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Chief investment officers (CIOs) of leading mutual fund (MF) houses have a lot to think about as they prepare for 2024, but Lok Sabha election results don’t worry them. India’s economy is on a firm footing and a change in government is unlikely to upset it, said top fund managers who sat together at the Business Standard BFSI Insight Summit 2023 on October 30-31 in Mumbai.
The market will continue to be driven by earnings growth and policies that the new government announces, they said at a panel discussion on ‘Will Global Slowdown & 2024 General Elections weigh on Indian markets?’ Their worries are high interest rates across the globe and the expectations of domestic investors. The CIOs who attended the discussion include Sankaran Naren of ICICI Prudential MF, Mahesh Patil of Aditya Birla Sun Life MF, Rajeev Radhakrishnan (CIO Fixed Income) of SBI MF, Ashish Gupta of Axis MF, Rajeev Thakkar of Parag Parikh Financial Advisory Services (PPFAS) MF, and Sailesh Raj Bhan (CIO-Equity) of Nippon India MF. Edited excerpts:
However, if the starting point is wrong, markets can disappoint significantly even with favourable policy results. Currently, we find ourselves in a moderate market. Prices are not very cheap, yet there’s a degree of affordability on the larger scale. However, the market is not attractively priced due to high expectations. Short-term investor expectations concern me the most, as the long-term outlook appears positive. The immediate challenge lies in the near-term earnings expectations, particularly the widespread anticipation of 20-25 per cent compounding returns in small and midcap investments in India. This mindset poses a problem, irrespective of elections. Uncertainty from elections could usher in a distinct market environment.
Ashish Gupta: Going by the data, there’s no direct correlation between election results and long-term market performance. While the first six months post-election may witness some impact and volatility, what truly matters is the economic progress and policies over a five-year span. Historically, concerns about single-party or coalition governments haven’t proven significant, as even coalitions have implemented forward-looking economic policies. Rather than fixating on immediate post-election market movements, it’s crucial to focus on long-term outlook. The market may experience short-term volatility due to high expectations and increased global uncertainty both on the growth front and geopolitics. We need to be mindful of these factors. For me, those are the factors that are front and central in our investment thesis today, rather than elections.
Market return data during the election periods underscores the lack of clear correlations between elections and market outcomes. The impact is largely visible in the three-month period before elections and the three months after. The starting points matter a lot. Currently, we’re not in a cheap territory; valuations hover around average levels. The valuations coupled with historically high interest rates in the developed world, the absence of meaningful interest rate impact raises concerns. At present, these are bigger worries than uncertainties surrounding election outcomes.
Consequently, the impact of any new government is expected to be minimal, given there’s continuity in reforms.
Our current economic standing is significantly improved, providing a robust foundation for ongoing momentum. The primary source of volatility lies in global factors, be it a global slowdown or elevated interest rates. These concerns remain, irrespective of whether we are in a pre-election or post-election phase. Notably, markets are reasonably priced, not overly expensive. Their trajectory will naturally unfold based on fundamental economic indicators, and that’s the lens through which we should analyse the situation.
A lot has been happening on the geopolitical and global economic fronts. In the last two years, we were talking about Russia and Ukraine. Now the West Asia issue has come up. Then there are problems emanating out of high interest rates in the US and other developed markets. China has its own issues. So, at this point of time, what would be your advice to investors?
Patil: In the last 10 to 15 years, if we focus on the developed market, particularly the US, it has outperformed significantly. This can be attributed to a liquidity-driven rally, with central banks injecting money and substantial financial strength creating buoyancy in the market. Additionally, a prolonged period of low-interest rates contributed to this trend. However, this scenario is changing as global central banks are now attempting to tighten, resulting in increased interest rates. The primary global risk lies in this shift.
In contrast, India did not witness a substantial injection of funds into the economy, even during the Covid-19 pandemic. Instead, the recovery in India appears to be steady and sustainable, driven by various reforms implemented. While the global economy is expected to slow down, India’s economy is poised to continue growing at around 6.5 per cent, supported by increasing investments as a percentage of GDP (gross domestic product).
Unlike the past decade where consumption dominated, there is now a new dimension to the economy with a boost from domestic manufacturing, the concept of China+1, and other factors. Despite a potential slowdown in the global economy, India has enough mechanisms in place to maintain a stable growth trajectory.
Looking at the market, the largercap space doesn’t appear overly expensive, and many stocks, despite underperforming, have seen their earnings catch up. Consequently, there are intriguing opportunities in the marke, currently. It’s suggested that any market correction due to global factors should be viewed as a buying opportunity. However, caution is advised in the midcap and smallcap spaces. Overall, it’s a buy on dips kind of a market.
Thakkar: In the current environment, as we discuss global uncertainties, the common investment response is a shift towards the domestic-focused businesses. Many tend to invest in Indian consumer-facing sectors.
However, the challenge with this approach is the considerably high starting valuations in that space, which have remained elevated for an extended period. Despite the counterintuitive nature, this sector poses maximum risk, especially with everyone banking on the sustained growth of India’s consumption.
Another area of concern is the recent surge in startups going public. Currently, there might not be a clear path to profitability for many of them, and some may just be breaking even. While success for some is anticipated in the future, collectively, they are likely to disappoint investors.
On the positive side, sectors like financials, which have underperformed, present opportunities. The current scenario features medium-term interest rates that are positive on a real basis when inflation is deducted. Individuals who have tinkered with their asset allocation, allocating fixed income funds to equities, should reconsider and rebalance. It’s advisable not to be overly exposed to equity, especially since debt yields have become attractive.
Radhakrishnan: Lower interest rates and a consistently stable geopolitical backdrop have been a default over the last 15 years. However, two significant changes are on the horizon. Firstly, considering the current state of interest rates, the prevailing belief is that global interest rates will remain higher for an extended period.
Additionally, geo-political tensions have come to the forefront, evident in recent events such as Russia-Ukraine and conflict in the West Asia.
These factors are expected to introduce increased volatility in the markets.
From the perspective of the debt market, fixed income appears to be in an advantageous position at this time. After a prolonged period, there is now clear visibility of achieving a positive real rate on a prospective basis, regardless of the inflation estimate taken into account. This presents an attractive opportunity.
While the RBI policy stance is likely to remain in a tightening or cautious mode for some time, it undeniably creates opportunities for fixed income investors in India.
On the equity side, my co-panelists are experts and often discuss valuation concerns. However, taking a longer-term perspective, there are numerous positive factors supporting the equity market.
Naren: Ten years back, during visits to Delhi, I used to tell people that you have had one decade of huge returns in real estate and hence it’s time to be careful. Now, a similar situation is playing out in midcap and smallcap space. The returns in mid and smallcap investments exceed 20 per cent per annum over the last one decade, going by the index. When an asset class consistently delivers such returns over a decade, it naturally attracts new investors en masse, reminiscent of the rush towards real estate a decade ago. This historical pattern raises concerns. In the US, smallcaps have given nearly zero returns over the last five years.
Contrary to the present enthusiasm for small and midcaps, it’s crucial to note that ten years ago largecaps were the favoured class. However, the tide has shifted after a decade of impressive returns. Megacaps have faced challenges in the last two years due to substantial selling by foreign institutional investors (FIIs), resulting in minimal or negative returns. This trend prompts scepticism about the potential of megacaps.
The current investing challenge lies in conveying that megacaps are not inherently bad, and smallcaps might not be as promising as perceived. The ever-changing landscape of investment markets is evident in the evolving perception of quality. What was considered non-quality, such as PSUs or sectors like telecom and power, has delivered remarkable returns in the past three years, challenging the notion that quality is synonymous with consistent returns.
The dynamic nature of investment markets adds an intriguing aspect to the process. What was unpopular three years ago is now popular, and vice versa. This constant evolution contributes to the fascinating nature of investing, making it an engaging endeavour despite its challenges.
Gupta: If we look at the various markets, apart from the returns and volatility, market breadth is a key factor. Over the last two years, the US market reveals an intriguing aspect.
Remarkably, 80 per cent of the returns originated from just five stocks, creating a notably narrow market. In contrast, India demonstrates an inverse trend, with a positive market breadth. As mentioned earlier, some large and megacaps have underperformed, emphasising the importance of examining not only the headline market move but also its breadth — a key indicator of economic health.
The global risk-free interest rate, standing at 5 per cent, has led to negative foreign flows, impacting the substantial ownership foreign investors have in the Indian market, particularly in large megacaps. Predictably, these mega caps have faced challenges in performance. However, equally noteworthy is the underwhelming earnings growth in certain sectors like IT services and conglomerates, despite their significant market presence. On the contrary, smaller market caps, such as those in hotels, real estate, industrial, and manufacturing sectors, have demonstrated commendable earnings growth in recent years.
Ultimately, the key is to follow earnings growth, whether in a large or small company. Optimism about performance should stem from a company’s ability to deliver consistent earnings growth rather than its size.
Bhan: The largest companies in India, currently, appear more affordable than the smallest ones. This clear signal suggests that sensible value lies elsewhere in the market. Interestingly, this situation mirrors what occurred four years ago when the market was narrow, dominated by a few top stocks, leading to missed returns. These once-forgotten blue-chip companies, previously overshadowed by discussions of megacaps, are now accessible at what can be described as growth firms’ valuations. The unique nature of this scenario underscores the market’s dislocation, presenting alpha opportunities for investors.
From investors’ point of view, which sectors are looking attractive right now?
Bhan: Firstly, it is the banks, one of the most hated sectors today. The largest of the largest businesses lie there. The valuations are sensible there. This presents a more favourable risk-reward ratio in comparison. Following financials, the pharmaceutical sector appears as a sensible choice. It is reasonably priced, especially when considering its affordability.
Patil: I concur with that assessment. Financials, despite having solid numbers, have underperformed, particularly the larger banks. However, considering the historical mean reversion, there’s potential for improvement, especially if the economy performs well. Credit growth has remained robust, and despite this year’s concerns, the sector exhibits reasonable valuations and a stable outlook.
In terms of sectors or themes for medium to long-term investment, manufacturing in India stands out. The emphasis on domestic manufacturing, coupled with the global China+1 policy, is expected to benefit the sector.
Numerous companies within this space present exciting opportunities from a longer-term perspective.
Among defensive sectors, pharma has also underperformed after a post-Covid rally. Over the last year, domestic pharma and healthcare, in particular, have faced challenges. However, there’s an anticipation of steady improvement in this sector. For those preferring sectors with good visibility, even if the growth rate is not exceptionally high, and with reasonable valuations, pharma falls into that category.
Thakkar: I’ll split the BFSI sector. We hold a favorable view on banks, but caution is advised with select NBFCs. In financial services, particularly in capital market finance-related segments, although there is currently substantial volume growth, there is a potential for a significant cyclical risk. This can lead to a considerable drop in earnings during a downturn.
Utilities appear attractive, but a cautious approach is crucial. It’s important to scrutinise capital efficiency and avoid a blanket investment strategy. Some utilities may exhibit high upcoming capital expenditure but lack a commensurate return ratio, warr-anting caution. Also, the pharma sector seems attractive.
Gupta: I acknowledge that I might have some bias. The first sectors that come to mind are banks and NBFCs. I also see potential in the automobile sector, which has been facing a downturn in both four-wheelers and two-wheelers for several years. I anticipate a medium-term recovery in this space.
Radhakrishnan: As a fund house on the equity side, financials is something that we have been overweight.
Naren: All sectors have been covered, and I would like to include energy and telecom. Energy seems to be universally underweight; it’s often overlooked by investors. This is why we emphasise energy and telecom, particularly because, even today, no company in these sectors is consistently earning satisfactory returns. I am inclined towards industries where companies are yet to achieve substantial returns.
Regarding market capitalisation, our preference leans more towards largecap stocks over midcap and smallcap ones. This stance has been emphasised multiple times for clarity.
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