Why Madhu Kela Moved Out of Reliance MF

Clearly, there is something fundamental that is changing at Reliance Mutual Fund, the lone trillion-rupee fund house in the country.

Four months ago, in an extremely silent move, Kela moved out of the mutual fund to Reliance Capital as chief investment strategist. It took a while for outsiders to notice this change, but when they did, speculation flew thick and fast. It came at a time when the Anil Ambani group, which owns the mutual fund, was negotiating a settlement with the market regulator over charges of misusing funds raised abroad. It also came at a time when its flagship equity fund, the midcap-focussed Reliance Growth, had begun to underperform the stock market.

Only when Kela began work at his new role, the contours of the change became clearer. Kela is turning his own investment philosophy on its head and is chiseling a ‘top-down’ approach as against a ‘bottoms-up’ one. This means studying the macro swings in the economy and industry and spotting multi-year trends that will yield investment opportunities. It is what the best international fund houses do. But this also requires casting the net wide and hiring domain experts. Exactly what Kela has set out to do.

“I have always looked at a company’s individual financial parameters and never really bothered about what is happening in the outside world,” Kela recalls in an interview with Forbes India. “But the 2008 crisis affected our portfolios and that is the time we decided to concentrate on the macro factors as well.”

A Salesman Par Excellence
Early in his career, Kela clearly showed his ability to see the big picture. A commerce graduate who also studied management at Mumbai University, he spent several years in the ‘sell side’ of the markets before defecting to the ‘buy side’ mutual funds.

Kela was instrumental in setting up the institutional desk at brokerage Motilal Oswal in the Nineties. “Madhu Kela managed to earn himself a reputation as a sales person because he used to put himself in the shoes of the fund managers and work closely with the research team,” says Ramdeo Agarwal, director and co-founder of Motilal. “There was an excellent relationship between the sales and the research team and Madhu was passionate about the business.”

His success at Reliance largely comes from the team he built in the early 2000s. With a ten-minute talk, he convinced Sunil Singhania, then of Advani Share Brokers, to join him. They often hunted in a pair, mainly through the vehicle of Reliance Growth.

One of their biggest bets was Jindal Steel & Power. In 2003, the doyen of the group, O.P. Jindal, had not yet got the market recognition that his companies later earned. The fund managers saw a gap between reality and the perception of the management by the market. They picked Jindal Steel & Power when its market capitalisation was a mere Rs. 300 crore. Their view was that profits will grow by four or five times in the following years. But they were in for a pleasant surprise. Profits went up by 40 times and market capitalisation rose 200 times in the next seven years. The P/E multiple moved up from 3 times to 15 times.

The Kela-Singhania team hit another home run when it invested in liquor company Radico Khaitan at a time when the business was a loss-making proposition and investors typically avoided the sector. They made 15 rupees for every rupee they put in. Similarly, with Pantaloon, they earned five times their investment.

Image: Vikas Khot

LOOKING FOR WINNERS Sunil Singhania, the new head of equities at the fund house, will continue to be a stock-picker

The Soul Searching
With such investments, Reliance Growth grew to be a very successful fund and also a high alpha one. That is, its movement was more volatile than the general market. This proved to be a handicap for Kela during and after the financial crisis. The smaller stocks which had so far given hefty returns proved difficult to sell in an environment where investors began putting a premium on size and quality. “This fund has a long- term track record and has emerged as the second best performing open-end equity fund globally over a 15-year period and the fifth best performing equity fund globally over a 10-year period. However, the fund’s performance has dipped over the past few years and it dropped to the third quartile within its peer group,” says Dhruva Raj Chatterji, senior research analyst, Morningstar India.

Almost at once, Kela and Singhania went in for introspection. Even much before the crisis, they had pushed Reliance Growth to invest in large cap stocks (up to 30 percent of funds) because its growing size needed the cushion. But now, they started taking a complete relook at the way they invested. Maybe, they realised, just a rigorous look at cash flows, margins and P/E was not enough because something that happens in some corner of the world could destroy the fund’s net asset value overnight.

There was another problem. About a fifth of Reliance Growth’s Rs. 8,000 crore assets was parked in small companies. The fund had invested less than 1 percent of its assets in each of these companies and was not required to detail them in its portfolio declarations. At a time when investors shunned companies with even a minor problem, many of these lesser known stocks went out of favour.

Thus, the turning fortunes of a mid-cap-led ‘bottoms-up’ strategy made Kela change his views. He began leaning on what he calls ‘blue-sky thinking’ more and more. It was clearly time for him to move beyond the mutual fund and take on a larger advisory role. (As if to signal the shift of stance, Kela has even moved to a different tower in One Indiabulls Centre in Mumbai’s Parel area where Reliance Capital and the asset management company are headquartered.)

The new approach is bringing insights that would have been missed by Reliance fund managers earlier. For instance, in December 2010, Kela saw that the average inflation expectation from brokerages was in the region of 5 percent. Kela had already started paying attention to inflation in a much bigger way and had hired a person in Delhi whose job was to follow the data and how the government changes and includes items in the official inflation basket. That leg work showed that the number could be much higher, at around 7.5 percent. Based on this, Reliance went underweight on the banking sector. By the time the banking index lost 10 percent due to the impact of inflation, Reliance mutual funds had already gotten out of the key bank stocks. The hit on the NAV was avoided.