While there is very little reason to complain about how markets have reversed in the last 10-15 trading sessions, should we now be cognisant of the risks which are surfacing — risk on inflation, risk on how cost is having impact on margins, risk on how globally central bankers are tightening rates?
Year to date, the broader market is still up 30%. The mid and smallcaps are up nearly 40% and 50%. So despite this pullback of some high single digit per cent or so, remember the markets have rallied very sharply from the bottoms about 18 months ago and some sections of the market particularly in the smallcap, particularly in areas where governance or sustainability of growth is suspect, are more susceptible.
Over the last few months, the sustainability of profits has not received as much attention as just the near term and now growth has. So what we are seeing right now is a little bit of recalibration in the market as the corporate earnings have come out for the quarter. There is a reassessment of what sustainable margins could be for some of these companies. Obviously during the Covid and post Covid timeframe, because of supply chain disruptions locally domestically in India as well as globally, there was margin expansion because there was consolidation of market share to a great extent amongst the larger players at the expense of mom and pop shows.
Now as the smaller unorganised players get their businesses back on track, some of the supply chain disruptions are also causing raw material inflation. You are seeing a combination of those things having a softening impact on margins. In any earnings season, it is hard to generalise everything into a few comments but one of the underlying themes that we are seeing is that lots of companies are reporting muted margins compared to expectations. The Street was expecting topline growth to be very healthy and mostly companies are delivering their topline but at more muted margin levels, which is coming as a bit of a negative surprise for this year.
I do not put too much emphasis on the tightening rates and what not; it has been very well anticipated for the last 13 years that the Fed would be tightening. We would see that equity markets globally are capturing that risk fairly well and India is moving in tandem with that. The US markets are close to their all-time highs and so I do not lay too much emphasis on that having much of an impact on the Indian markets.
The big surprise and the big delight for me is how banks are indicating that a famine has become a feast. NPAs are down and credit demand is up. Are banks a lag indicator or a lead indicator of the economy?
I think they are a lead indicator or at least in this context the commentary is very strong from almost every bank. They are expecting very rapid growth from here on in many sub-segments of their business units. They are expanding double digit across the board and even closer to triple digit growth. So the broad market is 100 plus per cent. Small caps are up 200%. They are lead indicators. The question is whether the market as a lead indicator was ahead of banks as a lead indicator. Even if you are a lead indicator, you can overestimate the signal and that could be the difference between what the banks are saying and how the markets are reacting.
Do you see a significant portfolio allocation in the funds which you manage and which oversee the internet and the new tech companies — be it Nykaa or Patym or Zomato or a few more? Do you see that change and migration happening at your AMC level?
We are in very, very early stages of this so-called new age technology phenomenon in India. This happened in the US some 20-25 years ago starting from the mid 90s when the Netscapes and the Yahoos got listed. All this analysis and media hype and criticism and euphoria very much played out in the US in the late 90s and I had the good fortune of managing US money at that time. And then it happened in the Chinese market about a decade ago or so.
In the US and the Chinese markets, these new age technology companies represent 15 to 25% of the overall market and in other countries it is similar or even higher. In India, right now they are a low single digit percent of the market cap including the companies that are in the pipeline right now and are about to be listed in a couple of weeks time.
Six months ago, there was hardly anything listed in this space, not even a low single digit, it was a fraction of a percentage of the market and over the next 10 to 20 years, I do not see why the Indian market would be any different from what we have seen in the US and other emerging markets and I would expect the new age tech companies to form say 20% of the market cap in some 10 to 20 years. We are just at the beginning of it. I am not suggesting it is the same companies that are getting listed which are going to make up that 10 to 20% or 20% of the market 10 to 20 years later because many of the Nasdaq companies which are the largest of the players today, did not even exist 20 years ago. Facebook was not listed 20 years ago, Google got listed in the early 2000s and many companies that were very large companies in 2000, are nonexistent right now. AOL was the largest of the companies, it is somewhere buried under one of the telcos which acquired it. AT&T and the Ciscos and Yahoos of the world are nowhere to be found right now.
So there could be a lot of churn in this and I am not saying it is a slam dunk. you invest in all these companies because they are going to get a lot bigger and a lot bigger part of our lives and the market, but the sector is going to be a lot bigger and any investment theme like ours would have to constantly be on the outlook for opportunities. We have seen some of the greatest opportunities in other countries and then there would be disasters in there as well. Investment themes which are able to better distinguish between the two can generate a lot of wealth for the investors.
You use the discount cash flow mechanism to figure out what you want in your portfolio. Time and again, you have said that you are sector agnostic. You have a broad portfolio but there is a bias towards private sector banks and consumer staples. What is your big idea for alpha generation?
We are across all sectors over the last decade and more. We have tended to find a lot of good opportunities in private financials and have hardly ever invested in government owned financials. We tended to have good exposure in technology or IT services companies predominantly in India, technology is IT services but whatever is non IT services also, we have tended to have good exposure in technology. While in the overall consumer space we do have good exposure, but not as much in staples.
Having said all this, we continue to find a great number of opportunities across sectors. Sectors where we struggle to find opportunities are utilities, energy, telecom, and real estate, even commodities in general. While metals have had a very strong run, we have struggled to find attractive investable opportunities. Given our philosophy and process and approach and focus on governance and sustainable cash flows and business models and scalability, we continue to find even at this time, more opportunities in private financials, IT services, healthcare, broad consumer including staples, and chemicals included in pharmaceuticals, industrials as well.
IT services, midcap IT services has been for long a great area, a very fertile area for generating outstanding returns or alpha for us but the risk of highlighting a single area is that one should not downplay the contribution of all the other areas that I have spoken about and we have somewhat been associated with having generated extraordinarily well in midcap IT which is the case but also in all the other areas the team has generated very strong and identified very strong opportunities.
