Quality and discipline pay dividends

Sticking to his discipline of investing in good quality scrips while the markets were undergoing bouts of volatility has helped Prashant Jain of HDFC Mutual Fund get the better of the benchmarks

In a year of volatile markets, Prashant Jain has been able to stay the course helping the two top rated funds – HDFC Top 200 and HDFC Equity – deliver good returns. Though the long term track record has been good, the outperformance this time around has been modest. Says Jain, “The outperformance has been moderate in the recent past. The exposure to public banks has impacted adversely, but exposure to several individual companies that have done well has aided performance.” While FMCG stocks (ITC, HUL, private banks like HDFC Bank, ICICI Bank) had a very good year (20-60 per cent), picks such as Tata Motors DVR as well as Zee Entertainment (60-80 per cent) boosted returns.

Though defensives have been star performers for him for a while and he has kept quality FMCG names in his portfolio since 2008, will the strategy change given steep valuations? “The challenging part of these markets is that unlike 2008 when quality was at a discount, today quality is at a very sharp premium,” says Jain. While he believes that a part of the premium is justified, the same will not sustain if markets do well. He concurs with analysts that cyclicals could be a good theme to look at. “There is merit in going down the curve and investing in businesses that are capital intensive and where the ROCEs are lower, but where the valuations are even lower.” However, given the muted economic growth, he advises caution on investment in companies with weaker financials, and the need to limit risk.
 

STEADY RETURNS
	1 Year Return (%)
HDFC Equity	12.16
HDFC Top 200	13.74
All are growth funds; Returns for year ended September 28, 2012; Source: HDFC Mutual Fund

While the defensive strategy has worked thus far, the results due to his exposure to financials has been mixed. Though private sector banks have done well on the bourses, public sector banks (Bank of Baroda, Punjab National Bank and Canara Bank) have languished with returns in the negative territory. Given that a quarter of its portfolio has an exposure to financials, will the rising non-performing assets impact performance on the bourses? Admitting that some of the financial stocks have a higher than estimated stress on asset quality, Jain believes that a predominant part of the lending is asset backed and given rising asset prices, should moderate losses over time. His other two arguments on the sector are reasonable profitability despite higher provisioning and attractive valuations which more than discount the asset quality pressure.

A follower of the growth-at-a-reasonable price philosophy, Jain who has been managing the funds for nine years now puts his faith on financials especially those in corporate lending in public as well as private sector as they offer good value. Oil companies are his other favourites. However, he reinforces the need to control risk. “Both these sectors have a challenge of asset quality and subsidies and though on a top down basis they offer good value there are issues that makes risk control very important in these markets,” he says.

While the September quarter numbers were not too exciting, Jain believes that going ahead, slow growth is here to stay for a few quarters. Bulk of the slowdown, according to him, has been due to lower capital spending with consumer spending too faltering. He however, believes that deleveraging, flat or lower provisions by banks next year, a depreciating currency and lowering of subsidy burden could lead to better profit growth in 2013-14. He expects price to earnings multiples to move up over time on the back of higher growth and lower interest rates. “Returns in the medium to long term are likely to be driven by both earnings growth and multiple improvement,” he says.

A higher return scenario, however, could come unstuck if growth remains sluggish and the fiscal situation deteriorates. In addition to the inadequate policy framework particularly infrastructure and related sectors, the most worrying aspect for Jain is the high fiscal deficit and attendant problems of higher inflation as well as current account deficit.

Going ahead, while the rate cuts will be among positive triggers, what the Street is looking for resolution of the Parliament impasse, reduction in subsidies, setting up of National Investment Board and speedy clearances to the stalled projects among other measures, feels Jain.