How comfortable are you with the markets right now? If you buy good companies, where earnings are visible, they are expensive. Isn't there a conundrum there?
Quality companies are expensive for a reason. Quality companies are characterized by high free cash flow generation on a sustainable basis, high return on capital employed (ROCE) and high return on equity (ROE). High free cash flow means no debt on their balance sheet and hence the entire cash flows are available for distribution to shareholders. High ROCE means less reinvestment rate to sustain higher earnings growth. Hence, quality companies tend to attract higher valuations in the marketplace. Stock market performance of quality companies may vary under various market cycle. However, if you invest in these companies for 10-15-20 year period, these companies have generated enormous return to the investors.
How have you changed your sectoral weightage to thrive in the covid-19 world? What are the sectors that you are overweight and underweight at this point?
Cash crunch created by Covid 19 will severely impact businesses/govt. finances. This could trigger consolidation, technology driven disintermediation, large asset sales & better targeting of govt’s subsidy distribution. In the short to medium term, emphasis is likely to be on health and hygiene. Consumer behavior would favor online platforms and aversion to crowd. In post Covid world, one needs to look at the companies having leadership / dominating positions in the sector, having strong balance sheet and strong cash flow generation. Such companies are likely to navigate the uncertainty far better and emerge stronger post crisis. From short to medium term perspective, funds would have positive outlook towards FMCG, IT, pharma and telecom. However, attractive opportunity is also present where disruption on the supply side is leading to surviving incumbents thriving post disruption.
Given the prolonged subdued performance of infrastructure funds, do infrastructure funds make sense in the current scenario?
One of the ways of reviving the economy would be heavy govt spend on infrastructure sector. High spend on capital goods/infrastructure sector tends to have high multiplier effect on the demand in the economy over medium term. Higher ordering in the infrastructure sector such as road, railways, metro, urban infra etc. would benefit engineering, procurement and construction (EPC) players, equipment manufacturers, cement companies etc.
Current valuations of EPC cos and corporate oriented banks are attractive when compared to historical valuations. Early normalization of demand should benefit cement sector. Gasification of Indian economy may continue to benefit companies in the gas supply chain in the medium to long term. With three players left in the telecom sector, increase in tariff should reflect in higher cash flow generations for the telecom companies.
Recently, fund houses have been emphasizing a lot on multi asset funds. Why have multi asset funds become a most talked about category recently?
Multi asset funds are talk of the town on account of black swan event experienced by the capital market in the last six months. Over last 20 years, there were three occasions where volatility in the capital market was at peak. On these occasions, there was a sharp fall followed by sharp recovery in short time period. This kind of volatility in various asset classes can be nerve wrenching for the investors. It can cause damage to their portfolio in short to medium term. The only way to deal with violent volatility in the capital markets is to have a balanced asset allocation which can reduce the short-term volatility without giving up too much return in the long term.
One strong reason to have exposure to various assets classes is that ‘winners rotate’. It is very difficult to predict winning asset class every year. All investment gurus give one investment advice “Don’t put all your eggs in one basket”. Depending on the risk appetite and investment horizon, investor can balance risk and reward by allocating investment in various assets classes such as equity, fixed income, gold and real estate. Asset allocation does not eliminate risk. But it can reduce exposure to extreme high and lows in performance.
Is the rally in the market justified? What are your views?
Post March 2020, all the major economies including India came out with all time high monetary and fiscal stimulus to counter the slowdown caused by COVID-19. Such a large monetary and fiscal stimulus convinced the market that it would lead to V shaped recovery in the economy and earnings. Hence, we had witnessed V shaped recovery in the stock markets. From economic point of view, large monetary stimulus is leading to an excess in the money supply. M3 (money supply) growth at 12% is now far in excess of nominal GDP growth which is inflating financial assets like equity markets.
In the short term, there would be disconnect between real economy and equity market. However, excess liquidity may create its ecosystem in terms of growth, credit and inflation. Generally, equity markets are leading indicator and hence may move well ahead of recovery in economy and earnings. Quarterly results of companies reported significant reduction in other expenditure. As per most of the managements, part of reduction in cost/expenditure are structural in nature. If this were to be true, then operating leverage could be big surprise as the sales recovers to previous levels. This means, earnings of the companies could recover to previous highs much faster than market is expecting. Risk to the equity market at current valuations would be second wave of infections and high inflation.
