Markets can sustain current valuations if earnings deliver: V-P, UTI MF

Corporate earnings and the outcome of the Karnataka polls are two big events back home that are likely to keep the markets choppy in May. SWATI KULKARNI, executive vice-president and fund manager – equities, UTI Mutual Fund tells Puneet Wadhwa in an interview that though mid-and small-cap companies are at a higher valuation as compared to their large-cap peers, one can still find value in select pockets. Edited excerpts:

What has been your investment strategy so far in the calendar year 2018 (CY18)?

We have not changed our investment strategy in the last six months. In UTI Mastershare, we follow ‘Growth at Reasonable Price’ approach. At times market may underestimate the long-term growth potential and value stocks. Accordingly, our focus is to look for such opportunities. One such recent example could be our investment in information technology (IT). Around six to eight months ago, we went overweight on the IT segment when market was underestimating the medium-term growth potential. The sector was available at an attractive valuation of around 15 – 17x price-to-earnings (PE) multiple as compared to the benchmark index, which was around 26x.

Another major change in last few months is in the financial services sector, where we had an overweight exposure to the retail banks and Non-bank Finance Companies (NBFCs) for last two to three years, we started increasing exposure to private corporate banks where valuations looked attractive assuming the normalisation of earnings over medium term.

For the large-cap segment, do you still see pockets of value and growth?

The consumer discretionary sector has seen steady growth and that it is likely to continue. I am positive on automobiles and consumer durables sector. The affordability has gone up and the cash flows have started to improve, especially in the rural areas. Besides having aspirations, the consumers are not much leveraged. This augurs well for the consumption story. 

Banks, too, are interested in growing their retail book in absence of avenues in the corporate sector. On the other hand, commodity prices have been strong, especially crude oil. Energy sector does hold value in this backdrop. Though the metal sector can be a bit volatile, I think the valuations are reasonable here.

How comfortable are you with the overall market valuation?

The valuations were stretched in January 2018. Despite the correction, they are still not in a comfort zone. High valuations were partly on account of an expected growth in corporate earnings, which the indices were supposed to deliver. The S&P BSE Sensex is trading at 23x trailing PE, though the mid-caps are still at higher multiples. Given the past history of earnings growth delivery, one needs to be cautious while investing. That said, the pace of downgrades seen earlier has gone down. The consensus 25 per cent – 27 per cent growth estimates for FY19 earnings could get corrected as there are a number of variables that can trigger this. 

How do you see the markets playing out over the next 12 months? 

The best of the macro-economic environment – be it inflation, current account deficit (CAD), fiscal deficit etc – is behind us. Moreover, the micros (fuel consumption, car volumes, discretionary demand etc) are improving. Given the inflation pressure, there are chances that the rupee becomes volatile and interest rates stay firm. That apart, monetary tightening by the global central banks, crude oil prices, geopolitical tensions (if any), upcoming state elections are some of the factors that can lead to volatility in the markets. However, if the earnings deliver, we can still sustain the current valuations.

To what extent are the markets discounting Bharatiya Janata Party's (BJP) possibility of a loss in the upcoming assembly elections in Karnataka?

State elections this year will be one of the causes for market volatility in the very short period. Our investment focus has been to buy companies having strong cash-flows and high return on capital employed.  Such business models of quality companies are usually sound and have proven track record of many years. So, the investor sentiment can swing in very short period but over a medium-to-long period, underlying companies will see their profits grow a tad better than Indian economic growth. Profit growth is always a fundamental driving force for the equity markets. 

Can the volatility trigger a slowdown in domestic fund flows into equities?

Domestic flows have been strong in last two to three years. The past market returns have attracted a lot of retail investors. However, the fact that the correction / volatility may not have been completely understood by the investors, who have started investing recently, the quantum of flow into the equity segment can be volatile. With more investors understanding their asset allocation needs for achieving their long-term financial goals, flows will become steadier. 

Demonetisation has accentuated flows into financial assets as against the physical assets, benefiting the mutual funds. Banks were also active, as they moved a lot of cash balances / CASA (current account, savings account) to mutual funds in absence of credit growth. Although I don’t see this massive shift happening again in such magnitude in a single year, there is a structural case here for the mutual funds to continue getting a steady flow through SIPs. 

What are your views on the mid-and small-cap segments?

Reforms such as the demonetisation and goods and services tax (GST) implementation as well as the inherent strength of the economy should benefit companies in the organised sectors over the medium term. Though at the headline level, the mid-and small-cap companies have higher valuation as compared to their large-cap peers, one can find value in select pockets, like construction, chemical & fertiliser, retailing segments, oil & gas, utilities etc. One needs to have a stock specific approach. 

Your views on banking sector?

Retail-oriented banks have gained market share over the past few years. They have better capital adequacy and strong retail deposits franchise also. All this will help them grow better. I expect this trend to continue till we see a further clean-up of balance-sheets and capital infusion in the public sector banks (PSBs). 

NBFCs have had an upper hand in terms to connect with the bottom of the pyramid clients and are at par with the banks in terms of following 90-day past due for NPA recognition. As far as growth is regarded, those facing the rural and consumer segments will benefit from going ahead. For corporate-facing banks, the recognition of NPAs may get spread till the second quarter of FY19 (Q2FY19). Corporate loan growth will only come back with a pick-up in capex cycle, which I don’t see happening till the general elections are over.

Your message to investors given the road ahead for the markets?

On an overall basis, I feel an average Indian is still quite poorly invested in the equity mutual funds and lacks understanding of the potential of equity mutual funds in long term wealth creation. Investors should cut the noise around the market levels and focus more on their asset allocation, take corrective actions early to be able benefit from wealth creation to meet their long-term financial goals. 

Market levels and valuations are good for savvy stock market investors, who can manage their asset allocation well and who think that they can time the market. Investing via the systematic investment plans (SIPs) makes more sense. For core equity holding, investors should look at diversified funds rather than sector funds.