In an interview with Anjali Raulgaonkar from Capital Market Publishers, Pradeep Gokhale, Senior Fund Manager, Tata Mutual Fund said, We feel the earnings growth in India will come primarily from improving private consumption (helped in part by monsoons and the 7th pay commission award), rising public sector capex and the impact of lower interest rates on corporate profits.
Mr. Pradeep Gokhale
1. What will the key driving factors for markets going ahead? How are your funds positioned in the current market conditions?
The equity markets have rerated substantially from February lows and valuations are slightly higher than long term averages. The progress from hereon would be dependent on the earnings recovery. While EPS growth estimated for FY17 is not very high, estimates for FY18 factor in growth in the region of 18-20%. The other factor, obviously is the global risk on risk off sentiments which determine the global fund flows into or out of equity as an asset class.
We feel the earnings growth in India will come primarily from improving private consumption (helped in part by monsoons and the 7th pay commission award), rising public sector capex and the impact of lower interest rates on corporate profits. Our portfolios are positioned to benefit from these trends and hence are overweight domestic cyclical such as consumer discretionary, cement and select construction and industrial companies and retail lending oriented banks and NBFCs.
We are underweight sectors with strong global linkages such as commodities and IT and also on corporate banks due to the impact on asset quality due to slower global growth.
2. Has the change in government proved beneficial to economy so far? How?
We, for the first time in last 30 years, have a Government that has full majority in Lok Sabha. Thus, we see pace of decision making and execution improving. Government measures in general are oriented towards improving productivity levels in the economy. There is clear focus on improving infrastructure while at the same time keeping fiscal deficit and inflation under control. Reduction in subsidies, focus on implementation of Aadhar, steps to improve financial inclusions, UDAY scheme, progress on GST, strong increase in public sector capex, are some of the examples of Government initiatives. Also, the Government seems to be taking decisions with a longer term view and not trying to do aim for short term results.
3. What are the essential traits for the stocks to be in your portfolio?
We primarily follow Growth at Reasonable Price (GARP) style of investing. We believe in buying businesses with good earnings growth prospects over the medium term, which are run by quality managements with a track record of good capital allocation, with reasonable levels of debt. We focus on company's return of capital employed (ROCE) and cash generation, earnings growth prospects, management quality, valuations and liquidity. Our experience has been that even if one buys good businesses at fair prices, the compounding of earnings gives you good return over a two- three year period. The core of our portfolio is built using this approach. We also sometimes use the value strategy, where reasonable quality businesses are available at attractive valuation. However, such strategy is used more tactically.
4.How are the market positioned to face global clues? Share your views on global economies and their impact on India?
In recent times, global markets have been dealing with the prospect of 'normalisation' of interest rates by US Fed. At the same time, we have negative interest rates in many developed markets. A rise in interest rates can impact equity markets in the short term. However, we feel markets are in a sense prepared for it and it would not impact the longer term trend of the markets. However,many large economies of the world such as Japan, European Union, China are going through a phase of low growth. In recent times, we have seen some stabilization and improvement in these economies, which has been positive for equity markets across the globe. Any further slowdown in growth, particularly in China would have an adverse impact on the markets.
5. How is India Inc's earnings picture getting affected by the collapse in commodities? Is it possible to scale it?
The collapse in commodities has helped the commodity consuming sectors such as consumer staples, consumer durables, autos etc. These sectors have seen EBITDA margins improve to historically high levels. It has also helped moderate inflation and thus given a boost to consumer demand. However, it has badly impacted the profitability of commodity producers. This also has had an adverse impact on the asset quality of corporate lenders. Recently, we have seen a stabilization of commodity prices at lower levels. If these prices remain stable at current levels, next year we would not have the negative earnings impact as it is already in the base.
6.Which sectors you are considering attractive from investment point of view and why and which sectors you are avoiding and why? What kind of stocks never enters your portfolio?
As stated above, we are overweight on domestic cyclical such as consumer discretionary, cement and select construction and industrial companies and retail lending oriented banks and NBFCs. We are also overweight on pharma and agrochemicals, more on a bottom up stock basis. We are underweight IT and commodity sectors due to weak global growth. We are also underweight corporate banks due to high NPA provisioning and resultant weak profitability.
As regards what kind of stocks that never enter my portfolio, I would say that the saying 'Never say never' is true in the investment business also where there are examples of companies staging smart turnarounds from the brink of bankruptcy. Having said that, generally I try to avoid businesses with low entry barriers or where the level of value addition by managements is low, companies with high debt levels and history of capital misallocation.
7.How your equity schemes differ from your competitors'?
Growth at reasonable price (GARP) is my preferred investment style. Thus typically my portfolios have companies with secular growth potential and higher return on equity (ROE) which is normally associated with higher P/E and P/B ratios. Generally, we have a lower share of the typical value stocks. Also, our portfolio turnover is also on the lower side.
8. Has the inflation started to rise again? What will be the RBI's move in coming policy amidst rising CPI?
We have seen some increase in inflation readings, partly due to lower base as the previous year we had record low inflation due to sharp fall in commodity prices. However, the increase in inflation has been moderate and within the limits stated by RBI in its monetary policy. Thus we don't expect a structural rise in inflation unless global commodity prices improve substantially. Our debt team expects RBI may do a rate cut of 25 bps by March 2017.
9.How often do you re-balance your equity allocation?
Typically, we don't take large cash calls in the equity portion of the balanced fund. Our equity investment ranges from 70-75% of the fund. If by capital appreciation, equity portion exceeds 75% of AUM, we tactically book profits. Similarly, in a market correction, if the value of equity portion goes down, we add to our equity weight.
10. Kindly share your investment strategy with us. Are you making any changes to your scheme's portfolio as we witness change in market?
Our strategy is more focused on companies with earnings growth. In the equity market rally from February lows, value stocks have outperformed growth stocks. Thus the valuation differentials between value and growth stocks are not very high. Hence, we feel returns going forward will be more determined by earnings growth prospects. Hence, at this juncture we are not materially changing our strategy.
11. What would you like to advice to the investors in the current scenario? What strategy would you suggest the investor to adopt at this point of time in the market?
We are positive on the Indian equities continues over the medium term. The Indian equity story is structurally very attractive due to factors such as its demographic profile, low household debt levels, scope for increasing share of financial savings within the total savings pool, increasing urbanization. The macro-economic fundamentals remain strong and earnings outlook is improving. We would therefore advise investors to continue to invest systematically in Indian equities and use any volatility caused by global factors to their advantage.