The banking sector is one of the few spaces with some upside for market investors: Prashant Jain

(L to R) Prashant Jain, CIO and fund manager, 3P Investment Managers and Ashwani Kumar, portfolio strategist and co-fund manager, 3P Investment Managers. Image: Neha Mithbawkar for Forbes India

In the last of a three-part interview series, Prashant Jain, CIO and fund manager, 3P Investment Managers, is joined by his co-fund manager Ashwani Kumar, to discuss their portfolio strategy and decode how the fund outperformed markets since its inception last year.

Jain and Kumar, who have navigated volatile market cycles over 33 years, are overweight on banks even as most lenders continue to report deposit and margin challenges. In fact, as of June 28, the fund’s total exposure to five bank stocks comprises the highest allocation, of 31.4 percent, in the portfolio.

“Many heavyweights have underperformed for a fairly long period and valuations have become quite reasonable,” Jain reasons. “This is one of the few spaces where there is some upside and it is also a very large part of the benchmark index.”   

The fund managers are also very bullish on the consumer discretionary sector, which accounts for 12.1 percent of the portfolio. “The income pyramid in India used to be triangle but now it is diamond-shaped,” Jain explains. “Spaces like airlines and food delivery are low penetrated categories and we expect them to exhibit good growth.”

3P Investment Managers is moderately underweight on the IT sector and sees margin headwinds in the offing. “It was only during the Covid-19 pandemic that IT companies grew at a fast rate, but that big surge is now over. There is also some risk of a slowdown in Europe,” Kumar points out. “These are high quality businesses, but the valuations are a bit expensive and growth visibility is low,” Jain adds.

Read parts one and two of Jain’s interviews to find out why the former CIO of HDFC Mutual Fund expects returns from the broader market to track corporate earnings growth of around 12 percent CAGR in the long term. “You can’t time equity markets. You have to think long-term and be tolerant of volatility in the interim,” Jain cautions retail investors. Edited excerpts:
 

Banks: ‘Valuations have become quite reasonable’  

Jain: Top down, banking should grow faster than India’s normal GDP growth. Capex is picking up and at some stage companies will come to banks to raise funds. Balance sheets of banks are extremely healthy and we have come out of a long NPA cycle. So, provision costs should remain extremely low. Plus, this sector has been underperforming; not all banks, but many heavyweights have underperformed for a fairly long period.

Valuations have become quite reasonable. The discount of banks to the broader markets or other sectors is more. So, we feel this is one of the few spaces where there is still some upside. Also, it is a very large part of the benchmark index. These are some reasons why we are overweight on banks.

Our approach is to buy businesses that have the capability to win in the marketplace; this means they will either maintain or grow their market shares. The banks in our portfolio will not lose share; all of them have very good digital capabilities and I think the digital banking environment will help larger banks gain market share because of their ability to service a large customer base, small and big-ticket customers.
 

Deposit growth concerns: ‘Deposit rates likely to rise’

Jain: The base of savings in this country is very large. India is close to a $4 trillion economy and the gross household financial savings is about 10 percent or $400 billion. Roughly, 10 percent or $40 million a year is being invested into equities. So, I don’t think the challenge to bank deposit growth is the flow into equities. It’s a very small issue if at all.

What is happening is that the share of small savings has gone up more because the rates there are a bit higher than bank deposits. But ultimately the deposit and the credit growth will have to converge. You can’t write credit if you don’t have deposits. So, deposit rates will have to move up if this mismatch persists. Or there may also be an increase in the lending rates, which could slow down loan growth.

But ultimately, when banks run out of excess liquidity, they’ll push up deposit rates. We need to appreciate the fact that India is fundamentally a lower inflation economy. Our nominal GDP growth is around 11 to 12 percent. So, for deposit growth to sustainably grow faster than that, we will need a significant uptick in the savings rate as well.

Also read: There isn't room for current market multiples to move up: Prashant Jain

Industrial sector: ‘Large market opportunity for companies’

Kumar: We had a 10-year drought in capex, basically because there were NPAs and an over-investment in certain sectors. Generally, the global economy was also slow and therefore capex capacity utilisation was low. Commodity prices were low for a large part of the last decade and that led to companies not investing, because profitability was quite low. Now, all this has changed. There is China-plus-one, there is PLI, India has reduced its dependence on China by restricting imports. So, that has increased the total available market for Indian companies.

New sectors, such as defence in particular, have emerged. Companies, in the private and public sectors, have become more ambitious and they have done well. There's a large market opportunity. Geopolitical conflicts and ongoing wars have led to a global increase in government spending on defence. So, India is taking some advantage of the global situation with exports from private and public sector companies.  
 

Consumer discretionary sector: ‘Expect faster growth’

Jain: The income pyramid in India used to be a triangle, but now it is diamond-shaped. What this shows is that low-income families are shrinking and the middle-class and the high-income groups are growing much faster.

Our per capita income is now about $2,500. So, at this level of income, basic necessities are reasonably met and you see faster growth in discretionary products and services. Therefore, we are overweight on consumer discretionary spends in spaces like airlines and food delivery. These are low-penetrated categories and we expect them to exhibit good growth. We are also careful to buy into businesses where the market structure is not very fragmented and is supportive of growth.
 

IT sector: ‘There are margin headwinds’

Kumar: Generally, the IT and energy sectors are relatively slow-growing businesses (8 to 9 percent). It was only during the Covid-19 pandemic that IT companies grew at a faster rate, but that big surge is now over. There is also some risk of a slowdown in Europe. Besides, we are finding opportunities in other sectors with much faster growth and relatively similar valuations.

Jain: Basically, these are high quality businesses, but the valuations are a bit expensive and visibility of growth is low. Plus, we also worry that India's current account deficit has sharply moderated. So, we expect the rupee to depreciate more slowly. This is not good for the IT sector, because wage inflation in India is higher. I think these are margin headwinds. Having said that, we are only moderately underweight because this sector has underperformed quite a bit.

FII outlook: ‘They will be selective’  

Kumar: India is quite well-positioned. But a lot of companies in the country, a lot of sectors, are relatively overvalued. Maybe banks, some utilities offer value on a relative basis. Others are much more expensive. But FIIs will come back because domestic growth should pick up in the next few years from 6-7 percent to 7-8 percent. But it will be selective. It is not that everything is going to go up. Unless it is a passive investment, the active investors will essentially look at banks and some companies in the power sector.
 
Jain: It's very hard to forecast foreign flows. India’s macro prospects are probably the best in years in terms of growth, political stability, and geopolitical acceptance. What works against India from a foreign investor’s point of view is valuations. We compare, we invest only in India, so we seek absolute and relative value within sectors. But FIIs have options of investing across multiple markets. It is hard to say when FIIs will come back or not come back. But the key point is that the dependence of Indian markets on foreign capital has substantially reduced as it is being driven by local investors.