Investment Philosophy

CIO: Thank you for giving us this opportunity to speak with you. Could you start by telling us about your basic investment philosophy?

Anticipate and recognize change early

Samir Arora: Well, we really aim to anticipate and recognize change early. Perhaps the maximum amount of money is made early in the cycle, when there is maximum change in let’s say, a company, an industry, the perception of a company, in corporate governance and so on. The whole idea is to recognize change at any level – micro or macro. We have analysts who carry out the micro-level stock analysis. I take the macro-level calls as to which sector to buy or within a sector, which company to buy.

CIO: Could you tell us about a couple of changes that you identified during the last decade that worked for you or did not work for you?

Samir Arora: Well, one idea that did not work as originally envisaged was India Liberalization Fund, which was launched in 1993 to buy privatization stocks in India. We had anticipated privatization very early. The first stock we bought was MTNL at Rs300 in December 1993. In fact, for five years we never bought privatization stocks in a significant way for any fund. The result: Although we were one of the first ones to think of privatization stocks in India, we did not capitalize on it fully, once privatizations really took off 8 years after we had started.

But, we have also had our share of successes. One theme we successfully rode on was "public sector being a defender of market share with private sector being the new entrant". Let me give you two instances of where we used this. One was Zee, which was up against the state-owned Doordarshan and the other HDFC Bank, which was up against the public sector banks.

When we bought Zee in 1997-98, its market cap was US$60mn. At that time a cable company in Thailand with just 200,000 connections had a market cap of US$400mn. When we looked at Zee’s history, we found that the company had an unfair reputation in the markets although the business model was very strong. Actually, unlike several other companies in India, it had not issued any warrants or options to its promoters and had continuously paid dividends and taxes. We considered that to be a positive from the perspective of the minority shareholders. So, we invested in the company, which proved to be fruitful just as our investment in HDFC Bank.

We have also been early in catching the emerging BPO story. You see, the publicly listed large IT services companies are going to project BPO as the big story for their growth. Soon, everybody will be interested in BPO stocks. We have been  fairly early in investing in a company like Digital, which will have a significant exposure to BPO. We now hold almost 7% of the company. Personally, I made a lot of money in Yahoo and AOL using the same theme. In 1997-98, the market cap of these companies was very small. But in just two years, the whole scenario changed. You know, when everybody gets interested in a sector, the valuations do not matter at all.

CIO: In whatever interactions we have had in the past, you have extensively used this top-down macro logic across various companies. Lately, we talked about India's wireless market cap and the kind of opportunity that presents to financial investors. Could you discuss the thinking process involved in this approach?

Supplement micro-level analysis with macro-level feel

Samir Arora: See, we have analysts, who do the micro-level analysis – you know things like looking at the numbers, growth rates, valuations and the like. I take the macro-level calls. So when you interact with me, you see the macro logic. But my macro logic will not work if my analysts said that a particular company on a standalone basis is not a worthy investment candidate. It is not that we don’t take a macro view on a sector, but the stocks that we actually end up buying are those in which we have conviction. At the same time, even if we are convinced about the standalone potential of a particular stock, we may not actually invest because of a negative macro-level view.

Let me give you examples to illustrate. Look at the last two years’ stock performance of ITC and compare it to Philip Morris. What is the logic? Why should ITC’s stock performance be connected to Philip Morris’? But you can see a clear relationship on Bloomberg. Both stocks exhibit similar trends. When Philip Morris does badly, so does ITC. Now, in India you don’t have the kind of regulatory risk as you have in the US. While US cigarette companies run the risk of becoming bankrupt due to the award of high punitive damages against the health hazards posed by smoking, this is not so in India. Given the US experience, fund managers tend to discount the possibility that x years later, a similar situation might arise in India as well. So, during the Bill Clinton administration, when the Philip Morris stock was not doing well, ITC was also under pressure. However, with the pressure on Philip Morris decreasing from about a year before Bush came in, the willingness to hold ITC has increased amongst global fund managers.

Now, let’s look at telecom. Several investors made lots of money in emerging markets like China. It is most logical for a fund manager to say, "I missed China Mobile but now have an opportunity in India" or, "I made a lot of money in China Mobile and in India you now have the very same drivers". Suppose this top-down approach works but for some reason we feel that the promoter of the Indian cellular company is not good or its competitive position is very weak, then it is unlikely that we will invest in the company. What I am saying is that while we will use this top-down approach, the bottom-up analysis is also done separately. We will not buy a stock just because, let’s say, its market cap is very low. But like in Zee’s case, if we separately find that the stock is a worthy investment candidate, we will invest.

In Zee, we had found no corporate governance violation when we first invested in the company 5 years ago. We were measuring corporate governance by only 2-3 things. It had not issued warrants at that time when several other companies in India had. Unlike others it had not made a private placement. It used to pay taxes I think at the rate of 25% or so. And, it used to pay dividends, which meant that the money was real. Yet, Zee was a predominantly macro call and the micro call was a bit off. So, on the one hand, we give the benefit of doubt to many companies. But on the other hand, we also have a long memory in the sense that if we have been burnt once, we do not go back to the same company easily. This is something that you have to remember in a bull market because there is always an opportunity to get carried away.

CIO: In this process, how do you resolve the contradictions? For instance, some of the companies you have invested in may not have the best of managements. Or in some cases, valuations that you are paying might appear enormously high. Take BPO for instance. On the basis of historic earnings, these stocks are definitely not cheap.

Look at pre-tax profits

Samir Arora: Let me explain. Today E-Serve pays tax at the rate of 48% whereas the IT services companies pay zero tax. Now I know, you know and the world knows that one day every company has to pay full tax. Yet, everybody gets shocked when the budget proposes a tax on IT services companies and their stocks tumble due to the announcement. We believe that tax is not a negative and if some company pays tax, we do not cut it out of its earnings. A tax-saving company is perhaps the worst company in India because it lets taxes determine its strategy. In 1998 or 1999, we decided that we would look at all numbers on a pre-tax basis.

As far as BPO is concerned, I believe that it is a big opportunity for India. If there is a company that is already growing at 18-20% every quarter and will have a significant exposure to BPO, then I think it is worthwhile looking at it. It has a market cap of US$100mn, it is already a profit-making company and it has a large MNC parent that is fully committed to it. The parent is giving the company plenty of business and this is only likely to grow.

When we invested in Zee, we used to say that if you can get an entry into the business in India for US$50mn, it is enough. On a macro-level, it does not really matter what exactly the company will do at that stage. So, it is with Bharti today.

The market valuation of the cellular space in India is about $5-6 billion as there are just 5 players and the largest is quoting at a valuation of about $1.7 billion. The cellular market is expected to grow at 40-60% for the next 5-7 years. The same cellular business is collectively valued in China at $140 billion. Now if India is a great country to invest in, then there has to be some consistency in valuations across sectors. This is the very simple broad theme on which we have invested in Bharti.

CIO: If we were to divide what you look for in a company before you invest into two parts, what would you say are the necessary conditions and what are the sufficient ones?

Samir Arora: I manage a technology fund, a basic industries fund and a consumer fund, and I sell them separately to the people. So, it is very different from a person like Warren Buffet, who says, "I only buy consumer because I don't understand technology." Very few people in the world manage three completely different sector funds, with completely different investment logic behind them. Yet, the consistent thing would be that a bottom-up and a top-down analysis are done separately. Our investment approach is a combination of top-down and bottom-up.

Bottom-up basically entails intra-industry comparison; not cross-industry comparison that an individual investor would do, "Should I buy Infosys or should I buy ACC?" That is the second level of research. The first is top-down, that is, whether you should be a little overweight in technology or say cyclical or perhaps, cement and that is my call. We look at valuations, the growth rate and the quality of the management. But above all, because we are viewed as investors being able to move stock prices we get to see many companies that want to change.

In such cases, we have often worked with them to drive change. Of course, whether or not they actually change is a call they have to take. There are several instances where we have got directors changed in private companies just to help them get a high P/E. Whether we want a good management or we want a management that wants to be good is a tough question. But in many cases, money has not been made by buying the best managements but the managements that want to become the best. The bigger game is in the change not in knowing, let’s say, that a Lever has the best management.

CIO: Right, so you would say that your necessary condition would be to identify some big change?

Identifying a cheap stock is easy; find why it won’t be cheap any longer

Samir Arora: Yes, it is not enough to say that xyz is cheap. Probably last year as well, it was cheap and the year before. There are many stocks that should be at the top of cheapness list, but nobody looks at them. That is because nobody knows why these will not remain cheap the next year. Change is therefore, critical.

CIO: You have also been a believer of the philosophy that the valuation premiums or discounts that some stocks enjoy are actually for good. You’ve said for instance that an x IT stock will always quote at a discount to the leader in the sector. Could you explain?

The leader always enjoys a higher P/E rating than the rest

Samir Arora: Yes, I don’t think that the valuation gap – in terms of the P/E they enjoy – between Infosys and Satyam or Taiwan’s UMC and TSMC will narrow down. P/E is earned in the market, which is not an easy thing to do. In my seven years of experience, I have not once seen a company enjoying valuations at par with the leader in that industry. Also, if you start with a clean state, it would be easier to maintain or enhance your P/E rating than if you start on the wrong footing.

But we are not just talking about the stock going up. We are talking about its P/E narrowing vs. the leader of that group. So, while in a bullish market Satyam’s P/E might go up, Infosys’ would also go up. Therefore, the valuation gap would remain. You can also see this in other sectors. In consumer goods, for instance, Hindustan Lever enjoys a higher rating than others.

Also, the markets have a long memory. So, if you have a company with a history of problems, the markets are likely to be wary about re-rating the stock even if it begins showing good earnings performance. Here, let me mention what Warren Buffet says about problems. He says that problems are like cockroaches in the kitchen for there is never only one cockroach in the kitchen.

See, it is true that P/E is dependent on earnings growth. But just because a company is able to grow its earnings phenomenally in a particular year, you don’t begin to rate it at par with the leader. You need to see that company consistently putting up that kind of performance for, say, five years before you see the valuation gap vis-à-vis the leader narrowing. Therefore, we don’t bet on a narrowing of the P/E gap.

CIO: In one of the Wealth Creation studies at Motilal Oswal, it was found that 90% of stock returns over very long periods of time have actually been made out of re-rating rather than earnings growth. For instance, it was found that if you had bought Infosys at the right time, 90% of your returns would have come from re-rating.

Samir Arora: I would think that the re-rating actually happened for the sector as a whole and the narrowing didn't happen. See, I remember that about a year ago, in some studies Satyam came out as being the number one stock in India based on its last four or five year performance. But I don't think that its P/E narrowed against Infosys at any point in time.

CIO: It did. At the peak, the valuation gap between Infosys and Satyam had dramatically narrowed…

Place your bet on earnings growth rather than a P/E expansion

Samir Arora: Okay. May be it happened. But what I am saying broadly is that we don’t buy a stock on the basis that its P/E relative to the leader of that industry will narrow in our horizon. The lower P/E may be a support – a buffer that will help you on the downside. But if our analysts were to say that buy Satyam because its P/E is 15 and that will become 30 in 2-3 years because it is doing the following things, I will not buy that argument. But if they said buy Satyam because its P/E is 15 and given the expected growth in earnings, its price would rise by, say, 50% in two years, I would.

See, a high P/E doesn’t come just because of high earnings or because you are part of a good industry. It is earned over a period of time. It just happens because you are good corporate citizen, because you started clean, you kept clean, you communicated clean and investors are satisfied with your due diligence.

For example, we believe that Digital Globalsoft will have a higher P/E in the future as it has the necessary pedigree and if it can be consistent in its growth and deliver on its promises. Unlike many other Indian companies aspiring for higher P/Es Digital does not have any overhang of bad history and has not been unfair to minority shareholders etc. Therefore, if they prove to be good corporate citizens they can get a higher mutliple over time in line with the current leaders in the sector.

However, betting on multiple expansion in general is difficult in India as Indian market has a long memory and if you do not start right you never really get a premium valuation.

CIO: You migrated from being a country fund manager to a regional fund manager. Could you tell us a little about how this has helped you and what are the merits and demerits of taking up this additional responsibility?

Samir Arora: Well, the demerit is obvious. Sometimes, you just don’t have enough time to focus on any one country. During the last few years, our business in India has grown so much that we just don't even look at many of the smaller names. We, our analysts and I, now have a larger role and the size of our India funds has grown so large that very small companies do not make much of a difference to the performance of the funds.

In terms of the merits, these are also very clear. You are able to compare stocks on a regional basis. You are able to attract the best analysts because they are excited about taking up a regional role. In many cases, stocks in India are influenced by foreign flows and foreign information. Because of our current role, we are able to identify these more easily.

Yet, across the region and even across the world I think in terms of bottom-up selection some of the best names are in India. There are managements restructuring to improve their efficiency in an environment that does not support this. To see state-owned companies like State Bank adopting change is amazing. Such things get missed by somebody who is not close to India. So, we are very close to India.

CIO: At the analyst level, how useful has it been to track a region? Have you seen any material change in the performance or the quality of recommendations?

Samir Arora: Well, we started tracking stocks on a regional basis in 1998. Now whether it's to do with the quality of information or views, or with the fact that we had our biggest bull run in 1999-2000, we don't know. But in 1999, our Indian funds went up by 280% and 2000 was also not bad. In 2001, because of our long positions in technology, we underperformed the markets.

Now, it is not that it worked because of having an Asian role. The markets supported our performance but whenever we buy, we do so with the maximum conviction because we are able to do due diligence across a number of factors. Also, India is unique in our scheme of things. Sectors like software, pharmaceuticals and even consumer goods companies of the kind we have in India – multinationals or companies with long histories – are not there in our universe. We track sectors like auto, steel and telecom across the region.

CIO: Purely from a return perspective, what would be your macro call on India vs. the rest of Asia?

Samir Arora: In a relative sense, except for last year, India has not been bad. But on a stand-alone basis, India has been very disappointing. The Indian index has not gone anywhere since I started in 1993. Just being in equity did not ensure that you made money. You know equity is supposed to outperform debt but I haven’t seen that happen in India at least in my seven years of experience. When we started Alliance 95, the index was 3810. Today, it is below that level despite the fact that the composition of the index has changed to include better performing companies.

Today Alliance 95, which invests 60-75% in equity, has an NAV of about Rs50. But it is not just because it is exposed to equity as you can see from the level of the index. Success lies in picking the right stocks, and doing so is not easy. We were hoping that going forward we would be able to make money by just being in India. Over and above that, we could make some more money by outperforming the index. Making 100% of the money by outperforming the market is too painful a way to earn a living. However, making money by simply being in equity is only possible when there is a secular bull run in India; I hope that happens sometime soon.

For the first time in several years, you have Indian companies as a group generating higher returns on invested capital than their cost of capital. There is an actual reduction in costs or improvement in efficiency across the whole spectrum of companies. You have a macro-level positive in that PSUs are getting a life as stock market citizens. So, while we were always bullish on India on a bottom-up basis, this time we are bullish on India on a macro basis. Earlier, our stance on India used to be "bearish and overweight". But now we are "bullish and overweight". We have always been overweight because you cannot find the likes of HDFC Bank and Infosys in the rest of Asia.

CIO: You are bullish on India. You were overweight and you continue to be overweight...

Samir Arora: The reasons for being overweight on India have become both bottom up and top down- previously it was only bottom up.

CIO: How to you see India performing on a relative basis, going forward?

Samir Arora: I would say that if we found the right stocks in India and the right stocks in some other market, then the right stocks in India would do better. In India, you have a good menu to choose from. You can bet a big part of your money with conviction on a micro-basis, which is what we have really been trained to do. In China, on the other hand, we would take a macro-level bet. This, of course, could partly be due to the fact that I am more familiar with India.

I cannot say how the index in India will perform in the next five years – whether or not it will outperform Korea or Taiwan. See, today just because we have carried out one privatization exercise successfully, we cannot say that we have changed. In the stock market, nothing changes in a very short period of time – you could have a fall of the government, for instance. So, let us not get carried away, saying that India is on an automatic path to success.

In India, we have a big problem at the policy level. Now, let’s say that today the BJP is in power. Now, to take a very long-term macro-level call, you need to be convinced that it does not matter whether it is the Congress or the BJP or xyz that forms the government because they all have the same policies. But it is not like that. Even if we agree today that the Congress will also support privatization, the point is that you waste a year in changing from one government to another.

CIO: How have you gone about approaching some of the new markets that you took up a couple of years ago?

Samir Arora: See, the first thing is that in those markets I have still not reached the stage where I am truly buying undiscovered stocks. We are only taking bets in the 40-50 names that the world has. Although our Asian funds have nearly twice the money in Korea vis-à-vis India, the stocks that we own in Korea are only 10 as against 14-15 in India. So, in one sense there is a dichotomy. My job has therefore, been picking 10 out of the 50 names, not to discover a 51^st stock.

China, Korea and Taiwan are the markets where I have been investing and I believe that if you have learnt how to invest in India, you have learnt everything. You have learnt the questions to be asked, you have learnt what cheating people can do, you have learnt why two stocks in the same sector don't get the same rating. These issues are actually prevalent everywhere.

Yet, the fact is that I am a foreigner in these markets. In India, we laugh at the foreigners when they buy some stock we consider expensive. So it must be with me in those markets – I just haven’t discovered the 51^st stock. Perhaps I need more understanding of those markets – visiting local companies and plenty of effort. But, overall, what is happening there is really no different from India.

CIO: How has your investment philosophy evolved over, let’s say, the last five years?

Samir Arora: Well, five years ago, we were very small. Therefore, we could go and buy the smallest of companies and it would still have an impact on our portfolio. Now, the tough thing is that by nature we would love to discover new stocks. Discovery itself now no longer means 20-baggers but stocks with, say, a potential to double. Even if we successfully did so, we would not be able to buy it in a big way because of unavailability or if we bought it in a big way, it would mean losing, say, 40% of the potential return. So, the job has become less interesting in a sense because now you have to deal within the large stocks.

But there is a huge value added even when you have to choose from within the top 50-100 stocks. If you look at our portfolio over the last five years, except this PSU phase that I have talked about, we have done a good job. Broadly, there is enough value added in the business by staying away from goofed-up obvious bad stocks. But there is a different thrill in discovering a completely new name. We have had our thrills in companies like Balaji Telefilms, E-Serve, Digital etc. There are several companies that no other fund owns but in which we hold 5-8%. But in many cases they don't make much of an impact to our NAV except that we get associated with them and we double our money. The investor gets to sleep and we keep our jobs.

CIO: You told us about what drives you into a stock. Could you take us through what drives you out of a stock?

Samir Arora: There are several big positions that we have quickly eliminated and never looked back. But there are some, which we keep going back to. Yet, our real returns during 1996-2001 came from not selling stocks too early. Take for instance, HDFC Bank. We started buying the stock after it got listed in 1995. At that time the stock traded at Rs30 but till 1998, it had not even reached Rs50. So, for three years, the stock remained flat. But after that it went up five times to Rs250. Now, for the last one-and-a-half years, the stock has remained stagnant. Yet, we keep buying the stock because as long as the company’s earnings keep growing at 30%, and the stock remains stagnant, it is bound to become cheap.

We bought 5% of Satyam in 1995 even though we were very small at that time. We were able to do so because at that time, the company was also very small. But for two years, the stock did not move much. But after that, the stock gave us phenomenal returns. You know, we own Digital for such a long time but most of its return has come in the past 6 months. So, we have to hold on to these stocks for a long time before they do anything.

Now, let me tell you why we stopped buying Hindustan Lever. Previously, we had the same argument for Lever as we have for HDFC Bank. You cannot lose money because after six months it will become cheap. However, in between Lever’s growth became very low. So, by holding it, it didn't become cheap. That is when we sort of sold it. Now, selling a stock when something goes wrong is relatively easy. The difficult thing is selling a stock when its valuations become too high. We normally sell more on company disappointments rather than on valuations.

In the past, we have held onto our picks, particularly technology stocks, for too long. We held on to Infosys because we believed that the company was doing a great execution job. For five quarters after its stock price peaked, the company kept delivering its guidance, which was issued before the stock had peaked. The stock peaked in March 2000. The company met the March quarter guidance as given prior to the peak, then the June, September, December and March 2001 guidance. It was only in June 2001 that the management issued a lower guidance.

So, for five quarters, the company met its pre-peak guidance but the stock had gone down may be 35%. The micro-view was that the IT services companies were doing great, they had good orders and were signing on an average 25 new clients every quarter. So, we held on to them. About six months later, that is, post the September 11 attacks, we realized that these companies don’t really know how much business they would do in the next quarter. We have to just identify the best companies that we want to buy in the sector and take a macro-call.

CIO: Basically to summarize, would you say that your exit criterion is a change in the fundamentals of the company?

Samir Arora: Normally, yes, it is a change in the company. Hopefully, we will also remember that extreme high valuation could also be an exit criterion – we have used this criterion much less. What I am saying is that if you look at our history, both the reason for success and the reason for criticism are the same, "You hold your stocks too long". Zee, multiplied 160 times since we bought it. Every Rs10 invested in the company had multiplied to Rs1600. But we did not multiply our investment to that extent because by the time we sold, it had already fallen to Rs700. So, we basically ended up multiplying our investment 70 times.

I remember having said in an interview with one of the business magazines that our year-end target for Zee was Rs250 when the price was around Rs. 100. However, the stock had multiplied 10 times by the time the year had ended and we did not sell during the year. Even if I had sold at Rs300, I would have tripled my money in a year and that would have been considered as a great job. While some might say that not selling at Rs300 was a good decision, others might criticize me for not selling at Rs1600. The same goes for Infosys. We made about 55 times in Infosys but we could have walked out at 20 times, as well.

We normally start with some valuation/price target when we buy a stock but more often than not, these targets gets revised based on new information about the company. It is difficult to sell sometimes for we start falling in love with our stocks as analysts and fund managers and forget to have a dispassionate view.

CIO: What valuation tools do you use in your analysis of companies?

Samir Arora: Primarily, we use P/E. We do not usually use EV/EBITDA, other than in telecom, because this parameter is used to justify that EBITDA is your answer, which is not. For a normal steady business in India, we have never relied on EV/EBITDA. So, while P/E is the main parameter we look at, sometimes we look at P/PBT to neutralize the effect of taxes. We also look at RoE but I think looking at DCF other than in one-two sectors, is an absolutely ridiculous way of doing things. This is because you really have no idea about what will happen in a company beyond three years.

CIO: What is the investment objective underlying your entire investment philosophy?

Samir Arora: The objective is to beat the benchmark and competition while generating absolute returns comes as a corollary. We try to beat the benchmark because over a long period of time, the benchmark normally does give you absolute returns. While in a bear market, one way to beat the benchmark might be to go, say, 20% cash. But we don’t do that. If we are an equity fund, we stick to equity.

CIO: If you were given the choice to trade between asset classes to maximize absolute returns, would you do so?

Samir Arora: First, let me tell you that we are always bullish on equity and here’s my favorite story: Infosys has been one of our largest holdings in India. The stock used to trade at multiples of 80-90 but has corrected considerably since its peak in 2000. In an internal study, we found that when Infosys fell 60%, virtually every small stock fell 90-95%. It is therefore, good that we did not sell Infosys on the grounds of high valuation because our normal tendency would have been to find stocks in the same sector but which had more reasonable valuations. In our study the top two performers in the TMT space during January 2000 to November 2001 were Infosys and Wipro. These stocks had the highest P/E in January 2000 and had fallen the least by November 2001. Thus, while not selling all our TMT stocks and buying stocks like BPCL could be called a mistake, holding on to Infosys within the TMT space cannot.

Now, coming to shifting between asset classes, as in equity to debt or vice-versa, you need to understand that we don’t want to take an asymmetric bet with the investor. Let me explain. Let’s say that our fund went up 100% in six months and the market went up 105%. Would that be called good performance? Well, 100% in six months is a phenomenal return but then as active fund managers, we should have been able to deliver higher returns than the benchmark. Having generated 100% returns in six months, let’s say, we decide that the market has peaked and we sell all our equity investments and move to debt. At the end of the year, however, you find that the market has gone up 120% and your fund, now totally invested in debt, has generated just 115%. What do you say to your investors?

As a predominantly equity-fund, even if we stay predominantly invested in equity with the aim of beating the benchmark, there will be periods of time when we underperform. In the last two months, we have underperformed, because we didn't have enough PSUs. However, the investors who invested with us in August 1998 should have no reason to complain. Yet, investors who invested with us in December 2001 could say that we returned, let’s say, 14% against some other fund’s 18%. Unfortunately, that is how it is. So, it is not ever a point of walking away because the investors have completely different entry points and different investment horizons. They expect you to outperform over the periods that they are invested in the fund and they are each invested over different periods.

CIO: Could you tell us about some of the risk control measures that you adopt for your portfolio?

Samir Arora: Well, there are many risk control measures that naturally come up in our portfolio construction. One is that currently SEBI says that you cannot have more than 10% in a stock. That itself brings automatic risk control on a particular stock. As far as holdings in a sector are concerned, we did not have any conscious restrictions. But it came naturally. See, there are five analysts who are covering different sectors. It is very unrealistic as an organization to have a situation where you are always buying stocks covered by one analyst and not having the time and money to devote to the other four. Each of our analysts would want stocks from their universe to be bought. So, just because of the way the organization is structured, we are adequately diversified across sectors. Fixing the maximum weightage in a particular sector does not make much sense. At the peak of the TMT boom, for instance, we had 50-55% exposure to the sector. In an absolute sense, this appears high. But relative to the benchmark it was not.

CIO: Are these limits applicable to your emerging market or Asian funds, as well?

Samir Arora: Globally, our emerging market funds restrict their exposure to a particular stock, to 5% of the fund corpus, or the benchmark plus 2%, whichever is higher. In the Asian funds that I manage, I restrict my exposure to a particular stock to the benchmark plus 4%. We also have a country limit of 5%. The idea is to reflect truly the stock selection as the reason for a return, rather than a bet on a currency, a country or a sector. Given these restrictions, we are clearly growth-biased investors. So, merely by definition, we will have a bias towards high growth sectors, whatever they are at a point of time. For instance, we don't have a shipping analyst in Asia, even though there are some Asian shipping stocks that we could buy.

CIO: How big is your investment universe? What are the factors that influence it?

Samir Arora: Well, as I told you, I manage three sector funds. Now, for each of these funds, we have to cover effectively every company in the particular sector. We cannot be unfair to those small sector funds by saying that we will look at only the top 50 companies. The sector fund has to buy at least 15 companies to be a meaningful fund in itself. That creates more work but is a huge help in that we have space for every stock. We have a fund for nearly every good story. While a small stock may not have much of an impact on our bigger funds, this is not so in case of our sector funds. So, we don't really have a size limit. However, a small stock does not get the same attention, as we cannot buy it in every fund. Discovering a small stock only for the sake of one fund is not as exciting as doing it for every fund of ours. Nevertheless, in theory we can look at any stock because we have all kinds of funds.

CIO: If you have a company with good management in a bad business and another company with a bad management in a good business, which would you choose?

There is no concrete definition for "good management"

Samir Arora: We want good businesses. A good business with decent management is better. In a bad business, the value that a good management can add is very low. We have seen in the past that even if you have a management that does nothing, a good business often keeps its momentum. But, yes, if you have a completely fraudulent management, then whatever the state of the business, you are unlikely to benefit.

The problem is that we sometimes do not know what is the limit of good corporate behavior. Is a company with large no: of outstanding options for management good to motivate them or a fraudulent behavior. Stock market analysts want companies to be open to shareholders but do not like companies that worry too much about their share prices. Would you rather have a company, which does not even meet the shareholders once a year like many multinationals or companies where the promoter will know every minute what is happening to his stock. Do you like managements where the owners are in charge or do you like professional management, which can also leave at short notice and at the slightest hint of problems.

Every case is different and we have to continuously adapt to what is good. GE beat their earnings guidance every quarter for a number of quarters and everyone thought that was good. Now since times have changed every analyst wants to know how exactly GE did that and whether everything was above board

Life is unfortunately more complicated than we think.