How the year starts has no bearing on how markets
will end the year. I expect equities to surprise us on the upside by the end of the year. There are hardly any alternatives available to investors right now and perhaps this has been driving strong inflows into equity mutual funds for some time now. Although flows could moderate but the direction may not change in a hurry as competing asset classes such as real estate are going through their own set of challenges.
Thanks to the recent correction valuation is now attractive. Benchmark indices are now trading at 14-15 times one-year forward earnings, closer to their 20-year average ratios. This was not the case a year ago.
Then there is the growth case. Although growth has disappointed over the last few years but this is expected to catch up and mean revert soon. Already the GDP has moved up from sub 5% levels a few years back to a 7% plus rate. Discretionary spending, capital expenditure and corporate earnings are also expected to follow the GDP trajectory albeit with a lag. In a domestically driven economy like India where domestic consumption forms more than 70% of the GDP, pent up demand in the system has surprised many a times. Just look at the strong CV sales and also the modest passenger car sales in the current fiscal which was marred by poor monsoons, no significant increase in IIP or mining activities etc.
Our sense is that if we get a normal monsoon this year it would certainly help rural demand revive. This along with a booster in the form of OROP as well as 7th pay commission payouts can bolster overall consumption demand in the country.
Mid-cap funds including yours had done quite well in the last one year. What can we expect from them now?
Mid-caps funds did very well last year but we have been cautious on the segment for last six months now. Mid-caps have been trading at a premium to large cap stocks; though historically it has always been other way round.
Large-caps should do slightly better than mid caps over the next twelve months as the valuation gap normalises. This could happen either through a continuing sell-offs in mid-caps or greater buying in large caps stocks. We are therefore guiding our investors not to increase allocation towards midcaps yet.
You have taken over the UTI Equity fund from Anoop Bhaskar, can we expect any changes in the way funds are being managed.
To start with let me say that this fund was being managed as a fairly stable and low risk fund with about 75-80 per cent in large-caps and the rest in mid and small cap. This broad strategy will remain same although sectoral allocations will change a bit. For example banking used to be 20-21 per cent of the fund which may increase to 26-27 per cent and mostly in private sector banks. Exposure to pharma may go-up to 15-16 per cent from around 7-8 per cent currently. Third, the fund was underweight on consumer with 7-8 per cent exposure but this might increase to 15-16 per cent of the fund over time.
But aren’t consumer stocks prohibitibly expensive?
That is a wrong way to look at consumer companies. We look at them from their ability to generate sustainable free cash flows that keep growing over time. Consumer companies not just in India but even globally have shown this huge ability to create value for investors basically on account of their high RoCEs through economic cycles. The opportunity for these companies gets even better in an emerging markets
like India as various consumption categories are still underpenetrated providing them a long runway for compounding growth. Unlike many other sectors, in this sector incremental capital infusion is not required and hence these companies usually have a clean balance sheet with little or not debt and infact they throw out a lot of cash each year back to their shareholders. Most importantly, these companies are the top of the mind brands in their respective categories and command strong pricing power and hence have an ability to maintain margins and profits.
But the same can be said about IT companies or pharma makers?
Take pharma companies first. Yes pharma companies also generate strong cashflows but they also face some kind of regulatory risks. On the domestic business there is this risk of drug price control which can put pressure on margins and profits. On the international business the biggest risk is that of regulators shutting down the plants on account of quality and compliance issues. I guess 2015 was a peculiar year for the sector as many companies received some or the other observations from US FDA which has led to a temporary loss of business. Finally the pharma sector also has to face the currency risk especially for business coming from emerging markets
like Africa, CIS, Latin America etc. Therfore I would doubt if the pharma sector should trade at the same kind of valuations that the consumer sector gets. Having said that Pharma is a good sector to be in from a medium to long term perspective and we remain overweight on it.
As for the IT sector, I belong to the camp that believes that they are under valued relative to free-cash that they generate. The sector does face some kind of a risk on account of technological changes, automation etc but the business model is reasonably stable. Ofcourse these companies are not going to go back to the 20% plus kind of dollar growth as they saw in the previous decade and therefore they would also not be getting back to the valuation band of 25-30x, that they commanded during the same period.