RD 360: Ramesh Damani with UR Bhat and Ajit Dayal

The panel comprises of UR Bhat, MD of Dalton Capital Advisors and Ajit Dayal, Chairman of Quantum AMC.
Here is the verbatim transcript of their comments. Also watch the accompanying videos.

Q: Can you give me a bio of Peter Lynch, one of the most revered fund mangers of our time?
Dayal: He is a legend. He was the fund manager for the largest fund at that time Fidelity Magellan and wrote a phenomenal book that investors should read is called, ‘One up on Wall Street’. In the book, he just uses common day experiences to explain what stocks could be interesting to own and what stocks may not be interesting to own.

 
Q: One of his maxims was never invest in a stock, that you cannot explain to a child with a crayon. Explain that to us?
Bhat: It’s very simple because finally it is a market which is a clearing house for all ideas so therefore if the idea has to catch people’s imagination then they have to understand it in a jiffy. Nobody has lot of time to understand because it has got to be in encapsulated form. For e.g. Bharti, which is one of the biggest success over the last 10-15 years in this market. Analysts were not even able to model how many handsets will get sold so they were trying to see whether it a proxy. So, it was completely clean slate but idea was that this is so convenient that almost everybody will probably want to have it over the next two-three years.
Q: Peter Lynch is very famous for doing bottom up stock picking. He once famously said in another maxim that if he spends 13 minutes discussing economic trends and forecast, he wasted 10 minutes. What do you think of that?
Dayal: In the Quantum Long-term Equity Fund, which we have help create and we have a fund manager team for that, it is very much a bottom up stock picking firm which I am sure Lynch would be very proud of. At the same time we do not ignore the macro environment.  I tend to disagree with Lynch on this. I think it’s important to understand what is happening around you and then pick your companies then the stocks and tmanagements that you think can do well across different economic cycles and different market conditions. 
Q: What would you pay attention to? What are the big macro factors that you pay attention to?
Dayal: In this environment that we live, I certainly would look at government policy like interest rates, inflation, government deficits and in the international environment. Also, I would worry a lot about FII flows which means I would worry about the silliness of Ben Bernanke printing out notes all over the world.
Q: Demand and supply are important.
Dayal: Demand and supply are extremely important.
Q: But coming back to UR Bhat’s point investing by explaining in a crayon. Do you follow that practice?
Dayal: Yes and no. I think it’s important to simplify the logic of why you are making the investment but at the same time if you took that little card and you told the little child that there are a billion people in this country and they need homes so buy real estate. You would have lost a lot of money if you would have bought real estate stocks in 2007. It makes a point that people need mobile phones, real estate, cars, scooters, bridges, homes, hospitals everything but the question is can you make money from that investment. To us that’s the management that will tell you whether you can make money or not.
Q: A billion people in India needing this is a great case for India itself, isn’t it?
Dayal: It’s fantastic?
Q: What is your favourite Peter Lynch maxim?
Bhat: I think his logic was that we should take PE and growth together. I think he was the one who propounded PEG theory because I think that is extremely important because the market tends to look at PE in isolation without looking at growth. For example. in the heydays of 1999-2000 in IT sector, people were talking of growth that was probably going to be forever in the IT companies.  All growth is contextual and in fact if that were the case then we should have had companies which have survived for 500 years. There are hardly any companies in the big mainline indices which have survived from more than about 20-25 years. If you see there are only five companies which are there for the last 30 years. So it is that there is always change, sector leadership gets challenged, new sectors emerge, so all these things needs to be factored in so therefore PEG is a very important contribution of Peter Lynch to investment thinking.
Q: One of the things that I always enjoyed thinking about reading Peter Lynch is that you should never water your weeds and cut your flowers. Explain that in Lehman terms and what it means if you do that in a portfolio?
Dayal: What he is trying to say is if you own Zee, Infosys or a company like NEPC Micon. So if Infosys went up which it did after listing in 1992-93-94 you would not be selling Infosys, selling it to strength and buying into the weakness of NEPC Micon, you would have lost a lot of future wealth. So what he is saying is that, ‘don’t do that, don’t make the mistake of selling your winners and then putting the money into junk’ but I think at the same time you have to have a diversified portfolio and no one stock should really dominate your portfolio and effectively have a big influence on your wealth.
We knew someone in the late 90’s who had 95% of their entire wealth in one stock and to us that was silly, it’s not that he own the business, he was an investor. Even though that stock had done very well and I am sure he is very happy about it, it still is very risky because there was a period of time when the stock was not doing well and I am sure his wealth had decimated at that point in time.
Q: What do you think of that? Do you think diversification is good or bad?
Bhat: In a very systematic investment that if you want to follow that I think diversification is important - that is if you are sort of benchmark against, if you are a professional fund manager on your fund. If you are investing your own money I don’t think diversification is a great idea in my view. If you understand a company very well and you know the sort of risk that you are taking I think you get rewarded only for your connection ideas and so just having ‘X’ stock because it represents 10% of the market is not going to make great sense because your interest there is making absolute returns. In that case I think you need to get probably good four or five high conviction ideas and buy into them and hold them.
Let’s go to John Templeton and he said the most famous words in stock market investing, this time it’s different.

Dayal: Again, Sir John was an absolute guru legend. I had the joy and the privilege of working with Tom Hansberger who was his partner and to help set up his firm called Templeton, Galbraith & Hansberger Ltd and in fact just to add a little bit to what Sir John said, he said ‘actually there are five famous words in investing - This time it’s different - and the fifth word you don’t hear and its - ‘Sucker’.
Q: What's your favourite quote from John Templeton?
Bhat: Of course value investing was something that is his contribution to the market which is extremely important because there is always this dichotomy about value and growth which is something that I have never been able to understand because it is joined in the hip. Unless of course you are looking at value in terms of distress situations but otherwise value is most often realised when there is growth otherwise there is no great value.
 I mean unless you are buying an asset at 1/10th the price because it is about to be sold.  Even there you have seen even in India lots of companies which hold investments of other companies which they have traded at 1/10th their net asset value but they continue like that for decades because nobody has an intension of selling. So therefore unless you won’t be able to say that, unlock the value there is no point in holding value.
Q: I will read John Templeton’s famous quote, it says, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria” any comments on that?
Bhat: Absolutely, every euphoria that we saw whether in 2007 or 2000 always had some thing going for it. Like say for example in 2000 the whole idea was that internet is opening up in completely new dimension to business - that every thing will be done on the net and everything will be electronic. That came to a very sorry pass. Let’s say for example in 2007 the big housing collapse in US was just opposed on the assumption that US or at least the economists have been able to keep interest rates permanently low and they have mastered monetary policy. This is what it looks like and it was not so.
Q: Are there any new errors in terms of investing?
Dayal: Absolutely. I think we are kind of living through one right now because we have seen this bull market in India which is board in the pessimism of post Lehman and everyone was so skeptical about the elections coming out in 2009. And then will the world recover and the green shoes happen, how long will they last?  So all that kind of went on and we are not probably at the maturing stage of this market now and again the retail investor in India has not been part of this.
That’s kind of a final indicator, when the retail investor “yes I was wrong of being in. I am actually taken out whatever, Rs 20,000-25,000 crore from the Indian mutual funds this year. I am going to bring that back in and when they will start coming in, that’s probably going to be the end of this bull market.
Q: Give me a quick bio on George Soros?
Dayal: George Soros is a brilliant speculator, I guess he is the one who broke the Bank of England very famous in the 1990’s, made a billion dollars in shot. He has also lost bets of that size too but he is the one who has got the hedge fund industry sort of going in some sense by originating what is by far the most popular and the first hedge fund. I must make one confession though we share the same company name not the same networth, his networth being lot more than mine.
Q: There is a very famous saying, “Its not whether you are right or wrong that’s important but how much money you make when you are right and how much money you loose when you are wrong”, your reaction?
Dayal: Absolutely true, I think you may be right on buying a stock and then you may say yes it’s a great stock to buy and I want to make money on it but you may have not made enough money or sold out too early and you got out of it, whereas you may have wanted to get out of a stock but you were debating and investigating when to get out and you may have lost a lot of money while you were thinking. So you end up with one thing that you like and you didn’t make too much money and one thing you didn’t quite like but by the time you actually decided to get out of it you just lost a lot of capital.
Q: But if you like something, isn’t your feeling, if you like something you have to bet big, you have to put serious money into this?
Dayal: We are in a different camp from you are in that sense. Our view is that a portfolio for an individual or for a fund that we manage on behalf of individuals should be between 25 to 40 stocks and no one stock should ever be more 10% at market value of a portfolio. So we are conservative as of now.
Q: Your view on that?
Bhat: If you are a professional fund manager, then I think you have to go with all these diversification because you can’t afford to loose too much money. But if you are investing your own money and you understand the business so very well that you know who is going to be the potential winner. I think over-diversification kills that potential return.
Q: Give me example?
Bhat: One that I found very interesting was Jindal Steel and Power, I met this gentlemen way back, may be 10 years ago, understood the whole business. They were churning out profits like nobodies business but it was quoting at a valuation of some 2 times or 1.5 times or something like that. Nobody loved this and I went and asked him, I tried to understand this company quite a lot and found that there is something that these guys do and there is a lot of growth going forward.
Q: Invest first, investigate latter another thing Soros has given us, is that a fair way to look at?
Dayal: Not at all. In our opinion you got to do a lot of investigation before you decide to invest or before you decide to get out of some investment, so we don’t quite agree with that.
Q: The airline stocks were being thrown away and the more I investigate the more complicated it got in terms of airline seat, revenue per mile, but market cap discounts all the best. So we invested first and then we started investigating, so sometimes that does workout.
Bhat: Yes just sort of put the foot on the door not really get in completely but I think that’s what makes you investigate it much more deeply.
Q: One of the best popular saying is never confuse genius with a bull market.
Dayal: Absolutely true and I think that what happened between 2005 and 2007 was that the whole world was born with geniuses. I say they were not geniuses, they were fools, silly people and gamblers. They paid a lot of money across the rising tide and then the markets proved in 2008 that they were not geniuses.
Bhat: Absolutely. I have always seen that when money making becomes very easy you have to pinch your self.
Q: When the pan wallah gives you tip, is it time to just take money out from the market and walk away?
Dayal: Absolutely. When the pan wallah gives you the tip, when my father starts telling me how I should be managing money I know it’s time to move out, definitely.
Q: Have you done that? Have you ever been able to walkout from a market at the peak?
Dayal: Yes. We have been very disciplined. We never understand peaks, we really never got the top or the bottom but we have been very clear because of the discipline, research investment process that we have this long term value investors, we were big buyers of stock after Lehman, big buyers. Our cash levels fell to the lowest in history, were 1% cash in the portfolio and now at this point in time we are close to 18% to 20% cash because we are seeing the markets going up and the valuations going away and the euphoria is about to come. So, we may be early and that’s fine but we want to be safe.
Q: Bill Miller, another great fund manager said if it’s in the news papers, it’s in the price.
Bhat: Absolutely. The market rewards you only for miss-priced priced stocks. Something like Titan is an example where you knew that there is a huge growing market out there and there is a huge demand. So you really need a quality product, probably the Tata brand and then that market can be tapped and of course the management was not in question because it was the Tata’s. Therefore that was something that I bought very early, in the 20’s, when it about Rs 20 I bought it.
Q: There is one expert which says, “Period of prosperity contains the seed of its own destruction.” Bull markets don’t go on forever?
Dayal: There has only been one sort of bull market for centuries and that’s gold in some sets but it has gone through enough cycles of its own bear markets. It is the only currency that has existed since time and memorial.
Q: What's your favourite market maxim of all times?
Dayal: At the time when I was working with Ashok Birla I met a small investment management firm from UK who said “if you shake some one’s hand and you don’t get five fingers back don’t shake their hands again.”
Q: Have you applied that in life sometimes?
Dayal: There are some very large companies in this country which are market favourites and we were big buyers of their stocks in the days when I was local partner for Jardine Fleming Funds, they were the top three holdings in our portfolio but they did things that we did not like. Bad corporate governance, not sharing with minorities and our view was that no matter how big they get, no matter how much of a market cap of the entire index or of the country’s GDP they occupy, if they are not willing to share with minorities for the same risk that we are taking as them we should get the same kind of return if you will but they don’t believe that then we don’t want to be investors.
Q: I truly believe that when you invest in a stock you are buying a part of the business.
Dayal: Absolutely. We are taking the same risk as a founder. The day the founder had IPOed, his money and our takes the same risk and deserves the same rate of return.
Bhat: That was this one which says that for every problem there is a solution that is neat, plausible and wrong. The example is way back, probably the 80’s, you had these leasing (check) boom, every other firm was coming with a leasing company.
Q: But when they talk about leasing boom there is always some scam going on.
Bhat: Absolutely. So you need to be very careful about that, whether this smells like a scam. Say for example Lehman today, the way emerging markets really galloping it looks like as if the market has taken a view that India is completely insulated from what happens else where in the world, India is destined to go at whatever double digit growth forever and whatever happens in the US or Europe doesn’t matter to us and of course every time the market goes up we seem to be in bull run by this.
Q: You mean we are not an island to ourselves?
Bhat: Not at all island to ourselves. We are going to be influenced what happens there and I think we will probably come to you or pass some time