needs to clearly back his best ideas. As it is in the large cap segment there are limited stocks, just 90 of them based on our definition of large caps. For a mid cap fund it should be in the 30%-50% range to ensure that it's well-diversified.

Pfn: According to you what should be the ideal investment horizon for an equity fund investor?

Mr. Shah: For a large cap equity fund, we recommend 1-3 years and for mid cap funds it should about 2-4 years.

Pfn: What is your view on sector/thematic funds?

Mr. Shah: Global trends indicate that thematic funds are going to get very popular. The theme is not just one or two sectors, rather a broader opportunity encompassing several sectors. For instance, the outsourcing opportunity is not restricted to technology; it includes manufacturing and pharma among other sectors. The capital goods and infrastructure theme includes several sectors.

Pfn: Do you think thematic funds can outperform diversified equity over the long-term? We see thematic funds performing only in short bursts and they tend to lag diversified equity funds over the 3-5 year time frame.

Mr. Shah: Yes, we believe thematic funds can outperform diversified equity funds over the long term. In developed markets there are thematic funds that have done this.

Pfn: But if you look at the numbers in the Indian context, thematic/sector funds still have some way to go because diversified equity funds have put in a far superior performance¦

Mr. Shah: Yes, that's because the thematic funds segment in India has only kicked off in 2004. Before that you had sector funds, which are too narrow and not the same as thematic funds. If a theme is enduring and has a long cycle, it can do better than a diversified equity fund.

Pfn: The thematic fund manager has only one theme to invest in. No matter how enduring the theme, it still compares poorly to a diversified equity fund, which has several themes and is not over-dependent on a single theme¦

Mr. Shah: A thematic fund invests in a single theme, but there are several sectors within it, maybe as many as 12-15 sectors, so it's pretty diversified in that sense.