bl.portfolio caught up with Madanagopal Ramu, Fund Manager and Head – Equity, Sundaram Alternate Assets, at his office in Chennai. The firm manages ₹8,000 + crore of AUM, with offerings across PMS and AIFs catering to high net-worth individuals (HNIs). Madanagopal Ramu talked of his investment framework and stock selection process, among other things. Excerpts from the interview:
You have a strong focus on mid and small-caps in your funds. Why do you think the smaller-market-cap segments have an edge?
According to me, India is a 6/6.5 per cent growth story — neither an 8-9 per cent, nor a 3-4 per cent. With 4-5 per cent inflation, you are looking at the economy which is growing at 10-11 per cent in nominal terms. While this is not a flourishing growth story, it is a pretty decent one. This forms the backdrop for my investment framework. Take the manufacturing portion of the GDP — while I don’t know whether India will become the manufacturing hub of the world in future, I can say that the next 10 years will be better than the last 10 years.
And, we do see smaller players in manufacturing who are doing higher margin businesses being driven by the private capex when that happens. Agriculture always depends on the monsoons and this will continue to grow 3-4 per cent. Services has always been our bedrock of support. Though the IT sector here may see 1-2 years of slow growth, given the AI momentum globally, it can make a comeback to a 10 per cent growth. When these things come together for the economy, the sweet spot will be in the mid-cap space.
I would say large-caps will do well when the growth is slightly lower (ie lower than 6/6.5 per cent) and small-caps will do extremely well when the growth is something like 8/9 per cent as many small companies start growing. You will get opportunities there also as there are various sectors in India which are very small in size. I am saying all this from a 5-year/10-year perspective. Net-net, the opportunities in this space are generally in the ₹10,000-25,000 crore market-cap segment. A lot of companies that have done well for us have started from that size.
Private consumption is also a big contributor to the GDP. This has not been doing well lately, though……
When the country is growing at 10-11 per cent nominal growth, you cannot ignore consumer discretionary because, for one, household income of urban set will always be substantially growing compared to the rural household. This will spill over to spends on education, health, entertainment, retail. In the last year or so, while the sector as a whole may not have done that well, we were lucky to be present in stocks such as Trent, Titan, Zomato.
Our other holding — Sapphire Foods — was impacted due to issues such as inflation/slowdown in urban consumption. But what is surprising is that in stocks such as Zomato, user growth should not have been there if there were inflation issues. But that was not the case. So, I think in job growth, there is a bit more struggle than what we are seeing on the face of it as per the Naukri job index which we monitor, and this is having some impact on certain pockets of consumption. And these are high-paid jobs. If high-paid jobs grow, they have a multiplier impact on consumption.
What are the other sectors where you find promise?
When the nominal GDP is growing 10 to 11 per cent, financials have to grow. If you look at retail credit penetration in India, household debt divided by total GDP is substantially lower in India than any other country in the world — about 15 per cent. It can go much higher because, for one, not many households are still bankable and even if they are bankable, they are being sourced by unorganised lenders. We are seeing the early signs of it already and we have picked up Home First Finance, the affordable housing player, from this space. Five-star Business Finance is another. These can be a five-year growth story easily. The other sector is internet companies.
In India, Internet penetration levels are very low, and it will only grow. My sense is that you will have a lot of operating efficiency kicking into these domestic internet companies because of the AI investments that they will do. Mid-corporates globally are starting to look at AI. So, this year, IT spending broadly might be stable but within that, digital spending will be starting to grow. However, one needs to be selective.
What are the filters you use to choose stocks in your preferred segments?
When I look at sectors I prefer, I need minimum 20 per cent growth. Then, I do not touch anything with ROCE less than 17/18 per cent. In a sector where there is growth opportunity, if the management is not able to generate close to 20 per cent ROCE, I don’t think there is a need for an equity investment except when there is a favourable cycle at play.
Along with the above parameters, if the company is generating good cash flow and the company is reinvesting that cash flow also back into the business, having a clear roadmap for the next five years or so , and the stock is fairly valued (neither cheap nor expensive), then there is compounding effect of 17-18 per cent possible (in the portfolio) even if one or two picks go wrong.
With the markets rallying sharply, high-teen returns seem a given. How do you convince investors 17-18 per cent CAGR is a good number to look at?
A 15 per cent CAGR return can be good but today people are questioning whether 15 per cent makes sense because they are looking at a 5-year rolling return of 16/16.5 per cent for the Nifty and whenever it touched this, it has fallen from there; the lowest point of Nifty 5-year rolling return is 8 per cent. For mid-caps, the 5-year rolling return peak is 23 per cent, which happened in 2017 and 2008 and also now. The low point for mid-caps is a negative 7 per cent.
So, while we know what direction the market can head, what will trigger this correction, I am not sure. The flows have been phenomenal. We also underestimated the capability of domestic flows to sustain for such a long time. But when normalisation happens it can be much sharper — you might actually see two/three years of no return/slow returns and then the 5-year CAGR rolling return coming down to 12-13 per cent. When Nifty Midcap normalises, you can see two/three years of decline. So, what I am telling investors is that there are years like 2023 where our thought process is being challenged with mid-cap stocks having a great run. But if you look at it from a long-term perspective, a 17- 18 per cent compounding growth compared to 12 per cent Nifty growth is a reasonable spread for them.
The December quarter is seeing better top line growth than the last two quarters. Is demand making a comeback?
Broader growth looks difficult. If rural recovery happens, you can do better. So, I feel the demand scenario will be so-so only. You cannot have one point where everything is doing well. There will be pockets which will do well. All retail is not doing well, but jewellery, for example, is. Consumer discretionary companies, last year, saw a good growth because of the Covid recovery. This year, they are struggling on the back of it. FMCG companies are growing in only low to mid-single digits. India growth is still 6- 7 per cent. And in this, if you choose the right companies, you will make good money, is what I feel.