Interview with Sanjiv Duggal, Investment Director (India) of Halbis
Halbis Capital Management provides specialist, fundamentally based, alpha-seeking products including long-only equity, fixed income and hedge fund products. Halbis launched its first hedge fund vehicle in 1999, making it one of the earlier institutional players in Europe. Today, its line-up consists of six strategies with nearly US$1 billion under management. With respect to its historic performance in Indian equities, its cumulative returns since 1 March 1996 to 31 December 2006 were 1,336% vs 286% for the S&P/IFCI India Index (annualised 27.9% vs 13.3%).
Halbis manages various funds in the US, UK, Latin America and Asia. How does the Halbis India Alpha Fund compare with the others in terms of the associated return and risk levels?
The common link across the spectrum of our strategies is our focus on delivering the best risk-adjusted returns possible with little to no dependency on beta. Our Indian alpha strategy is no exception. The budgeted volatility is 10% (like our other hedge funds) and our net exposure range will be -20 to 40% with an average of about 30%. The strategy is also designed to naturally complement our existing long-only capabilities.
You say that the ‘rumour-driven’ volatility of the Indian equity market works to your investment team’s advantage. What kind of portfolio management practices are in place to enable your team to exploit this and to manage the risks involved?
Our approach is based on fundamentals and we make our own decisions based on our analyses, reasoning and views on market expectations/positioning. Therefore the frequent moves in stock prices caused by rumours create an opportunity to add alpha. We would like to stress that we are not momentum investors and do not buy into a positive rumour or vice versa.
What is the typical holding period of your funds’ investments?
We do not follow the concept of a typical holding period. However, we expect that our best buy ideas will have the longest duration, followed by best short ideas and then by pair trades. We will manage our portfolio on an active basis with market dynamics/opportunities and fund flows driving some of our decisions and hence holding periods.
The Eurekahedge India Long/Short Equities Index returned slightly over 82% over the last three years. Do you expect this trend to continue in the long run, especially with respect to the Indian economy? What kind of strategies do you have in place in the event of market duress?
Prior to the recent correction we had a cautious view on the market. Our stated strategy in February was to lower both gross and net exposure in the run-up to the budget especially if the market rallied given our concerns on valuations and high expectations of market participants on both corporate and economic growth. We expect both corporate and economic growth to slow down as the Central Bank continues to tighten monetary policy given their concerns on rising inflation, rapid credit growth and overheating in some parts of the economy. We had a stated bias to be more defensive and value oriented and would have lowered our exposure to mid/small caps (this exposure is limited to 30% of gross and 20% of net).
In the past three years we have managed to predict both (May 2004 and May 2006) the key market duress situations in the Indian market through a combination of research, analysis of market positioning and luck. Our approach would have been to gradually reduce net and gross exposure in the run-up to those events and would anticipate having been single-digit net long or neutral to short the market when the corrections started. Similarly we anticipate that we would have started taking up net exposure prior to the market bottoming in both cases as it is impossible to predict the top or bottom of markets. This relates in part to your next question as well since our portfolio will be constructed to be much less directional (and less volatile) than many of our peers’ portfolios.
Finally, we do not expect the trend of strong positive returns of India long/short funds to continue going forward. Please see response to last question as well.
Based on recent Eurekahedge research, there are over 20 India-focused long/short funds in the market. How do you differentiate yourself from your competitors and what competitive edge do you have over them?
Our portfolio will be more like a true hedge fund whereas many of the funds out there are levered long-only or long-biased funds that sell futures to bluntly hedge themselves. By contrast, our shorts will be stock specific and are meant to be alpha generative. We expect that we will have lower gross and net exposure to mid/small caps compared to our peer group. Finally, we will have a top-down approach to identify best and worst sectors and themes before focusing on stock selection (best longs, best shorts, best pair trades) within each sector or theme.
You have stated that your investment philosophy is to combine long and long/short strategies to achieve modest net long. How do you ensure that your portfolio is not long-only biased and is alpha generative?
Our prospectus and internal guidelines/limits will clearly spell out the parameters within which we will manage the strategy and our risk management colleagues ensure in all of our portfolios that we do not deviate from our mandates. We will neither permit ourselves nor be permitted to run a long-only fund. The whole point is to extract alpha from the market with a product that complements our existing long-only portfolio. However, on average we will have a net long bias of 25-30% and hence the returns of the market will have some limited influence on the performance of the fund. On the best ideas book, both best buys and best sells, we will avoid using index futures and attempt to add alpha from our longs and shorts.
How does your fund’s performance compare with that of a similar Asia-centric fund that is more regionally diversified? What kind of advantages does the India-centric strategy give?
The most obvious is our focus. Our investment universe is not infinite but clearly defined and the drivers of the local market are also easier to identify for any single market than is true for the pan-Asian marketplace. More specifically, the Indian market also provides a broader opportunity set than many other Asian markets. For example, the market is broadly diversified across a number of sectors with no single one of them dominating the landscape. The top two sectors in terms of market cap (tech and financials) make up only 40% of the total market cap. In a market like Hong Kong by contrast, banks and real estate dominate – both very sensitive to one key input: interest rates. And those sectors represent two-thirds of the total market. Moreover, there are 130 companies with market caps over US$1 billion in India today and the list continues to expand. Both the depth and width of the market present great opportunities for an active manager.
Is there an industry focus in your investment strategy? What is the typical breakdown of your fund’s portfolio? What kind of methodology do you adopt in picking individual long and short investments?
We do not have any industry bias in our investment strategy. As mentioned above, we start our investment process from a top-down perspective before focusing on stock selection – unlike most of our peers. Half of our book will consist of pairs trades which will match up within sectors or themes and be market neutral. The other half of our book will comprise our best ideas – the gap between the best longs and best shorts will give our net exposure. Typically we will look to run 150-200% gross exposure.
Our research is very focused on the key driving factors for sectors and stocks using our own assumptions. The sector allocation and stock selection process is described below:
We consider the economic and business cycle effects on each sector. In addition, we analyse government policy and skills/competitive issues to determine how we believe a sector will develop over the next 12 to 18 months.
We use a bottom-up approach for stock selection. The investment team conducts comprehensive research on companies in the investment universe which forms the basis for selecting stocks in the portfolio. Stock ideas are generated in-house with attention on fundamentals and valuation. We establish price targets for the stocks under coverage. When targets are reached, an evaluation takes place and a buy, hold, or sell decision is made on the basis of upside/downside.
Stock selection favours growth-oriented, liquid companies with identifiable competitive advantage, efficient operations and financial strength. Quality of management and its strategy implementation is a key consideration. We buy value stocks we can identify a catalyst for change.
We look at a variety of factors. Key focus is on cash flow, economic value added and also includes trends in returns on equity and capital, EV/EBITDA multiple, P/E multiple, price to book, etc. We examine these on an absolute as well as relative basis. While looking at these parameters we closely monitor market expectations to identify potential positive/negative surprises. Below is a diagram of the process.
Could you elaborate further on the scenario analysis and stress-testing mentioned in your investment process?
Please see responses above.
India is predicted to become the world’s third largest economy, behind US and China, by 2035 based on an expected growth rate of 5.3% to 6.1% in various periods (whereas India is registering more than 8% growth rate for the last three years). How do you see this influencing the future of India-centric hedge funds?
The recent rapid economic growth and the strong performance of the stock market have seen a lot of India-centric hedge funds being set up. We expect the economy to continue to grow at a reasonable pace over the next few years. However, the Indian stock market performance is not necessarily linked in this economic growth and the market should not rise as rapidly as it did over the past three years.
We expect further launches of India-centric hedge funds but investors will increasingly differentiate between the competing strategies and long funds. If investors are positive India in the medium term, it makes sense not to buy an India-centric hedge fund but to focus on long funds. We would expect pressure on the performance fees of quasi-long hedge funds. The deciding factor in our view will be how hedge funds cope with a range-bound or falling market over, say 12 months, as this will hurt liquidity of the market and have a disproportionate effect on mid and smaller cap stocks.