BS Fund Cafe: 'The linkage of markets with elections is very weak'

Leading money managers say broad market valuations are looking better after the correction and they are bullish on export businesses and corporate banks

Six of India’s leading money managers say broad market valuations are looking better after the correction and they are bullish on export businesses, corporate banks and select capital goods companies

Are markets expensive at current valuations?

Mahesh Patil: If you look at the valuations on a trailing basis, the markets are expensive. But, you need to keep in mind that the index composition has changed in the past 10 years. The percentage of non-cyclical sectors has gone up from 40 per cent to around 60 per cent — these sectors have higher price-earnings (P/E) multiples. 

When you are buying stocks, you look at forward valuations. Earnings growth has been in low-single digits in the past two-three years. We have been seeing growth starting to move up in the last quarter and this quarter. It is gaining momentum. We haven’t seen large downgrades either. We are looking at around 18 per cent kind of growth this year. The P/E multiple is not very cheap but it is also not as high as it looks on a trailing basis. 

Prashant Jain: Trailing P/Es are not the best barometer to look at the markets right now. India’s profit-to-GDP ratio is close to all-time lows. When margins in businesses are below long-term averages, trailing P/E can be misleading. The price-to-book value or forward P/E would be a much better indicator. If you look at that then I am much more optimistic. We have been positive on the markets, especially large-caps. You will find valuations are quite reasonable. In mid-caps there are excesses in pockets but it is a large space, and you can always find some value here and there.
 

In the Nifty, strip out consumer discretionary and non-discretionary names, and you will see valuations getting more reasonable. If you argue that this space doesn’t offer value at current high P/Es, the rest of the space becomes quite cheap. If you take a medium to long-term view, I am quite constructive on the markets, particularly on large-caps. 

How do you explain the dichotomy of a few stocks trading at high P/Es while the rest of the market languishes?

S Naren: We go through this debate periodically. A few years back, it was why large-caps are not going up and only mid- and small-caps were rallying. So that debate got settled this year. No one can believe that large-caps have gone to record highs and mid- and small-caps have corrected. Some stocks are pretty expensive at this point, particularly consumer facing names. The next few years will be interesting as you will see pockets of volatility. 

What should a debt fund investor’s strategy be right now?

Navneet Munot: After two pre-emptive rate hikes, it looks like the Reserve Bank of India will be on a pause. We have to watch global commodity prices, particularly crude oil and also the second round impact of the MSP (minimum support price) hikes, the direction of the monsoon and inflation dynamics. Bond yields have a different story. The near-term outlook is hazy because of the demand-supply dynamics. But, when the government is so focused on fiscal consolidation, even in an election year and the central bank is so committed to four per cent CPI (Consumer Price Index) target, these kind of yields are very attractive for a long-term investor. The short-to-mid end without assuming too much duration and credit risk offers decent opportunity. 

Mahesh Patil

Co-CIO, Birla Sun Life MF 

“We are looking at around 18 per cent kind of earnings growth this year. If you take that into consideration, then the P/E multiple is not very cheap but also not as high as it looks on a trailing basis”.

Where does India stand right now vis-a-vis the global economy and tariff wars?

Vetri Subramaniam: The economy is on a reasonably good wicket. Most of the high-frequency indicators are showing continued momentum. We are a little bit of an oasis at this point, happily growing in our little island. Globally, trade tensions are something to worry about. India is not at the front or centre, which is a good thing but there could be some level of collateral damage. Whether we look at the direction of reforms, or direction in which policy is going, all of it looks conducive. 

What do you like at present: large-caps or mid-caps?

Manish Gunwani: We have a neutral view between large-caps and mid-caps. The thing with mid-caps is also the same dynamics that’s played across the markets. You clearly have consumer, retail and finance stocks which have done spectacularly well for four years. Their price-to-earnings or price-to-book has expanded quite a lot. But, if you step aside from that and look at mid-cap cement, industrials and banks, there is at least relative value there. There is some momentum in the economy. Global growth is fine. I think, while India’s macro this year has caused some concern, oil doesn’t look like a compounding variable. My outlook on inflation is benign on a three to five-year basis. In that case financial assets should do well. A lot of these cyclical sectors should get a tailwind from that as well. 

How difficult is it to generate alpha?

Patil: When you build a portfolio you want to maintain a good amount of diversification. You want to take bets outside the benchmark, which will generate alpha. So, at a time when the markets have been so polarised in the past year — five-six stocks have accounted for most of Nifty returns — it has been a bit of a challenge to outperform the benchmarks. But, mean reversion will start to happen. Valuations in the broader markets after the correction are now looking much better. 

The markets are now rewarding stocks where earnings growth is good. Bottom-up stock picking would be able to generate decent alpha and if you look at the kind of alpha mutual funds have generated over the longer term, funds should be able to do that going forward as well. There is enough scope for funds to generate alpha over a three-year time frame. It might not be the same as what we saw in the past decade but reasonable outperformance from the total returns generated by the benchmark is quite possible. 

Jain: When you say alpha, I presume you are referring to the Nifty or to Sensex as the benchmark. Until one year ago, most funds were outperforming the Nifty and the Sensex. But, some funds were struggling against the broader benchmarks and the Nifty was trailing the broader benchmarks by a wide margin. That has changed now. 

In the past few months, as Mahesh mentioned, because five stocks contributed so much to returns; today the Nifty and the Sensex have done extremely well against the broader benchmarks. I don’t think it is right to just compare all funds with the Nifty and the Sensex, because funds have much broader portfolios. While the last one year without doubt has been challenging, it is just one year. And two, if you look at the broader benchmarks, you will find the picture is not so bad.

Prashant Jain

ED & CIO, HDFC MF 

“The multiples in the consumer space are rich — both in the discretionary and the non-discretionary space. I think apart from that I see reasonable value across most of the sectors if I look at the Nifty or large-caps”

Is the size of funds an issue?

Naren: It depends on the category. If you look at mid- and small-caps, in some cases it would be difficult to manage size. As a house (ICICI Prudential MF) we have actually been focused on hybrids, which can invest in both equity and debt. From a scale point of view, it is one of the best categories where size can be handled, because if equity becomes expensive, you can move from equity to debt, and if debt becomes expensive, you move to equities if they are cheaper. In sectoral funds, the challenges of size are lower. One of the good things the industry did was to scale up hybrid as a category. This is where the scale challenges are the least. 

The market is also bigger today and there have been so many more initial public offerings (IPOs). Over the next 10-20 years, scale will become a challenge but in the phase we are in, where flows have been slower than last year, this has become a much smaller problem for us. 

Is beating the benchmark or exchange-traded funds becoming difficult for active fund managers?

Munot: We (SBI MF) have built a huge capability on the passive side, not anticipating that alpha would shrink but believing that passive funds would grow, particularly from the institution side, such as provident and pension funds. There could be other segments of investors who will also put some core allocation to passive funds. But, over the  longer period, the industry has generated a decent alpha. Saying that it was easier is taking credit away from where they deserve. There is time arbitrage — if you have a longer-term horizon compared to a large part of the market which looks at the short-term news flow, you will find opportunities. India will always remain a stock-picker’s paradise, as there is also research arbitrage. I think there are still a lot of opportunities to generate alpha for a longer period. So, both categories will grow together. 

Navneet Munot

ED & CIO, SBI MF

“Going forward, picking the right stock is going to be a lot more important than taking broad sector calls, as some players in a sector may do well while the others may not, given the scale of disruptions that are taking place”

Subramaniam: Just to pick up from where Navneet left, it is easy to pick on the last one year and say funds have been struggling on the alpha front, but if you think on a longer term, the more the market institutionalises in terms of flows, alpha generation would eventually become a zero-sum game. Also, remember 50 per cent of the market is owned by promoters who are a completely different category when it comes to extracting alpha. 
 

So, if I want alpha, I will have to take it from these five extremely smart gentlemen sitting on either sides of me. It is like going to Wimbledon with four of the top players in the world, but only one can win, there isn’t alpha for all four. I think that is the challenge, it is pure mathematics — that is what the rest of the world has experienced, and we will experience it here too. 

Vetri Subramaniam

Group President & Head-Equity, UTI MF 

“If I want alpha, I will have to take it from these five extremely smart gentlemen.That is the challenge, it is pure mathematics—that is what the rest of the world has experienced, and we will experience it here too”

Do you see the machines taking alpha away from you?

Subramaniam: Well, they are going after every industry and you find that in every industry they are able to do what we thought only humans could do. I am certain at some point they will raise a challenge for us as well. The only good thing is that investing is part-science, part-art. And hopefully, the art part the machines can’t do. The science and art combination will help some of us. 

Munot: I think it’s going to be human-plus-machine, and not pure machine or pure human. Maybe all of us can live on that past glory, but I think the future belongs to human-plus-machine, no doubt about it.

What is the best strategy going in an election year?

Gunwani: If you see the 2004 and 2009 elections, the markets have neither gone right in predicting the outcome, nor in their reactions on the day of the results. Typically, we have found that the markets’ action on that day turns out to be the wrong reaction. So, it is a big imponderable for us. 

It is also necessary to step back and see how much elections really matter. From a macroeconomic point, the impact doesn’t seem that large. Of the Rs160-170 trillion economy, there is only Rs4-5 trillion discretionary spending, which the central government has control over. Also, our institutional framework is quite robust. For instance, whatever government comes, the Reserve Bank of India’s (RBI’s) inflation-targeting framework will continue. So, there is a sense of continuity across governments, which is very important. So, unfortunately, for the next nine months we will talk a lot about this, we will agonise a lot about it but honestly it will be fruitless. There are so many variables that move the markets.

Jain: The markets have given positive annual returns every election year since 1979. We don’t know why this has happened but it just proves that the linkage of markets with elections is very weak. As was referred to earlier, the linkage between elections and profits is very weak. But, the linkage between profits of companies and the markets is very strong. So, I think we should focus more on profits, and profit-growth and valuations, and less on elections. 

In my experience, whatever events are known in advance tend to get discounted by the markets. And, human nature is such that when faced with uncertainty we take a more conservative view of things. So, elections are less of an issue, at least for the stock markets.

Where do you feel safe right now — growth, value or defensives? Is it a top-down or a bottom-up market?  

Subramaniam: The market goes through cycles in terms of top-down, bottom-up and seasons change. For quite a few years now, I would date it to 2010 but we can debate that, it has been more about getting individual stock selection right. I am saying this based on my own data and the great work that others on this panel have done. Stock-picking is key as the intra-sector divergence of returns is also very dramatic. We have been in a period where stock-selection has helped in creating alpha. It will stay this way, but at some point, it will change and it could go back to the kind of era we had in the early to mid-2000s where actually sector-selection played a much larger role than it did in recent times.

Which sectors do you like and dislike?

Patil: The Indian economy is starting to pick up, though a bit late, and the momentum is coming back after the big reforms. A lot of the domestically-focused sectors are looking good, if one takes a two-three year view. Some of the cyclicals could do well from here on. Consumer staples look expensive, but it seems to be a fairly long-term secular growth story. Within that, discretionary consumption looks fairly well-poised, as penetration levels are low in many categories and the goods and services tax (GST) will help the organised sector. The capital goods sector is showing some early signs of capex recovery. Capacity utilisation levels are hovering around 75 per cent, which should touch close to 80 per cent by the end of the year. In financials, private and retail banks will continue to do well, but we think corporate banks have seen the worst of the non-performing asset cycle and could be another area to look at. 

Jain: The multiples in the consumer space are rich — both in the discretionary and the non-discretionary space. I think apart from that I see reasonable value across most of the sectors if I look at the Nifty or the large-caps. 

Naren: We broadly share Prashant’s view in consumer. For the past five years, export-oriented themes haven’t done well, so when we have a trade war going on, this makes long-term investing in export-oriented industries very interesting. There are a number of sectors where 10-year returns are very bad. If you look at telecom, corporate banks, select public sector undertakings which have weathered many storms, I think those themes also look interesting at this point. Broadly we are believers that when interest rates were lower, small-caps and mid-caps did pretty well. Also, many of the bulk borrowers, like some of the non-banking financial companies, did very well. I think clearly that return today belongs to both large-caps and to banks with a very good deposit franchise. 

S Naren

ED & CIO, ICICI Prudential MF 

“One of the best investing lessons is asset allocation. So pick asset classes like debt which have underperformed equity for five years. Low-duration debt is giving good returns. I don’t know why people think 8-9 per cent is a low return”

Munot: In the rally of the past five years, what has worked is earnings momentum or quality at any price or growth at any price, because growth was narrow. It has been only a small part of the economy, particularly consumption, which has done well. But, growth is becoming more broad-based, and we are on the cusp of an industrial recovery. If the global economy is doing well, and the rupee is weak, some exporters will do well. However, picking the right stock is going to be a lot more important than taking those broad sector-calls, as some players in a sector may do well while the others may not, given the scale of disruptions that are taking place, be it in governance, technology, GST, or changes in consumer behaviour. Even when the investment cycle revives, a lot of players who did well in the last cycle may not have the ability in terms of their balance sheet or execution capability. But, a lot of other guys will do exceedingly well, because the competitive intensity is going to be lower this time. 

Gunwani: Value-style picks have obviously underperformed. So, clearly that is a part of the market which is interesting. Specifically in mid-caps, what I also find interesting is a lot of spin-off, demerger sort of plays. A lot of PSU stocks have corrected over the past six months, maybe because of the uncertainty around elections, and are at a good risk-reward stage. I would be wary of consumer, which again seems to be a bit of a consensus but still keeps hurting us. 

If you’re investing with a three-year perspective, one of the challenges is that you have to take into account the reasonable probability of a US slowdown or recession. So, large-cap IT (information technology), or any business which is exposed to the US, and which is building in frothy estimates, is something I would be wary about. 

Manish Gunwani

CIO-Equities, Reliance MF   

“If you see the 2004 and 2009 elections, the market has neither gone right in predicting the outcome, nor in its reaction on the day of the results. Typically, we have found that market action on that day turns out to be the wrong reaction” 

What is your advice to MF investors? 

Naren: First, people who invest in SIPs (systematic investment plans) should continue through volatile phases. The second is clearly that people should remember that one of the best investing lessons is asset allocation. So, pick asset classes like debt, which have underperformed equity for five years. 
 

MFs have done a good job of collecting money in equity but they are both equity and debt vehicles. Low-duration debt is giving good returns. I don’t know why people think 8-9 per cent is a low return.