Better returns should drive investors back to equity markets: Jayesh Gandhi

Interview with President, Indian Association of Investment Professionals

The Indian Association of Investment Professionals (IAIP) and the CFA Institute conducted a survey among India members (including many of the country’s best known market minds). Its results suggest a meaningful correction in commodities and bet on equity being the best asset class for the current financial year. Jayesh Gandhi, president of IAIP, the India CFA Society and executive director at Morgan Stanley Investment Management, talks about these and related matters in an interview with Sachin P Mampatta. Edited excerpts:

Equities are said be the best bet for the year ahead, with the Sensex level in excess of 22,000. Would earnings support such valuations?

The IAIP survey has voted for equities as the best asset class for FY15, with a forecast that the Sensex could give meaningful positive returns even from the current market levels. Valuations currently are fair and in line with the long-term average, anticipating some pick-up in earnings. Corporate earnings, for the large companies, are forecast to grow in the mid-teens, significantly better than the growth rate in the past two years.

While in the past couple of years there has been downward revision in initial earnings estimates, the recent trend suggests bottoming out of earnings growth.

With pick-up in economic growth and stabilisation of macro economic factors such as inflation, interest rates, currency volatility, etc, it is likely that the actual earnings come in line with expectations, support valuations and provide upside to investors.

Which sectors could outperform and underperform?

Pick-up in GDP and economic activities should benefit all companies and sectors. So, it is difficult to predict sector returns. Nevertheless, a stronger case can be made for cyclical sectors, dependent on the domestic economy, such as banking, industrial products and capital goods, cement and consumer discretionary ones. These sectors have seen material headwinds in the business environment in the past two years, not only from a slowing economy but rising cost due to high interest rates and inflation. On the low base, companies in these sectors can see significant uptick in their earnings when there is a meaningful rebound in domestic economic activity.

Restarting of investment activities would be critical to sustain economic growth. The key here would be to unclog key infrastructure projects and the resources/mining sector, stuck due to policy inertia by the government and crony capitalism. The power and infrastructure sectors would be key beneficiaries of the new government’s initiative in this area.

What is the outlook for the mid-cap segment?

The survey results clearly suggest risk taking is coming back; mid-cap and small-cap companies are expected to outperform large-caps.During the past three years, particularly the period starting early 2011 to mid-2013, mid & small-cap stocks saw significant value erosion. While the large-cap index, the BSE Sensex, is at an all-time high, mid & small-cap indices are substantially below their peak. The IAIP survey suggests the trend in the past couple of years is likely to reverse soon. Pick-up in economic activity and better sentiment for equity markets should all contribute to higher returns for mid and small-cap companies.

What are the biggest risks to your equityforecasts?

Largely from domestic factors, also seen as the key drivers for equities. National election results and expectation of a stable government is part of the bullish equity view. Over 60 per cent of the surveyed participants expect a stable government and the new government to initiate policy reforms that would boost economic growth. Also important is the new government’s economic agenda and flow of reforms. The past 12 months have seen a slew of reforms and policy initiative. However, more policy action and a stronger movement in reforms is required from the new government.

Foreign institutional investor (FII) holdings are at an all-time high. What is the outlook for inflows? Is foreign ownership a risk, in the absence of domestic liquidity to absorb sell-offs?

FIIs continue to add Indian equities as they find India attractive, with well-run companies and sound business models at reasonable valuation. The absence of domestic investors into equities is a cause of serious concern; it needs to be addressed soon by the government and authorities.

One reason for retail investors could be the poor returns from equities after 2010. However, in the past year, Indian equities saw a strong comeback, posting double- digit returns, beating all asset classes. Better returns should drive Indian investors back to equity markets.

How big a factor would the US Fed's tapering be in the days ahead?

Fears that the US Fed’s decision to taper (slowly reduce) its bond buying programme would lead to a sell-off in emerging markets such as India have been unfounded. Many experts and strategists continue to expect adverse impact on EMs from a strengthening dollar and higher US interest rates. What is missed in these concerns is the fact that deflation is a bigger concern for developed economies, the US in particular. A stronger dollar could very well lead to imported deflation into the US, which the central bank there is keen to avoid.

While many EM equities and currencies have underperformed, India has stood out, as its external balance, the current account deficit (CAD) situation, has improved significantly over six to seven months. India could very well remain relatively less impacted by the global volatility in the currency and bond markets, as long as its domestic fundamentals show stability and improvement.

Both gold and oil, India's biggest imports, are expected to fall in the days ahead. What would this mean for the deficit situation?

Over the past six months, moderation in non-oil imports, reduction in gold imports and pick-up in exports has resulted in significant improvement in India’s external trade and CAD. Over the near term, the CAD is likely to remain benign and be more than adequately funded by capital inflows, substantially reducing the pressure on the currency. A stable currency outlook in an environment of global volatility is an important contributor to the overall stabilisation of macro economic parameters for India.

When do you expect to see a pick-up in primary market activity?

During the past six months, in which the primary market fund raising by companies has not been significant, the equity markets have been supportive. This is clearly demonstrated from the fact that the entire divestment program of the government, including the SUUTI sell-off of Axis Bank and the PSE ETF, were completed successfully in a short time. It is difficult to pinpoint the time lines but healthy equity market returns would definitely be positive for primary market activities and these should revive soon.