Sundaram MF's new CEO on why adaptability is key for active fund managers

For Anand Radhakrishnan, who is at the steering wheel, it’s a full-circle moment. Starting as a fund manager at Sundaram MF, he now returns as the new CEO. In an interaction with Mint, he shares his vision for the fund house's growth and insights on fund management in India. Edited excerpts:

Can you elaborate on your plans for Sundaram MF?

Sundaram MF has been around for over 25 years, evolving through various phases. In the early years (1996-2000), we were setting up the business during a challenging time. I remember this period as I was also a part of it. The markets were moving up, but the broader economy was still recovering post-liberalization. That was the time when we were establishing processes and systems.

Over the next decade, we have seen meaningful launch of funds and delivered good performance outcomes for our investors. We became known in the market for our strength in mid- and small-cap equities, identifying and capitalizing on medium to long-term growth opportunities. This helped the company scale up significantly on the equity side. However, our growth in the fixed income space was limited during that time and even subsequently.

During this period, we launched various small-cap, micro-cap, and close-ended funds. However, we unintentionally vacated certain core categories and we were not known as a big investment player on large-cap, flexi-cap or other diversified fund categories. This led to a somewhat lopsided asset allocation. The acquisition of Principal AMC helped us gain expertise in core categories like large-, large- & mid-cap fund and flexi-cap fund. We subsequently launched large-cap, flexi-cap and focused funds, rebalancing our offerings. I would call that as end of phase two.

The current phase is an opportunity to do three main things: First, continue delivering strong performance in our core areas of mid-cap, and small-cap.

Second, establish a respectable track-record in core categories like large-cap and flexi-cap, which is a work in progress. Achieving these goals will make us a more complete money manager. We will be seen as a more comprehensive asset manager on the equity and hybrid side.

The other agenda is that we aim to build scale in our fixed income space.

How do you plan to build scale in the fixed-income space?

Fixed income has lost some appeal post-tax normalization between debt mutual funds and other instruments. However, I believe investors will eventually recognize the value of debt mutual funds. After the credit experiences of 2018-2020, many fixed-income funds globally have become extremely risk-averse. This has reduced their ability to generate incremental returns over comparable alternatives. But I expect a gradual return to risk-taking, which will enable us to generate higher returns.

Globally, fixed-income funds remain significant, and I see no reason for India to take a different route. We aim to rebuild our fixed income franchise by leveraging market nuances. For instance, investors might want to lock into high-yield securities when interest rates are high or play the rate cycle with government securities (G-Sec).

Are there opportunities to innovate debt mutual funds as pure debt funds no longer enjoy the same tax efficiency?

Yes, there is an opportunity to innovate there from a post-tax return perspective. There are already existing sets of products where people are using the tax advantage of equity, but reducing the risk of it through derivatives and making it a more fixed income kind of a product. A typical example is an equity savings kind of thing. There is a whole range of outcomes between equity and debt.

Let us say equity gives 12-13%, debt gives you 7%. We can construct products between 7% and 13% range. Already, there are such products, positioned for 8%, 9%, 10%, and 11% returns. So, how are you finally positioned on post-tax return perspective. So, yes innovation can be done in this space. But we do not want to launch too many new products right now, but having said that if an idea is very powerful, we will do it.

Where do you stand on the active vs passive debate in the mutual fund industry?

Over time, the ability of active fund managers to outperform indices has significantly narrowed, sometimes even resulting in underperformance. This trend is observed in India, as well as globally. It is not just because passive funds have become big. The main reason is that the time fund managers have to take investment decisions has shrunk. Nowadays, there's hardly any time to analyze a company thoroughly. By the time the analysis is complete, the opportunity vanishes.

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Opportunity cycles have become much sharper, largely due to the democratization of information and analysis. Today, a lot more people are jumping at stock ideas. The number of participants looking to identify a profitable stock has increased manifold.

It’s not just mutual funds and hedge funds anymore; we’re seeing high-net-worth individuals (HNIs), individual investors, and even mass retail investors entering the fray. This influx of new players means fund managers have to be more nimble and alert to what’s happening in the market.

 

How do you think active fund managers are handling this?

Some fund managers have adapted well to these changes. They understand the need to act quickly and assess what’s priced into the market. These managers generally manage to keep their heads above water in terms of outperforming benchmarks. However, many others are still learning to cope with these rapid shifts.

Another major development is that many active fund managers have become what we call "closet indexers." This means their performance is closely tied to the index, plus or minus the benchmark index returns. This shift has happened because the fund house’s performance, the company’s business, and their own (fund manager’s) careers are at stake. The incentive to stand out and take bold calls has reduced significantly over the years. Instead, the index-plus-or-minus strategy has led to a narrow corridor of outperformance or underperformance relative to the index.
 

What has been the broader fallout on MF industry?

Negative incentives have also increased, thanks to relentless media feedback. If a fund manager doesn’t perform well for three consecutive years, they get labelled as bad investor.

Earlier, investors had more patience. They understood a fund manager’s investment style and knew that three years of underperformance could be compensated by a single year of stellar performance. We’ve seen this recently with value-style funds, which, after underperforming for four to five years, managed to catch up in just one year. However, today, investors views are path-dependent. The more unpredictable the path to performance, the less confidence investors have in that fund management style.

This has led to an increase in index-hugging behaviour among fund managers. Many new fund managers have become more index-conscious in their behaviour. There needs to be some unlearning among active fund managers.

From a business perspective, many asset managers are hedging their bets by launching passive funds to attract institutional and retail money. For making big active bets, fund houses often launch separate funds, such as value funds or contrarian funds, to avoid the risk of heavy underperformance in their core categories.

The mutual fund industry in India, and globally, is undergoing significant changes. Fund managers need to adapt quickly, stay alert, and sometimes unlearn old habits to thrive in this new environment.

What is Sundaram MF's approach to mid- and small-caps, given the asset manager’s long-standing focus in this space and now talk of a bubble forming?

Mid- and small-cap categories constitute 20-25% of our equity AUM, which is significant given that equity makes up over 70% of our total AUM. So, as an AMC we are extremely linked to market fortunes because of our low fixed income and higher proportion of mid- and small-cap funds in our overall AUM.

So, we do need to be aware of that particular position that we are in and see how best we can utilize any negative drift in the market or volatility. That is the reason the core categories need to be built from the firm's perspective.

We have seen investors flocking to those kinds of categories (mid- and small-caps). Luckily or unluckily, whichever way we would like to look at it, we did not get much flow in those categories in the last two years. Though our performance was good on a one- and three-year basis, we had again a bad patch in performance.

There was a change of fund manager in our mid-cap fund post-that performance challenge and subsequently, we have seen improvement. But people are still looking at those past performances and are not allocating any incremental money. It is both good and bad thing. Most of the new investors who are flocking into mid-caps are still not experiencing us. This is a bad thing.

The good thing is that if there is a market correction, the set of investors we have in our funds will continue to stick around because they have been on-boarded in the earlier cycles and are sitting on respectable returns. Even if there is a drawdown on that, their sensitivity will not be very high.

What are your thoughts on smart beta and factor funds?

There is definitely scope for smart beta or factor funds. We can convert qualitative and quantitative metrics used in active investing into rules and variables, reducing human judgment. For example, tracking the transition of companies from average to high quality can be systematized. By removing subjectivity and focusing on factors like quality, growth, and valuation, we can create smart-beta offerings.

Factor funds are particularly interesting. For example, "quality" is a term used frequently by fund managers. There are both stable quality companies and cyclical quality companies, both of which can be identified through qualitative frameworks. But will the fund manager allow a cyclical quality company to enter his mental framework.

A quantitative model, however, can track transitions more systematically; if a company is improving its return on equity (ROE) or return on invested capital (ROIC) or return on capital employed (ROCE). Conversely, a decline in such metrics can indicate a drop in quality.

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This method can be applied to other factors such as growth and valuation. The goal is to remove the element of subjectivity and let the data drive investment decisions. While models are not foolproof and can fail during market extremes, ongoing refinement and adaptation can make them robust over time.

See, the theory is that market prices have all available information, then capturing transitions can make a difference.

Active fund managers already use these models in their own mental framework. The key is to develop models that can adapt and evolve with market conditions. We are open to launching such products, but we need to build necessary capabilities.

Would you be open to launching these smart-beta funds?

Yes, we are open to launching smart-beta funds. Building and managing these models require significant capability, but it's essentially about converting mental models into mathematical factors. Ensuring these models can traverse market conditions without failure is crucial. These models need to be made smarter, there needs to be self-learning, and it might also require certain technology elements.

How are you planning to rebuild the fund management team at Sundaram MF?

The broader problem in the fund management industry is that most fund managers learn on the job. There is no intensive fund management degree available. While the basics of financial management and investments are taught, fund management involves much more, particularly the behavioral aspects. It's crucial to understand where you stand vis-a-vis the market and how well you cope with market dynamics. Many of these issues aren't formally taught; they're part of the firm's culture, passed down from senior fund managers.

At Sundaram MF, we're focusing on establishing a strong culture of learning and grooming. Some AMCs have done well in this area, creating environments where knowledge and experience are effectively passed on. It's not just about Sundaram MF; it's an industry-wide challenge. We need to trap organizational learning and pass it on to new fund managers as senior ones exit. It is not only true for Sundaram MF, but fund houses where there have been lot of transition in terms of fund managers.

We are investing time and effort in scaling up our internal capabilities. This includes tweaking processes and, if necessary, bringing in external talent. We are open to both approaches.

Regarding the CIO position, we're not in a hurry to fill it. The market is very competitive for senior talent, and we don't want to risk a cultural mismatch by rushing the hire. In the interim, I am here to provide support to fund managers, acting as a sounding board and ensuring smooth operations. We believe in taking our time to find the right candidate who fits well within our existing system and culture.

Traditionally, Sundaram MF has been reliant on mutual fund distributors (MFDs). However, digital platforms have seen significant growth thanks to the advent of direct investors. Do you plan to tap this segment?

So, ideally, we would like to be picked up by as many investors as possible whether they are coming through mutual fund distributors (MFDs) or banks or national distributors or fintech-led digital platforms. We are kind of neutral. But there are some real challenges.

One of the challenges we face on digital platforms is that fund selection is fully numbers-based, focusing on near-term performance We are working with these platforms to consider metrics like risk-adjusted returns. I think over time, their algorithms will evolve. We are also exploring how we can piggyback on their explosive growth. Not being prominent on these platforms can hurt our AUM growth, but trying to be there might also involve taking certain risks.

Mutual fund distributors (MFDs) have been our bread and butter. We've observed that MFDs don’t churn investor portfolios unnecessarily, which builds investor trust. This aligns with our principles of being consistent, staying the course, and believing that returns will eventually come.

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On the banking channel side, banks look at many factors when onboarding funds, including changes in leadership, the fund management team, and performance. They conduct thorough due diligence. While some of our funds are already onboarded, we need to make further inroads. Our share within the banks and national distributors is relatively low compared to the industry's share of AUM within banks and national distributors. So, we kind of need to move up. But in India, banks focus heavily on distributing their subsidiary AMC's funds

India is a distribution-driven market, and the larger the reach, the better the outcomes for a financial services brand. Sundaram MF also has a retail reach with 75-plus branches, but this is incomparable to a bank’s distribution strength.

Sundaram, like many other standalone asset managers, faces a disadvantage compared to bank-owned fund houses. Even if there is good performance, standalone asset managers will be at a mild disadvantage compared to a distribution-led fund house. Hence, breaking into the distribution ecosystem remains a challenge.