In an interview with Cafemutual, Huzaifa Husain, Head of Equities, PineBridge Investments talks about the role of luck in investing, the road ahead for infrastructure funds and more.
With the elections behind us, what are the next triggers for the markets?
India, over the past few years, has focused a lot on consumption. When consumption picks up, one needs adequate supply. The investment in producing goods and services has dropped in recent times because of well-known reasons. As a result, demand has been increasing faster than supply leading to a rise in inflation. Our country has also resorted to imports to meet the consumption demand resulting in a rise in current account deficit and a depreciation of the Rupee. Interest rates have therefore remained high, hurting the investment cycle. The previous government had started realigning the system in order to accelerate this investment cycle. Hence, progress on correcting this investment–consumption balance will be the next trigger for a sustainable rise in the market.
One of the most important requirements for this to happen is the ability of the financial system to provide the required funds. The financial system should become more efficient because at the end of the day any project would need money, and money is lent by the financial industry which is dominated by banks (majorly PSU banks). PSU banks have been struggling with their balance sheets which are low on capital and high on NPAs. It is, therefore, difficult for these banks to take fresh exposure. So this machine of allocating savings has broken down which would need to be fixed. So the most important aspect which we are observing is how this machine is going to get fixed.
Post the elections and the recent market rally retail investors’ interest in equity funds seems to have revived. Do you think the momentum will continue going ahead? What could derail it?
Let me answer the question in reverse. Take a company which needs capital. How should it raise money – debt or equity? For argument’s sake, assume that both the debt and equity holders want the same return on their capital. The cost for the company is nearly three times if it raises the amount using equity vis-à-vis using debt. The reason is that the interest paid on debt is tax deductible, thus lowering the cost of debt for the company. On the other hand, an equity holder gets paid post taxes and then has to lose the DDT on distribution of the profits as dividends. This difference between cost of debt and cost of equity has increased in the past few years as the effective tax rate of corporate has increased accompanied with a rise in DDT. Why should a company then raise money in equity? Hence, in our view, if retail investors need to get attracted to equity markets, the cost of equity relative to the cost of debt needs to be corrected.
Infrastructure funds have delivered superior returns on the back of expectations of positive announcements by the government. How is the situation on ground? Do you think there is still some upside on infrastructure stocks?
It is hard to imagine sustainable economic growth without infrastructural investments. Hence, we feel investments in this sector should do well over the long term. The reason for superior returns of such funds in the recent past is due to the huge underperformance over many years. Over the last five years, infrastructure funds have underperformed Nifty, so it is but natural for some catch up.
The stock prices have risen before any tangible changes on the ground. Typically, markets discount changes a few months before the actual change happens. For infrastructure funds to perform better than this, we think the change has to be better than what is already being expected. In our opinion, there may be some dissonance as markets may have discounted more than what the capacity of these companies is to deliver in the short term.
Do you think the markets have the potential to deliver the kind of performance we saw in 2014?
We feel that over a period of three years, the probability of the Indian equity markets delivering returns more than the post tax bank fixed deposits is high. In our opinion, anybody who has a horizon of less than three years should not invest in equity.
How is PineBridge Infrastructure and Economic Reform Fund different from existing infra funds in the market?
Our fund sticks to its label. As a fund manager, my value addition is what kind of stocks I choose to invest in. We are not telling investors that we will give you returns no matter what happens to the infrastructure sector.
Metaphorically speaking, a decade back, one would only see one or two kinds of soap and one shampoo in a typical Indian bathroom. Now, you’ll have a shampoo, conditioner, a face wash, a body wash, three kinds of soaps and a moisturizer. Everything is specialized now with clear benefits.
If one applies the same metaphor to mutual funds, then our infrastructure fund is a specialist fund. Just like how a conditioner is supposed to act as a conditioner and not as a face wash, our fund delivers when the sector performs. Our fund being true to its label, we hope to ensure that the advisor recommending our fund to a client positions it appropriately.
Since I took over this fund in 2009 even when the NAV used to go down sharply, advisors never called to ask why the fund was not performing as they could themselves see the state of infrastructural investments in the economy. But their confidence remained intact as they knew that as and when the sector delivers, the fund will perform. Today, we are happy that we have been able to do our best which I am sure our investors would appreciate.
Within the infrastructure space, which segment (telecom, construction, bank, etc.) are you bullish on?
We tend to look at this space from a developer, constructor and product company perspective. The project is won by a developer who has the longest cycle. Such a company bids and runs the asset for 20 years. The company then gives the job of constructing the project to a constructor, for example L&T which may take three years to develop it. L&T will need cement, boilers, ball bearings, etc. to construct the project. The raw material suppliers fall in the shortest cycle. What makes a good developer is the access to cheap capital which means it has to manage its risks very well. For the construction company, the efficiency depends on constructing the project on time. And for the product company, it is about using the right technology. The immediate beneficiaries of the infrastructure boom can be product companies (like cement) as they are likely to see an immediate positive change in their cash flows. After one or two years, the construction company may make profits. Finally, once the asset is ready, it may start making positive cash flows. When the cycle is down, people tend to invest in utility companies as they provide a constant stream of dividends. When the cycle is starting, one typically invests in companies which will immediately benefit. In our portfolio, we have companies manufacturing cement, equipment and boiler companies along with a couple of longer cycle companies.
How do you plan to mitigate risk in the PineBridge Infrastructure and Economic Reform Fund portfolio, given that it is a sector fund?
To us, risk means permanent loss of capital. When markets go up and down, it is merely a quotational loss. We try to mitigate risk by investing in companies which have great management, have a dominant franchise, have balance sheets which are not leveraged and are available at a price which we are comfortable with.
Your favorite book and why would you recommend it to others
The one book which has inspired me is Poor Charlie's Almanack: The Wit and Wisdom of Charles T. Munger. You get a perspective of everything – from how to lead a life to how to make money.
If not a fund manager you would have been...
If not a fund manager, I would still be investing for myself.
How important is luck in investing?
You have to be in the right place at the right time in order to make money. I am lucky to have an opportunity to manage money in a country which has the oldest stock exchange in Asia. Indian markets have diverse companies listed which help spread risks. Having said that, at any given time, all managers of money have the same opportunity set in front of them and hence how they perform is a function of their individual skill sets.
