Investing in 2020: The crystal gazers

(The story was published before the spread of the coronavirus in India.)

‘HNIs COMING BACK TO LARGE-CAPS FROM ALTERNATIVE ASSETS’

Investors should allocate 70% of equity to large-caps, says Mirae CEO.

Swarup Mohanty, CEO of Mirae Asset Global Investments India, says in an interview that his investment thesis doesn’t differ based on market capitalisation. And while at a broader index level “mid-cap valuations have moved from a premium of 35% to large-caps” to a discount of approximately 15%, as an investor “one should have a combination of large-caps as a core portion” and the rest towards mid-caps. He expects low-interest rates, government spending, and monsoon led recovery in the rural economy to support a gradual upturn in the demand environment in 2020. The fund house believes corporate banks will drive earnings growth in the near term, and sees a mean reversion in the stocks that are currently trading at a significant discount to their fair value. Edited excerpts:

ON THE ECONOMY

In the last few months, the government has announced several steps to arrest the slowdown. This, coupled with the Reserve Bank of India (RBI) lowering rates by 135 bps [basis points] in 2019 and a monsoon-led recovery in the rural economy, should help arrest the slowdown. While we cannot pinpoint the exact time for the growth cycle to restart, we expect a gradual recovery in demand in 2020 [calendar year] driven by low-interest rates, government spending, and rural recovery.

Corporate earnings are a function of the underlying economic performance. In the near term, earnings growth is expected to be driven by corporate banks as their credit cost normalises. Over the medium- to longer-term, as and when the economy picks up and also due to the base effect, we should see earnings growth for the broader markets improving.

ON MARKETS

Over the years I have seen that the market value of any company is a function of the underlying cash flow it generates. As an investor, we get rewarded if we continue to invest for the longer term within the earmarked asset allocation. Coming back to the recent market rally, markets seldom trade at fair value and we expect mean reversion in the stocks that trade at a significant discount to their fair value.

In the recent time period, at a broader index level, mid-cap valuations have moved from a premium of 35% to large-caps to a discount of approximately 15%.

Our investment thesis doesn’t differ based on market cap; however as an investor, one should have a combination of large-caps as a core portion and the rest allocated towards mid-caps. Since the last couple of years, we had felt the mid-cap stocks were trading at a significant premium, and hence suggested a higher skewed allocation to large-caps. Considering the attractive valuations of mid-caps now, we suggest investors can look at a 70:30 allocation between large-caps and mid-caps on the equity side. Also, we are very bullish on the outlook for both equity and debt segments for 2020, and hence we have a positive stance on our Hybrid Equity Fund which invests 70%-72% in equities (which has a larger allocation to large-caps) and the remaining in fixed income.

ON SECTORAL ALLOCATION

We are positive on private corporate banks and selectively hold some positions in insurance and some high quality beaten-down NBFCs [non-banking financial companies]. We believe the profitable market share gains from public sector undertakings (PSUs) and weaker NBFCs should continue for [quality NBFCs].

ON INVESTMENT STRATEGY:

We use a bottom-up approach in portfolio construction while keeping cognisance of the sectoral weight in the benchmarks. Our investment philosophy is to buy quality businesses run by competent people at a reasonable price and holding them for an extended period. For a couple of years, HNIs [highnet-worth individuals] had been allocating more funds to alternate assets. However, in my assessment, some of those have not yielded the desired results, and hence we believe HNIs have again started allocating to large-cap funds, which have continued to deliver better risk-adjusted returns. We have seen good growth in the ETF [exchange-traded fund] market globally and in India. We believe that in India, data is suggesting that it’s getting difficult to beat the benchmark (at least the large-cap indices) for most funds (as low returns and costs are having a significant impact), but still a few well-managed funds (including our large-cap fund) have been able to create decent alpha in this space. There is space for both well-managed large-cap funds and ETFs to co-exist in the market, as they appeal to different segments of retail and institutional investors.

‘ECONOMIC REVIVAL MAY TAKE LONGER THAN EXPECTED’

Aditya Birla Sun Life AMC expects economic activity to pick up in 12-18 months, but the Nifty and the Sensex will remain buoyant due to global flows and reforms.

Aditya Birla Sunrise AMC expects banking and financial services, consumer durables and discretionary companies, select auto companies, capital goods, cement, and pharma to perform well in the coming quarters. “We may also see value buying coming in the public sector companies that will be driven by both strategic sales and also improvement in efficiency parameters,” says A. Balasubramanian, managing director and chief executive officer, Aditya Birla Sun Life AMC, in an interview.

Balasubramanian cautions that markets cannot be driven by a few stocks, and is concerned about the high concentration of select stocks in mutual fund portfolios. He says the challenge for money managers is to find companies that have remained unscathed from the debt trap at the company level and promoter level. “As we move forward, one has to look at companies that can benefit on account of a cyclical upturn supported by strong balance sheet, and [are] focussed on a single business vertical,” he says. Edited excerpts:

ON THE ECONOMY:

It appears we are in a period now of bringing stability to the economy, especially after the NBFC crisis and the actions taken by the finance minister to revive sentiment. During the last one year, different macro variables across segments have shown deceleration and the recovery path is likely to take a little longer. Recognising this fact, the central bank has been cutting the interest rate and providing adequate liquidity in order to keep the interest rate affordable or benign. In our view, real uptick in the economy at the nominal GDP level could materialise over the next 12-18 months. It should be noted that our growth slowing down is also linked to the global slowdown and hence we need to give it some time, as a turnaround may take a little longer than anticipated.

ON MARKETS:

In the last two years, the Nifty and the Sensex have been outperforming the rest of the market, driven by a handful of stocks. Given the fact that their weight in the index is also pretty big, ETF [exchange-traded fund] flows or index funds have been further adding to higher demand, thus pushing up the valuations. Having seen this, the markets cannot be driven by a handful of stocks beyond a point while ignoring the right valuation. There is no doubt on the probability of other stocks in the Nifty 50 performing better as we move forward. In order to make this happen in a decisive manner, one has to see a performance uptick apart from a change in buyer behaviour to look at opportunities in this space. It appears to me that it is just a matter of time. The Nifty and the Sensex would remain buoyant due to global flows as well as the hope that is being built as a result of various policy measures undertaken by the government. We might see an upside of 5%-8% from the current level over a period as a result of this.

ON SECTORAL ALLOCATION:

Equities should remain attractive; however, one should invest in this asset class beyond a one-year horizon. Within this, sectors like banking and financial services, consumer durables and discretionary companies, select auto companies, capital goods, cement, and pharma should do well, among others. We may also see value buying coming in the public sector companies that will be driven by both strategic sales and also improvement in efficiency parameters.

ON INVESTMENT STRATEGY:

Portfolio construction would play a crucial role in managing the risks associated with the market and various sectors. It will also be equally important to measure the portfolio weights with respect to index weights. This, in some sense, will create a first level of defence in portfolio construction. We do keep an eye constantly on the stocks or sectors that one needs to be overweight or underweight on and accordingly initiate suitable action in the portfolio construction. Given the rising complexity and the slowdown that one is seeing both locally and globally, there is a higher need to focus on asset allocation. Equities have run up a lot and therefore may go through a consolidation phase. Debt, too, has rallied on the back of continuous rate cuts by the RBI. Gold, too, has outperformed during the current fiscal. While there is merit for interest rates to be cut further, it will also take into account the rising concerns around the fiscal deficit. On the other side, the equity market is still living on the hope of the structural reforms the finance minister has undertaken, such as tweaking GST rates, and finding a solution to pain points in the telecom, NBFC, and real estate sectors. In such a scenario, one has to keep a right balance between debt and equity either through balanced funds, or directly as individual categories, spread across short-/mediumduration funds in fixed income and multi-cap funds in the equity space

‘WE ARE OVERWEIGHT ON FINANCIALS, INDUSTRIALS, AND TELECOM’

SBI MF’s Munot prefers ‘discretionary’ to ‘staples’ stocks in the consumption space.

Navneet Munot, chief investment officer at SBI Mutual Fund (SBI MF), says in an interview that given the “trough profitability levels currently and our expectations of a cyclical uptick in the economy, we see a case for stronger earnings over the next three years”. He adds that signs of improvement at big loss-makers such as banks and telecom, should also aid corporate earnings. Munot explains that a new earnings cycle will lead to a broad-basing of profit growth that will support the overall breadth of market performance. “Our expectation over the coming year is for the breadth in equity mar - kets to improve with mid- and small-caps outperforming, along with a revival of interest in ‘value’ stocks and cyclical sectors,” he says. After a dismal year, SBI MF expects credit funds to make a comeback. “Going forward, as confidence in the economic recovery im - proves, we expect credit spreads to continue to shrink. Therefore, credit funds should perform well over the next year,” Munot says. Edited excerpts:

ON THE ECONOMY:

There is a confluence of factors that has led us to the current situation. The near-term disruption caused by some of the government’s structural reforms, a challenged financial sector, high real interest rates, and then the liquidity crisis—caused partly by local factors and partly by global central banks resorting to quantitative tightening—came together to lead to a slowdown. A lot, however, has changed for the better of late. The RBI has cut rates by 135 bps [basis points], the banking system is awash with liquidity, and global liquidity has meaningfully improved as most central banks have turned accommodative. In addition to easy money, corporate banks’ balance sheets are in much better shape now; the recent moves have strengthened the bankruptcy law, thus paving the way for easier stress resolution; credit spreads have started easing too, especially for better-rated borrowers, all of which should improve transmission going ahead. This, we believe, will lead to an improvement in credit off-take and the economy. In addition, various policy initiatives by the government, with the corporate tax cut being the most big-bang one, should also aid recovery. On a structural basis, however, we need to do a lot more—ranging from reforms on labour and continued thrust on lowering cost of capital to judicial and administrative reforms that ensure that the sanctity of the contract is upheld, and allow for speedy dispute resolution if needed.

ON MARKETS:

We are largely a bottom-up driven house and for an equity investor three years is anyway the minimum duration over which to evaluate an investment. That said, our analysis of earnings yields versus bond yields suggests that we are fairly valued at the headline index level currently. Given that the returns are a function of two variables—change in price-to-earnings and earnings growth—we believe earnings growth will determine returns trajectory hereon. Given the trough profitability levels currently and our expectations of a cyclical uptick in the economy, we see a case for stronger earnings over the next three years. With signs of improvement in the big-loss leaders such as corporate banks and telecom, that should also aid corporate earnings.

ON SECTORAL ALLOCATION:

The current crisis [in the banking industry] has separated the men from the boys. Given the broader under-penetration of the sector in India, we believe the winners will continue to deliver strong shareholder returns. We continue to look for banks and nonbanks that are strong on liability franchises, digital capabilities, risk forecast and assessment, and better asset-liability profiles.

ON INVESTMENT STRATEGY:

A new earnings cycle should lead to broad basing of profit growth which, in turn, should improve the breadth of market performance, in our view. This is especially relevant as stocks perceived as safe havens trade at hefty premiums to the rest of the market today. Early signs point to a change in market undercurrent—‘value’ stocks have significantly outperformed over the past two months. Similarly, along the capitalisation curve, small-caps should start to perform as markets get more confident of a recovery. While our investing style is bottom-up driven, a look at our funds reveals that we are overweight on financials, industrials, and telecom. Within consumption we prefer discretionary to staples, given the stretched valuations in the latter. Globally, passive investing has taken off in a big way. However, the industry penetration is quite high globally, unlike in India where penetration and awareness are still low. In India, a large part of passive investments today are by institutional investors, mainly provident funds. Further, given that alpha generation opportunities continue to exist in India owing to the large and disparate investible universe, we believe there is a case for both active and passive to coexist. Investors should follow an asset allocation based approach to investing, stick to their investing discipline without getting swayed by emotions, and rather than let volatility deter them, should use volatility judiciously to their advantage by keeping a long-term investment horizon.

‘WE’RE IN A STOCK PICKER’S MARKET’

Market rally remains narrow as players err on the side of caution, says Axis MF.

It is a great time for investors looking to build a portfolio, says Chandresh Nigam, Axis Mutual Fund managing director and chief executive officer, in an interview. “We see opportunities across the market cap spectrum,” he says, adding that markets are at alltime highs but there is a wide dispersion in the way stocks are moving. Edited excerpts:

ON THE ECONOMY:

Multiple structural reforms over the past few years have reshaped the Indian economy. This has caused short-term pain. Given the extent to which policy action has changed the way business is done, corporate India as well as consumption has been impacted. The synergies of these changes should start kicking in over the next few years, primarily driven by de-bottlenecking and transparency in business operations. The changes reflect in the ease of doing business metrics published by the World Bank. The slowdown today is reflective of legacy issues winding down and should normalise as we go forward. Classic examples of this happening are in the banking space where the Reserve Bank of India’s emphasis on transmission of rates is driving interest rates down while the insolvency code and NPL (non-performing loans) clean-up are making banks’ balance sheets healthier.

‘WE’RE IN A STOCK PICKER’S MARKET’

Market rally remains narrow as players err on the side of caution, says Axis MF. The tax system has seen a major overhaul with the GST changing indirect taxation and a huge corporate tax cut. The issues plaguing investment and corporate capex are long-term structural ones which take time to resolve. The government, on its part, has taken a series of steps to resolve the deadlock and close out legacy issues. Resolutions through the bankruptcy code have started and we have seen incremental relief for bankers and financial creditors. Given that all these things take time, the movement should be seen as a positive step. The RBI has kept the liquidity taps open while mandating banks to lend to end users more proactively. The incentive is to disburse more loans at rates that are market-linked. All these are positives in the current environment. ON MARKETS: Markets today are at alltime highs but there is a stark dispersion in the way stocks are moving. The current rally continues to remain narrow as market participants err on the side of caution. Foreign investors continue to remain bullish on the India story given the relative global context. Despite the current market levels, underlying stocks continue to remain well below their highs. As the economic sentiment revives and the market broad-bases itself, we should expect markets to perform normally. Markets have been negatively impacted over the last 18-24 months on the back of tailwinds both on the global geopolitical side of things and domestic macroeconomic factors. During this period, the market has clearly rewarded quality. The flight to ‘safety stocks’ had led to narrowness in the market. Today, we see some broadening of the market. To that effect we believe that we are in a stock picker’s market and it is a great time for anyone looking to build a portfolio.

ON SECTORAL ALLOCATION:

Banking and finance as a sector is a relatively large one. Our exposure across funds has been largely focussed towards retail-centric private sector banks and select NBFCs with strong brand presence and market pedigree. Well-managed books have been favoured by the market in light of concerns over asset quality in the aftermath of the IL&FS crisis. As a sector, we remain constructive on this space but will remain stock-specific in our investment approach. We see opportunities across the market-cap spectrum. Companies with strong business moats and credible and transparent business practices have been able to weather the storm and come out leaner and primed for the growth cycle. As the economy recovers from the growth shock, such companies will be in a sweet spot to capture business opportunities in their respective sectors. On a broader note, mid- and small-caps in general have seen a significant price correction over the last two years. We see limited downside from here for these companies.

ON INVESTMENT STRATEGY:

At Axis, we primarily follow a bottom-up stock selection approach with a minimum two- to three-year view on stocks. We retain a bias towards high quality and growth with strong fundamentals and these are hallmarks that are the key lookouts for our fund managers to select companies for their portfolios. There are four principles that the investment philosophy at Axis is driven by: strong corporate governance/strong promoter pedigree; secular growth rate of the sector, which is anywhere around 1.5-2x of GDP; strong business model, which demonstrates its pricing power in the product category and the business it is in; and ultimately good RoE [return on equity] and cash flows. Our portfolios are based on this philosophy and we have been following it since our inception in 2009. I would like to go one step further than to pick a category of funds. You have seen winners across market capitalisations. A common theme amongst the winners has been strong business models, and transparent, taxpaying companies with a focus on growth and innovation. Our call is to invest in such companies. Given that the aim of equity mutual funds is to perform consistently over long periods of time—thus generating long-term wealth— structural growth stories rather than cyclical short-term stories are our focus points in our equity portfolios.

This story was published in the February 2020 edition of the magazine.