Expectations from a Hedge Fund: I run a long/short hedge fund which means that we are always long some stocks and short some stocks (sometimes specifically having pair long and shorts but most of the times owning stocks and separately shorting some other stocks). In the minds (and expectations) of our investor we are supposed to deliver better risk adjusted returns than a long only fund. This basically means that we under perform a rapidly rising market (for our net exposure to the market is no where near 100% unlike a long only fund) and end up out performing  a falling market.

In general, the investor does not mind giving up a part of the upside on the expectation that we will not give him the same downside (or draw down) as the market.

In 2008 when the markets were falling steeply I resisted reducing my longs or increasing the shorts in the first few months. All I was saying in this recent interview was that if the market fell sharply (say 10% in a month) I will not resist it this time and go along in selling/reducing net exposure/increasing shorts for my investors are happier if I can protect them on the downside even if I end up giving up a part of the upside (if the market goes up soon after falling sharply  and I am whipsawed).

In our view risk is basically risk of a large drawdown (sharp 10% type fall in our NAV over any period). In the hedge fund business, short term performance is quite important and I have reconciled to that. Of course, the investor is not being totally unfair for he is willing for us to give up part of the upside to protect the downside. We try and reduce this drawdown by actively buying puts, shorting index and shorting stocks and reducing net exposure if markets are weak (this may be counter intuitive – for we sometimes sell when the markets are weak instead of adding to the positions. After experience of 2008 it is not obvious to me that is a wrong strategy although we try not to panic at every twist and turn). In general, we keep our long positions for the long run and try and reduce net exposure in volatile times by adding to shorts through futures markets (rather than disturbing the long positions).

Individual vs. professional investors:

How many times have we heard the argument that individual investors are no match to professional, institutional investors in equity market? According to conventional logic, institutional investors have the best resources to meet the long-term investment goals of investors.

All the strengths and resources of an institutional investor appear real, but it is not clear how these resources help them in developing a long-term view. Access to Bloomberg and Reuters, an army of analysts attending corporate results conference calls and access to other live data sources helps institutional investors gain short term edge. On the other hand, retail investors operate with no differential competitive advantage over institutional investors in access to short-term news. Not constrained by any benchmark considerations and not having to show their weekly performance to clients, retail investors are ideally suited to hold a long-term view. However, the problem is that these investors pride on their short-term views.

The problem with the stockmarkets is that retail investors, who have the luxury of being long-term choose to be short-term and institutional investors, who have the resources to be short term, use them to try and achieve long-term success. No wonder none of these groups are successful, and the debate never ends.

Sector preferences:

In general we do not buy consumer staples, pharma and commodity stocks and like infrastructure, financials and urban oriented under penetrated sectors. We do not buy ultra small cap but are sometimes willing to buy illiquid stocks. We also do not like Indian companies expanding aggressively in foreign markets for we bet on India and not on Indians. The real factor we like is scalability (that means that revenue opportunity should be very big- it is for this reason that I stopped liking ENIL and TV 18 initially).

I have bought only one FMCG company and the weightage of that is also less than 2% in my portfolio so I have not changed my big picture view that overall I do not like this sector for various reasons (high P/E, moderate growth, reliance on rural India which grows much less than urban India, services and manufacturing in general, costlier to target rural customers due to lower concentration of consumers etc)

I like commercial airconditioning business for I believe that this is the best way to play creation of urban infrastructure- malls/IT parks/airports/hotels/high rise office blocks etc all need a much higher proportion of commercial airconditioning content. We own the leader in a significant way (also because of its international business and other segments).

In the case of the 2 wheeler company we bought the stock earlier in the year (around December/January- may be the interview was in March) and sold it recently. After it was clear that India was having a very weak monsoon period we decided to reduce our weightage in stocks that were strongly supported by rural growth and consumption. Although we all expect that current drought across rural India will not have a big impact on the market (due to global liquidity), it cannot be the case that no company will be affected. In general, we do react to news/views if we believe that it will have a material impact on stock prices in the short term (even if we believe that in the long term the stock in question is OK).

I liked real estate sector earlier this year as the stocks were discounting serious liquidity issues- which starting disappearing as companies raised capital. I do not like mid cap real estate companies and I do not consider normal companies which have some valuable piece of land as real estate companies. Also, in many such cases where a normal company has some real estate and it sells or develops that land, there is no guarantee that they will not invest the proceeds in their mediocre current businesses (some how all companies which were sitting on valuable land parcels were otherwise really mediocre).

Basically what we like are companies that can compound their earnings for a long time with infrequent dilutions. Infrastructure sector offers the possibility of years of growth which will basically be exploited by the same group of companies (in each sector). I do not like areas where the top down growth is not so obvious and not so high (telecom sector for example currently). Within the infrastructure sector I like power sector.

We like the second largest housing finance company and own it.

General:

 1. I do not think that what FIIs/MFS are doing every day makes any impact to the stock prices and there is no reason to bother with that. The only time it matters is if large blocks change hands which were a clear overhang on the market( for example when Fidelity had a change of manager recently or the TCI fund decided to exit Indian PSU banks earlier this year). In general, there are now so many individual fund managers at each mutual fund company and they all cannot be good, by definition, so following the MF transactions have even less value than when you knew exactly who has bought.

2. We do not invest in a company without meeting the management but I am not sure that each time these meetings add value (for managements are nearly always bullish about their business and prospects). Many times the management is very articulate in explaining their future but global issues overwhelm the fundamentals.

3. I read 3-4 investment books a month and my all time favorite is “Fooled by Randomness”. Other books I have liked are “Reminiscences of a Stock Operator”, “The Future for Investors” , “Against the Gods”, “The Black Swan”. “When Genius Failed” “Devil takes the Hindmost” etc. These books are for enjoying not only for necessarily learning.

4. I am not sure whether family businesses are worse or better than professionally run businesses My view on corporate governance is that in general all companies have poor governance in absolute. The biggest fraud in India currently is the issue of warrants to promoters with 25% down payment. However, once you accept that all companies have pathetic governance it no longer irritates you and you can treat corp governance as a scale rather than treat it as YES/NO factor. Therefore, some companies have better governance than others but in absolute I can find flaws and conceptual or philosophical frauds in nearly all companies.

5. I do not think that an individual investor needs to buy only a handful of companies to make real money. If you hold 20-25 companies the impact of fraud is significantly reduced.. If one stock goes up a lot and becomes  a disproportionate part of the portfolio it does not mean that you have to sell it solely for diversification reasons. I do not consider your risk of losing paper profits in the same way as losing original capital and therefore your portfolio may end up becoming concentrated and that is OK. Concentration should evolve with some stocks doing really well and not by your buying them in a concentrated fashion. 

6. In my fund I do not invest in fixed income or indeed anything other than listed stocks At a personal level, I think that individuals who are not full time investors (and therefore have an independent source of income via job/business etc) can afford to have a high allocation to equities. In fact professional investors (who try to make a living through investments) should have a certain portion allocated to fixed income to provide stability in bad phases.

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In general we do not buy consumer staples, pharma and commodity stocks and like infrastructure, financials and urban oriented under penetrated sectors.

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