Difficulty in beating index a sign of maturity of Indian markets: Expert

There is limited upside for Indian equities unless we see a slowdown in the spread of the pandemic, says Vidhu Shekhar, country head - India, CFA Institute. In an interview with Ashley Coutinho, he says that stock picking has become harder with the pandemic but the potential reward for stock-picking skills has increased. Edited excerpts: 

Retail volumes in the market have shot up in the last few weeks. What do you make of this trend?  

This seems to be a global trend, with people sitting at home and turning their attention to trading. Modern trading platforms use a variety of behavioural nudges to encourage trading. This combined with the rise of online gaming has given a fresh impetus to the interest in trading. All this, when combined with a few weeks of good performance by markets, has contributed to the rise in retail trading. Irrespective of what happens to the markets, long term outcomes for uninformed investors and traders are seldom positive.  

The market seems to have run ahead of fundamentals on hopes of an early rebound in the economy. How difficult has stock picking become in this environment? 

Over the past few years, it has become increasingly hard for fund managers to beat the index. Covid-19 is unlikely to change this trend, though it is too early to tell. My guess is that while stock picking has got harder with the pandemic, the potential reward for stock-picking skills has increased. Each sector will produce its own winners and losers. Companies differ in terms of the resilience of their balance sheets, their ability to hold on to business in a shrinking market, and their agility to reinvent themselves. While some of the early pessimism is receding, there are still too many uncertainties that make long term predictions difficult.  

Is a correction imminent given the significant run-up from March lows? 

Whether markets will correct or not will depend on earnings recovery in the next few quarters. Liquidity should remain adequate but financial sector stress and availability of credit will drive consumption as well as investment. There is limited upside unless we see a slowdown in the spread of the pandemic. Over the long term, outcomes will depend on the structural reforms as well as the long-term impact of the Covid-19 pandemic. 

What is your view on the mid- and small cap space? 

Mid caps and small caps are much more exposed to the uncertainties related to the pandemic, so it would be harder to find value and avoid mistakes. Having said that, there will be some winners that emerge out of the shakeup, and investors who can identify these stocks early enough will be rewarded.  

Given the pandemic, will the stress on environmental, social and corporate governance (ESG) investing pick up in India? 

Focus on ESG is a long-term trend that will be accelerated by the pandemic. Over the last few years, Indian asset managers have been integrating ESG considerations systematically into their investment process. This started with a higher attention being paid to corporate governance, and the pandemic has focused attention on other risk factors as well. We also expect clients and investment advisors to focus more on ESG issues. Products that are explicitly with an ESG label are still in their infancy, but we have seen significant new interest in this space in recent weeks.

Fund managers, particularly those of large cap funds, have struggled to beat the benchmarks. Do we see an acceleration in the shift towards passive funds in India?  

Difficulty in beating the index is a sign of maturity of Indian markets and the Indian asset management industry. This will continue to put pressure on asset managers; to what extent this will translate to a shift from active to passive depends on the wealth management industry. We still have a distribution led model in which the interests of investment advisors are not aligned with those of their customers.  

What are the global cues to watch out for? 

The biggest impact will be from the pandemic. If the pandemic slows down and we don’t have significant winter outbreaks, global demand will pick up and that will have an impact on Indian markets as well. Any positive news from successful vaccines will also be positive. US Presidential elections will be an important event to watch, and there could be surprises arising from US-China relations. The global economy remains fragile. The rally in US stocks has been primarily driven by tech stocks. Around 100 of the S&P 500 stocks are trading at less than half their all-time highs.  

What are your thoughts on banking and NBFC stocks? 

While there will be a few strong performers, it is difficult to be optimistic about the banking and financial sector as a whole. There is no way to prevent the rise of NPAs. The RBI committee on the resolution of Covid-19 related stress under Mr KV Kamath is expected to recommend a resolution process that supports banks and NBFCs as they deal with bad loans. This is important and will cushion some of the effects, but it will take time for all the stress to play out and it is not clear how much time the financial sector will take to deal with the problem.  

What is your advice to investors at this point in time? 

Investors and those who advice them need to go back to the drawing board and re-learn their approach to long term investing. Several of the assumptions on which we have built our investment approach have changed forever. Some of these changes have been building up even before the pandemic. We were used to living in an economy with high growth, and growing consumption and investment demand. That changed over the past few years because of external factors, because of our inability to continue structural reforms that started in the nineties, and partly because of policy mistakes. As a result of factors compounded by the pandemic, we are entering an era of low growth and low returns. At the same time, risk tolerance has gone down, placing additional constraints on asset allocation. Investors need to create a new investment policy statement and a new plan appropriate to the new realities we are facing.