Image: Vikas Khot
THE INVESTING ROUNDTABLE From left) S Naren, Ramesh Damani, Prashant Jain, Kenneth Andrade and Ajit Dayal
When 2012 came to an end, most investors who had the fortitude to keep their faith in equities were happy. In 2013, things are a little uncertain. The UPA government will go into elections in a year’s time. Oil prices are steady but there is a likelihood of an increase. Eurozone is still fragile. To get clarity amidst these confusing signals, we needed some help. Forbes India invited the intellectual cavalry of top Indian money managers: .Prashant Jain, executive director and CIO, HDFC Mutual Fund, S Naren, CIO-Equities, ICICI Mututal Fund, Kenneth Andrade, CIO-Equities IDFC Asset Management and Ajit Dayal, chairman and founder of Quantum Asset Management
And to draw the best out of them, we got on board Ramesh Damani, BSE member, who understands money as well as words. He spoke to them about what they expect from the equity markets in the year ahead. Excerpts from the discussion:
Ramesh Damani: Naren, what are the odds that we start with a new bull market in India?
S Naren: If you go back a year, people wouldn’t have believed that you could see a return of almost 20 to 25 percent in dollar terms. The irony is that we talk about a new bull market after a 25 percent rally in dollar terms; but if you think about it, the market has gone up from a year before. I think the challenges have never been on the corporate side; they’ve been on the economy side. If you see reforms during the year before elections, that would be a great achievement, and we would have a situation where you have an election in 2014 and the continuation of the reform process that started with the bull market in December 2011.
RD: Is the jury still out then?
SN: The challenge is that we are also looking at whether 2013 will be a good year for China. For example, if China gets its act together, the flow of money to growth will get split between India and China unlike that in 2012. If you see the size of the markets and the inflows into Philippines or Indonesia, they are really very small. 2012 was the year when Indonesia broke all rules. They started to increase fuel subsidies; they also started the equivalent of increasing labour wages around Jakarta substantially. So, I’m not clear on Indonesia.
RD: Prashant, what is your opinion? Are the December lows of 2011 going to hold? When did the market bottom out?
Prashant Jain: I think the lows of 2011 should hold, as breaching these now would imply extremely low P/E multiples, which the markets have experienced only in the most extreme situations. This, however, does not imply that the markets cannot or will not correct. In fact, short-term uncertainty and volatility is as much the basic nature of equities as are superior returns over the long run, particularly in a growing economy like India. At the same time, I think the downside is limited and the upside-to-downside is favourable.
RD: What gives you the confidence that the bad times are behind us?
PJ: India has generally changed under crisis and not when the going is good. Change in a way has always been thrust upon us. The challenges facing the economy and the risks of status quo are forcing corrective steps, as there are no easier options left. India has inherent strengths and thus, if we take the right steps, the problems facing the economy can be resolved. We are witnessing a sense of urgency in policymakers, and a number of steps to correct the fiscal deficit, to improve confidence of companies and investors, and to revive the investment cycle have either been taken or are in progress. Though these may take some time to show results, the direction is now right and the worst on the economic front is behind us.
RD: Typically in your experience if the bull market has started, what legs does it have?
PJ: Nil index returns over the last five years, reasonable valuations, likelihood of better economic conditions in FY14, peaking interest rates and high-quality premiums, which are indicators of low speculative build-up, are the things that make me optimistic about the markets in the medium to long term. If you look at P/E multiple charts in the past, they have bottomed out between 10 to 12 times and markets have not peaked out before 20 P/E multiples. They have not gone back to 12 P/Es without first experiencing 18-20 P/Es.
Image: Vikas Khot
Finally, the behaviour of the majority of investors is a contrary but reliable indicator. In my experience of 20 years and three market cycles, retail has either not been a buyer or has been a net seller at close to bottoms, and a net and significant buyer at close to peaks. This is unfortunate but true. If past experience is anything to go by, then the spate of redemptions that mutual funds have witnessed over the last year or so are as indicative of better times ahead as they are mistimed. RD: Can the bullish sentiment continue?
I think valuations are fair. You’ve got an index that might not see its previous lows but we’re still some time away from a fully blown out bull market. In the next couple of years, that has to improve before we actually move on.
So, where is corporate India going to get that money to expand balance sheets? If you look at the balance sheet expansion of the BSE 500 manufacturing companies in the period between March 2006 and March 2012, the growth for some of them will add up to market capital. But the balance sheet growth has been from Rs 7 lakh crore to Rs 30 lakh crore and that is essentially what has driven the bull market cycle. I don’t think India has the capacity to do that type of balance sheet expansion. So, we’re probably not in a bull market cycle but you will get some balance sheet expansion.
RD: The index treads water, basically?
Exactly, yes.RD: Ajit, I’ll let you have the last word on this debate.
If you look at pure valuations that looked very attractive in the last quarter of 2011, I think the markets were fairly strung up and I’m not sure whether we’ll have an immediate run up. This bull market, as we’re calling it, is just foreign flows. No one expected it; no one anticipated it. It just came in. And the foreign flows are not coming in because they had faith in Indian reforms. They’re coming in because there is less money going into China and there is a desire to invest somewhere in the emerging markets. The retail money has walked out of the market in the last five to seven years, and until we change the way we look at the investor, they’re not going to come back.RD: How do you do that?
You do that by having an honest mutual fund industry. We in the fund management industry always talk about corporate governance before we invest—we should step back ourselves and see the corporate governance in our own firms for which we manage money. RD: Is the gold market a paragon of corporate governance? With gold they sell you bad metal at metal shops.
Gold is gold! RD: But real estate is the biggest scam going around; is real estate the paragon of corporate governance?
That’s why money is going into bank deposits. And if it’s going into real estate, it’s because you want to buy your home. Not many of us have the money to buy a second or a third home; so there’s money that’s going into real estate for all its wrong square footage pricing.RD: It’s not corporate governance that’s driving people away from the mutual markets…
Of course it is! Don’t forget that you have the option of not buying a fund—you don’t have the option of not buying a home. We’ve done a massive disservice to our investor base which is why our banks are addressing all the deposit flows.RD: Prashant, you mentioned in your opening remarks about the quality premium. In your estimate, in an investment universe of 5,000 companies on the BSE, how many are high-quality companies?
Quality is both subjective and relative. It is therefore hard to answer this in exact terms, but if one looks at sustainability, then I would say there are a fairly large number of such companies.RD: What benchmark do you set: A company of the calibre of Infosys or HUL?
A sustainable business and a decent return on capital: Those are the basic criteria for a benchmark. I think with a decent return on capital, we should have between 300 to 500 businesses that we track.
Image: Vikas Khot
Naren(left) and Jain
There are approximately 250 companies across different sectors that we like. We may not buy them because of valuation criteria more than concerns about the management, but we can track them. Of those 250, at any point in time except for a bull run, you find that roughly 20 percent are within some sort of tolerable valuation that you are willing to buy. If you were to add the other screen of trusting the managements, that 20 percent would shrink a lot more; maybe even to half. And that quality of management is crucial because, for that good company to get the higher P/E, it needs to have the discipline and the capital structure. It’s like talking about issuing new equity stock. So when Jet Airways had done an IPO, there was a rush of people to get in; the stock collapsed, went back. Since the last three or four years, we know that Jet needs capital but the founder of Jet has got a price in his head below which he doesn’t want to sell. What I found is that managements get greedy over bull markets; so the number of reliable, disciplined people shrinks.RD: And those are the companies who get the highest P/Es always—the ones who are disciplined?
Absolutely. You gave the example of HDFC Bank versus ICICI Bank. I would put my last penny into HDFC group on any given day as opposed to ICICI because of the way the companies are run.
Though that is how markets should be generally, it is not true in all market conditions. In 1992, 1999 or 2007, quality probably was at a discount. I have observed that quality premiums are generally high in poor market conditions and low in very bullish markets.AD:
So go back to 2006 or 2007 and compare Trent and Pantaloon [Retail]. Where was Trent during the peak of 2008? It was nowhere. Everyone hated that stock. Pantaloon was the best place to be. Today, Pantaloon is 50 or 60 percent below its peak, and Trent has surprised us with its discipline. RD: Are there other parts that the market is ignoring?
If you just step back and look at the entire financial system in India, I for one can’t relate to the dispersions of valuations in the private sector and public sector banks. Not that the public sector banks are very efficient, but in two to three years they will deliver the payback. RD: Is it a risk factor in an election year, when the government announces inclusion programmes, aggregate subsidies?
It is a risk factor. That’s part of how the banking system has come through to become what it is and we have seen it in the past. RD: You invested a month ago in a market which essentially said, get out of FMCG stocks. What is your view on that?
I believe the biggest opportunity in India has to come from exports. If you see the trade data over the last 10 years, the clearest area of deterioration has been trade account. Anyone who is a good-quality exporter is the sitter opportunity over the next five years. We’re finding it pretty difficult to identify companies which are very good in manufacturing and are exporting significantly to the West.
RD: So, negative on FMCG; long-term export-oriented would be the call for 2013? Prashant, I know you’re a fan of consumer stocks… What is your reaction?
I did not say that these are bad investments. All I said was that the quality premium is very high.RD: You look at the bottom half of the market then? You’re sector agnostic at this point?
The markets are characterised by high-quality premium—whether it is valuations of high ROCE [return on capital employed] secular growth sectors like FMCG over others, or whether it is within the sectors between different companies—IT, pharma, banks ,engineering, construction, etc. RD: Ajit?
Let me quickly talk about gold again. Central banks all around the world are buying gold. They’re telling us not to buy it, so be careful about that. We’re optimistic on gold because it’s insurance. In terms of sectors, FMCG is much overpriced. RD: There are two sectors that have created a lot of buzz in the market: Pharma and media. Do you have a view on them?
In pharma, we have been absent in 2009-10. If it does go into the bull run, you can be sure we’re out of it. On a pure valuation basis we’re not able to justify holding anything in pharma. In media, we have been owners and have been getting out. We feel we’ve had a very nice run up to the course of last year. We’re lightening up over there.KA:
I hold the same view. In pharma, we are moving out of the space, and in media, I’d like to see a bit of profitability before we enter. It’s been a business that has taken a lot of investment, which is still relatively easy to get into if there is liquidity. I don’t think the barriers to entry in that business have changed at all.
Image: Vikas Khot
Both IT services and generic pharmaceuticals are high-quality businesses and are globally competitive. The success of IT companies has been known and talked about for a long time, but in my opinion, Indian pharma companies are also world class, and are steadily going up the value chain. India has emerged or is rapidly emerging as the hub of the global supply chain in this industry. These are also two rare examples of industries where Indian companies are meaningfully ahead of their Chinese counterparts.RD: Which reforms are important? Do you have something that you wish the government would do in 2013?
The only thing that matters in my opinion is fiscal deficit and making it easier for businessmen to run their businesses in India. RD: Does the market believe that Chidambaram in his new innings, phase three actually, can bring the fiscal deficit under control? Has he taken the right steps so far?
It’s a tough call but the challenge has been the fourth and fifth year of our election cycle. The issue is not with the government’s capability of understanding financial markets and reform, but the challenge is to implement something in the fourth and fifth year of a reform cycle and see the benefits before the elections. That becomes pretty complicated for anyone.
RD: How do you see disinvestment going ahead this year?
Disinvestment helps the fiscal deficit because at the end of the day, it means more paper for our market. So what happens is that a part of the upside of the market gets reduced because of the paper that gets issued. Having said that, is disinvestment better than having a higher fiscal deficit? Certainly. But along with disinvestment, if they were to come up with any other ways like what they did in September with the diesel price hike, it would be positive because Indian tax-to-GDP ratios are ridiculously low. There is massive scope to increase the tax-to-GDP ratio in India, compared to almost anywhere else in the world.RD: Prashant, what’s your number one worry?
What I’m worried about is the spike in oil prices because that’s out of our control. Spike in oil prices impacts both the current and fiscal deficits and that in turn can derail capital flows as well, which are very critical at this stage to handle the correction phase that is underway. Besides this, if the government is found wanting in its resolve to reduce the fiscal deficit—both by improving the tax-to-GDP ratio and by reducing the social spend and subsidies—then that is a risk.
RD: What about retail FDI? Does that take root in India?
It will eventually come in one form or the other, so I’m not really worried about companies not participating in it right now. I like to look at it this way: Retail FDI in India is going to be good for the economy, the consumer at the backend, but it’s not going to be very good for domestic players in this space.
RD: But in every market in retail, domestic guys have always retained the leadership.
Let’s look at how telecom evolved from a 2- to 3-player market to a crowded market, 15 players at one time. Who benefited from it? You went into a penetration rate of 65 percent. Retail FDI, whenever it hits India, you’ve got five guys already waiting in the wings and another five showing interest. So you’ve 15 players fighting for the same space; what’s going to happen to the market?RD: But isn’t India such a vast and under-penetrated retail market? Ajit, what’s the number one thing the government needs to solve?
Corruption! Corruption and subsidies to the rich. I don’t know if we’ll be around as a society 10 years from now, unless we start doing something about corruption. I think it’s doing a tremendous disservice to our society to say you cannot fight it. I believe that the gap of the spread between the rich and the poor has increased dramatically in India.
I happened to attend a conference in Delhi two years ago. It was held by IDFC and Chidambaram was the home minister then. He gave a wonderful talk; 999 people left the hall to ask him questions outside. There was one man left on the stage. I asked him what he thought of the talk. In his talk, he had said we have to take care of Naxalites and the terror problem. The gentlemen said, “In the forests where we live, when the policemen come, we say: Here come the terrorists”. Recognise that: Get these things fixed and India will boom.
Image: Vikas Khot
RD: Is this boom despite the fiscal cliff in America, the European slowdown and the global terror threat? What is your take on these global factors?
I think the euro zone crisis will hurt the exporters and the fiscal cliff will dislocate currencies; India will take a hit. Will there be a Lehman-like event? Yeah, there could be. Should you wait for that event as an investor? In my view, no. As long as you have your gold, your equity in some ratio as fixed deposits, you’re fine. SN:
Global issues? We worry about local issues. If you start worrying about global issues, you will never cease worrying.RD: Fair enough. But what does the RBI do? We’re so far behind the curve here, should we cut interest rates?
We need much lower interest rates. Solution is simple: Cut fiscal deficit and interest rates sharply. RD: What’s your call on RBI cutting interest rates?
I agree with him entirely. We have never had three consecutive years of high inflation in my memory. High inflation kills purchasing power. Growth is good only when it leads to increase in purchasing power. I would say that we need to bring down fiscal deficit by increasing taxes and cutting subsidies.RD: But those measures would throw you back into recession!
I would disagree. The entire slowdown in the economy from 8 percent to 5 percent is a result of slowdown in a third of the economy which is constituted by investments. Until very recently, consumption hasn’t slowed meaningfully. We are consuming ahead of both our income [high current account deficit] and of the production capacity. If you look at the imports of electronics, these numbers are getting bigger by the day. We don’t have any worthwhile manufacturing set up in India in a large number of industries and that is a key weakness. An increasing proportion of consumption in higher income households is being met by imports. To grow sustainably, India needs large investments—both in infrastructure and in manufacturing. To correct the imbalances, even if it means a slowdown for some time, it is welcome.RD: Speaking of tricks, as you say in Hinduism, there are no mistakes in life, only lessons learnt. Can you tell our retail investors a lesson they should learn?
Continue to be careful and beware, it’s a very tricky world. Globally, locally, there’s a lot of bad stock out there. Remain diversified and continue to buy gold.
Equity has been one of the weakest asset classes and that’s normally the one that makes money. I think fixed income has had its fair share of running. You’ve had an inflection point when equities as an asset class should take a hit some time. I think 2012 was that year; 2013 will be a working out of growth rates. Incrementally, you will see growth rates come back into corporate P&Ls; if the government sorts out its problems, I think they’ll be back.
In my opinion, and there is general agreement on this, exposure of Indian households to fixed income, and physical assets like gold is very high. In fact, gold imports that were 0.4 percent of GDP until 2008, have gone up to 2.8 percent of GDP last year.
In my opinion, investors should simply practice low P/E investing. They should not focus on news flow and instead focus on multiples.
Low P/Es are likely to be available only when the environment is challenging, when the news flow is adverse. Is it surprising therefore that the markets are up nearly 30 percent in 2012, a year that was beset with challenges.SN:
Practise asset allocation. Sell off on assets where you’ve made good money. Put money into assets that have not done well. Maintain this over the years.
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(This story appears in the 25 January, 2013 issue of Forbes India. To visit our Archives, click here.)