FIIs have become marginal players in Indian equity markets: Tushar Pradhan

In a Q&A, he says that as for earnings growth, the cycle is bottoming out

Tushar Pradhan, chief investment officer at HSBC Asset Management (India), in an interview tells Hamsini Karthik that flows from foreign investors shouldn’t matter much for equities any more. As for earnings growth, he believes the cycle is bottoming out. Edited excerpts: 

Constant earnings miss, including the trend in June quarter, has been a worry for many investors.

Earnings misses in the recent quarters have been on the back of a sharp fall in commodity prices, significantly higher than expected provisioning at financial institutions and a challenging global market for Indian information technology (IT) and pharmaceutical companies. These appear cyclical and we believe the cycle is bottoming out. While it has been a long wait, the uptick is a matter of time. Consensus earnings for the next two years still remain in the high teens. Global equity markets are showing a surprising lack of worry and volatility measures are at an all-time low. Global investors worry more on this count than on missed earnings.

How comfortable are you with current market valuations?

A smart investor has to not debate whether the market is under or overvalued. It mostly does not trade at fair value but the question to ask is, given the valuation and the alternatives available, what is the risk-reward equation? 

If we focus on absolute value, rarely can one make money except in extreme undervaluation, typically after a market crash, where even the most astute investors avoid exposure. The current market is pricing in a significant earnings recovery, and benign market and external conditions. However, no market is without risks and the normal caveats apply. These are the external events, unexpected rises in US interest rates and a risk of political turmoil. 

The equity market didn’t seem pleased with the amount of recent rate cut.

While the markets might demand a lower interest rate regime, on the back of unnaturally low inflation, an expected rise in inflation to four per cent leaves only a small buffer, in any case. I think the markets discount the implied rate without an actual move in any case. The expectation is of stable interest rates, rather than following every data point closely, up or down.

The global outlook for equities is also thinning. How do you see the asset allocation strategy? 

Developed markets’ (DMs’) sovereign bonds are probably the weakest asset class at the moment. Credit, too, is not looking attractive, given lower spreads from a year ago. Within emerging markets (EMs), bonds, especially in India, appear very attractive, given a stable macro environment, an appreciating bias to the currency and vastly improved trade and fiscal deficits. Our global asset allocation strategy prefers EM bonds, is neutral on global equities, overweight on select emerging market equities and underweight on DM sovereign bonds.

Even foreign investors have turned buyers for mid-cap stocks. You see this trend continuing despite steep valuations?

Mid-caps are particularly interesting, as they have the potential for becoming tomorrow’s large-caps. While the outcomes are very uncertain, a limited exposure, with due regard to quality and potential in the long run, has proved extremely rewarding for investors in the long run. Making sweeping statements such as “mid-caps are expensive” can be detrimental to serial compounders who scale up significantly through the bull and bear markets. We remain on the lookout for such opportunities. Having said that, there are pockets of overvaluation in the mid-cap segment.

Your outlook on foreign institutional investor (FII) flow this year? 

FIIs have become marginal players in the India equity markets. Domestic inflow remains substantially significant and, over time, will set the tone for liquidity. Thus, the importance given to FII flow over the past might not repeat and it hardly matters if net inflow has been sporadic. We have seen the market surge in spite of lack of sustained FII inflow. The Indian bond markets remain attractive for many foreign investors and that should keep FII interest up.