Vivek Law: How exasperated are you right now with the kind of continuous redemptions that you are seeing?
Prashant Jain: It is very unfortunate but I’m not surprised. I have now been in this industry for 24 years. This the third or fourth time I’m seeing a pattern of this behavior. I would hate to say that but Indians are less financially literate. The only way we understand asset class is by looking at past returns. There is no concept of PE multiples or valuations. Whatever asset class does well over the previous five years tends to grow exceedingly well. If you look at the net sales of equity mutual funds in the industry, about 80% to 90% of money has come in when market was at trading at above 20 PE multiples. At below 15 PE multiples there are either no inflows or there are redemptions. It is extremely disappointing but this is the way we are in terms of financial understanding.
S Naren: I was more exasperated in 2007. People were wanting to invest in equities at any valuations. Post 2008, a number of people who had seen markets along with me for 15 years said that we will put money in India the moment local investors redeem. Local investors refused to redeem. Only foreigners sold during that bear phase. In 2010 when FIIs were taking out money it was a good decision on their part. They are taking out one rupee and putting back only 10 paise when market corrects. That’s the part I’m not able to understand because we have not seen any big returns post 2010. So, they are not practicing asset allocation. As Prashant pointed out, past returns still matter. When we launched our US Bluechip Fund people were not keen on investing in this fund. They have only started investing aggressively after the fund started delivering good returns. People have realized that they have to keep booking profits. There has been no correction in real estate so investors are captivated by that sector.
Anoop Bhaskar: You have to look at India as very similar to US in 1970s. The US had two recessions in 1970s and they did not have any institutional money. I was reading a book in which it was mentioned that from 1971 to 1977, 50% of the IFAs in the US went out of the industry. We have huge similarities with what happened in US in 1970s and what happened in India in 2010. Retail investors will come when you have good returns and they’ll bear losses most of the time. They look at the past 12 month returns and put money in asset classes which have given the highest return. So the critical factor for US where it was in 1977 to where the industry has moved in 2013 is because there was a big emergence of institutional money. Provident fund money should come in equities. Today we have a market where retail investors think equity market is like casino, FIIs are driven by their own thing and no institutional players located in India. Till we have these three legs we will have the kind of markets we have. Our efforts have to be to convince the policymakers, politicians and public. If provident fund manages Rs 1 lakh crore and they have to put one percent in equities then it will not destroy the entire fund. If we don’t have such option available to us, we will keep seeing ups and downs.
Vivek Law: Anup do you believe that we in Indians are far more pessimistic about India than global investors are? Is that one of the reason why we are seeing lack of interest among Indian retail investors?
It’s
an odd situation right now when everybody is more pessimistic about where they
are in the world. So the Americans are more pessimistic about America and
Indians are more pessimistic about India. That’s just the nature of the economy
globally. So, most people are looking to invest outside of where they are. I
don’t think it’s a feature of being more pessimistic but it’s more of a
structural call. Everybody on this dais has produced fund performance which is
fairly; we would have thought by now the industry would have credibility than
it necessarily has. The problem is that while we show 15% to 20% compounded
return over a period of time but the investors have not had the same
experience. By the nature of flows coming in and out the average investor’s
realization is quite different because most of the money comes in at a higher
point and goes out at a lower point. So the whole concept of asset allocating as
a part of your investment process is not seeped through as a habit as it
normally should as compared to most developed markets. I think that’s the basic
challenge. As Anoop mentioned we need long
term products for that. NPS is a promising start. It will have good
implications over the next ten years. It takes longer time for these things to
come through. We are still a nascent industry. We also need the right economics
in the chain for more people into to the equity cult.
Vivek Law: We are moving in a market where we are celebrating at being at an all-time high but on the other hand there are serious question marks about a small pocket of market which is lagging behind. How are you reading the market? Where is your fund manager’s attention?
Anup Maheshwari: It is a very interesting market. The last three or four years have been good actually in the sense of sharp discrimination of management quality, sustainability of businesses and now it has also reached a point where it is offering an opportunity across the board. The good businesses will continue to grow and compound and over time deliver value and on the other hand you have businesses at the worst possible spectrum. There are enough companies at book value or below which require a small economic sentiment shift to produce fairly substantial returns. We are a point where most parts of the market are geared to deliver value over a period of time and poor quality businesses are available at valuations that even small shifts can create mean reversion. So it’s an interesting phase and it sort of makes us optimistic notwithstanding all the noise around us. But the fact is when you look at businesses bottom up you do get the feeling that there is money to be made. For instance, let’s assume that a commodity stock trading at half its book value today and if there is slight improvement in economy these stocks go back to book value and beyond. So effectively they have the ability to double very quickly.
Prashant Jain: I have one simple observation. Anytime if you invest in a Sensex or diversified portfolio of equities when market is trading at below 13 aggregate PE your three and five year returns have been very good. Markets in aggregate should do exceedingly well. Markets are there where they were five years back. Economy has grown, profits have grown, and PEs have come down. I’m quite optimistic on the markets. I personally find quality premiums extremely high. They are probably not sustainable as Anup pointed out when economy improves slightly. I find consumer and pharmaceuticals rich in terms of PE multiple although they are great businesses. The rest of the market is cheap.
Vivek Law: Are FIIs only looking at 25-50 stocks? Even if there is value but there is no money since you are facing huge redemptions.
Prashant Jain: Foreign ownership of Indian stocks was zero in 1990 and today it is 23%. They are increasing ownership in Indian markets by 1% a year. If you are averse to equities then don’t buy equities ever. But then why does the same individual buy equities at 25 or 30 PEs? We have seen in 1992, 1999 and in 2007 that these were the highest PE multiple years. The flow in mutual funds in these years was huge. Money does not come at low PEs. Retail has been a contrarian but reliable indicators of the markets. Whenever retail investors sells big time I think in the next three years markets are likely to do exceedingly well and vice-versa.
Vivek Law: So you are saying we are in that stage right now…
Prashant Jain: Mutual funds have got redemptions to the tune of Rs. 20000 crore in the last 18 months and still the markets are moving up 20%. The elections will be over in one year and PE multiples will be lower and results have been better than expectations. Currency depreciation has been good for earnings. Subsidies are coming down, interest rate and inflation is coming down. So things are improving. The PE multiples are low. The markets should be higher in three years.
S Naren: We have been focusing on value in the last six months because of the big divide in valuations across sectors. Post 2011, we have come to a conclusion that volatility is an in-built factor in the markets which you cannot eliminate. With this focus on volatility and value we had a much more comfortable experience over the last three years. Value in particular is very cheap and you have to be long term in it.
Vivek Law: Do you agree with Prashant that the next three years will be far better than what we have seen in the past?
S Naren: Like Prashant mentioned both consumer and pharmaceutical are highly valued compared to the markets. There is an opportunity to invest in other sectors. If you look at the broader markets then there are massive upside opportunities.
Anoop Bhaskar: I get a little worried where I see value. Most of the value companies are government owned. I would be more careful about value. The next punt will be to buy PSU companies because if we have a strong government then these companies will benefit. Apart from PSU companies, the other value companies are low quality businesses. They have projects which will earn single digit ROCs. So if you have a commodity company today which trades at 0.5 times its book value and has got Rs. 50,000 crore project on stream earning 6% ROC then it deserves to trade at that valuation because of the cost of capital we have in India. I get very confused when I look at the market today. The conventional thought is that FMCG and pharma is expensive. I find it difficult to find value other than the case of PSUs because at least they are large in size. Having a top down approach and even getting the sector right has not helped funds. The funds that have done really well have got the socks right within the sector. The market is becoming very stock specific and fund managers like Naren who have done an excellent job in identifying those opportunities at the right time have come out with superlative numbers and other like us who have struggled to come close to benchmark. Now everything boils down to stock selection whether you call it value or growth.
Vivek Law: Apart from consumer and FMCG, which part of the market is exciting now?
Anup Maheshwari: We see if there is any pricing power available in that sector. Any sector which has pricing power finds it much easier to grow earnings and give incremental return on capital. Telecom is one area where things seem to be getting better. The industry has consolidated well and you will see ROEs coming through incrementally. IT continues to be a fairly decent place to own. The underlying business economics are good. Currency hasn’t been the long term driver of IT sector. It’s been more the underlying business. Wherever we are seeing that industries have consolidated and large players having become more meaningful invariably that’s leading to pricing power. Cement is another case in point. Those sectors will tend to deliver consistent returns after a point. Beyond that we are looking at some of the valuation argument as well.
Prashant Jain: When markets have not done anything in five years and the economy has grown in rupee terms meaningfully then nothing that is outrageously overpriced in this market. In consumer and pharma I find no room for multiples to expand. There is value across the board.
Vivek Law: Is the next big trigger elections?
Prashant Jain: If you look at the Sensex returns since 1999 the returns have been good in election years. I’m talking about financial years. We don’t know why that happens. Elections are known event and all known events get discounted today. Those who are worried about elections would either not buy or sell today. I have seen only one correlation which works. Low PE investing works and high PE investing disappoints. We have seen a lot of good changes over the last six months. Markets have done well irrespective of the outcome of the election.
S Naren: You will see a fair amount of volatility in the next two years. There is one set of companies which are leveraged and are in deep trouble. There is another set of companies which are not leveraged but are in moderate trouble. If government gives them what is lacking for their projects to get fully operational I think the low ROCs that you see is more a function of incomplete projects. Those things can get rerated significantly. Both US and Europe equity boom happened in disbelief. The capacity utilization of the bulk of US and Europe’s industries had fallen to about 70%. Their operating margins went up as the capacity utilization went up from 70% to 80% without any capital investment. Something like that can now happen in India. In two years of very low industrial growth there are wide industries which are operating at below capacity at this juncture.
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