Bhat believes that some of the PSUs could definitely attract investor interest, particularly with a large relative valuation gap as compared to the market. The veteran money manager is also excited about the prospects of the country’s consumer electronics, financial services, pharmaceuticals and consumer-facing sectors as he bets on the economy to accelerate in the coming years.
Following are the edited excerpts:
What is your 50,000 feet view on the domestic and global economy?
The recovery in the economy, both globally as well as in India, has been faster than what was expected, and the expectations are for a robust GDP growth in the new financial year. The risk obviously remains of the incremental waves of the pandemic,but the big difference this time is we have rapid vaccination of the population and therefore the fear factor is much lesser than the first time around. A large part of the rally in the market during the financial year was driven by the significant liquidity inflows from foreign institutional investors. In recent months, fundamental reasons too, have emerged, with positive surprises in corporate results, and earnings upgrades by analysts. More importantly, a longer-term positive driver has emerged from the recent Budget, which has shown the government’s willingness to spend on capex via higher borrowings rather than increased taxation.
In your 26 years of being in this industry, have you seen a market quite like this?
While we have seen sharp declines in markets on a few occasions in the past two decades, the sell-off witnessed exactly a year ago, last March, was indeed unprecedented. And so was the speed and the extended duration of the bounceback that we saw beginning in April-May. One interesting aspect of the market during the year was the number of new retail investors in equities. It was not just in India, we have seen it happen in the US as well. And interestingly, an exactly opposite kind of reflection in terms of flows from domestic equity funds.
Domestics institutions have been net sellers in this market for sometime now in the face of FII and retail buying. Why is that?
I do not think that domestic institutions are taking a negative call on the market, or utilising the higher levels to book gains in recent months. It has been the domestic equity mutual funds which have been large sellers over the last few months. Insurance companies have been buyers, though,the extent of buying has been small. We are seeing a contradiction wherein retail investors have been investing in the market directly but at the same time they have been withdrawing from equity mutual funds. One reason for the withdrawal could be that there might have been disappointments in terms of the equity mutual fund performance over the last few years.
The second reason could be that there have been salary cuts or job losses in some segments which would have explained some of the outflows or redemptions in mutual funds. Lastly, there could be some reallocation of assets towards real estate possibly because we have seen some recovery in some of the metro cities. Early (and possibly continued) success for new direct retail investors who commenced direct equity investing, due to the sustained rally right through the financial year, could have been confidence-boosters for these investors.
Much has been said and written about what is happening in the bond market both at home and abroad. Are equity investors missing some hidden signal that bond markets are giving?
If we look at the Indian equity market in particular, a primary reason for returns being average, at best, in the past few years has been the absence of earnings growth in general: the scenario was such that bond funds were delivering better returns than equity funds even over longer periods like 5 years and 10 years, till a few months ago. This scenario has now changed and higher returns justifying the risk premium are seen over these long periods.
To answer your question, while bond yields have risen recently, they are still low in absolute terms. Equity markets are not giving up as much of the gains despite the rise in bond yields, because the earnings upgrade cycle that we have seen in India over the past few months, has not been seen in several years. With the signalling that has emerged from the Budget, we are optimistic in terms of an environment conducive to growth over the next few years. There is no denying that slightly higher inflation and slightly higher interest rates do appear to be on the cards, but we have to recognise that many corporates have utilised the past year to cut down on some costs permanently. That should help offset the increase in raw material prices as well as on the interest rates going forward. Historically, corporate India has effectively utilised higher inflation to add to their topline and bottomline.
Higher interest rates in the US could be a concern though, from the perspective of FII flows.
If the market is right and we do have some scope for policy normalisation from the RBI and US Fed starting next year, can equities absorb that or would you expect an adverse reaction from investors?
From the equity markets perspective, if large global central banks like the US Federal Reserve give signals of earlier policy normalisation, that is clearly one risk element which remains. If we have a quicker unwinding of the liquidity globally, that will mean that either we will see much lesser inflows from FIIs or we will start seeing outflows.
There is a reasonable possibility that we could see money coming back into institutional investments if retail investors perceive a higher level of risk associated with direct investments in individual stocks at levels which are much higher than those earlier during the year. We might see a rotation of investments back from direct investment by retail investors into mutual funds and ULIPs. We expect that while the equity market consolidates at the present levels with sectoral rotation, accompanied by a (gradual but considerable) correction in some individual stocks over the next few months, we could see this happening. It would be good to have this reinforcement of flows in domestic institutions, as it would help in absorbing potential large sell-offs from FIIs, and counter the risk of a liquidity reversal in the US later in the calendar year.
We have seen this great rotation from growth and quality stocks towards cyclicals. Is this trend sustainable?
From the overall market perspective, we could be in for some time consolidation in the market, given the levels at which it is. At the same time, we will see sectoral rotation continuing. Temporarily, we might see more money coming back into some of the defensive sectors, for example, the pharmaceutical sector and the consumer sector, which have lagged the overall market up move in the past few months. As far as commodities are concerned, there are expectations of an extended upcycle. Higher infrastructure spending in the US, a focus on GDP growth, as well as higher raw material costs, could result in some of the commodity prices remaining elevated, even if they do not rise further.
Some other cyclicals could also continue to attract investor interest if they deliver on earnings expectations in the next couple of quarters.
With the government stating aggressively that it does not want to be in business, is it time to look at PSU stocks from a different lens?
It may not be appropriate to look at PSUs in general as a category, one would need to be stock-specific here. On an overall basis, yes the valuations of PSUs have suffered in the last few years due to various factors, including a lack of growth as well as intermittent supply (or overhang of supply) of paper even at lower valuations. There is a possibility of both of these being addressed, with a revival in growth as well as a preference for stake sales to strategic investors. On a stock-specific basis therefore, some of the PSUs could definitely attract investor interest, particularly with a large relative valuation gap as compared to the market.
PSUs are always looked at as a tactical trade and not as portfolio stocks. Would this change now that privatisation and disinvestment is picking up?
We have continued to own a small percentage of our portfolio in select PSU stocks since the past few years. We will continue that. What I meant was that we may not be able to paint all PSUs with a common brush, we will have to be stock-specific. I do think there will be more institutional inclination to have a longer-term holding in some of the PSUs which each of the institutions might identify for their portfolios.
From a longer perspective, which are the sectors that are getting you excited and why so?
The production-linked incentive (PLI) schemes are a very positive development. To begin with, we are seeing the consumer electronics sector in the forefront. We have seen some announcements in the pharma sector as well. In coming years, if implemented well, this could help some sectors attain globally competitive scales.We are more positive on the financial sector space, along with pharmaceuticals and consumer-oriented sectors, as a revival in the economy, global opportunities and improved consumer sentiment and per capita income over the longer-term, could be drivers for these sectors.
