The Hindu Business Line : `This bull market is different from previous ones'

Tridib Pathak, Chief Investment Officer of Cholamandalam AMC, believes that there is no reason to worry about a big-time stock market decline as long as India manages to sustain its "growth gap" with the rest of the world. He points out that this bull-run is different from the others in the past because stock prices have barely kept up with the take-off in earnings growth for India Inc. We caught up with Mr Pathak during a recent visit to Chennai, for the unveiling of Chola Tax Saver.

Excerpts from the interview:

Mutual funds have really scaled up their stock market purchases over the past few months. Is this a sign that domestic investors are taking to equity funds?

A series of new fund offers has been launched over the past few months. New money is coming in persistently through these offers. Yes, there are signs that domestic investors are becoming more comfortable with equity investments.

As the older funds are not adding assets, is this sustainable money?

I agree that there is a perception issue attached to new fund offers. Mutual funds have to be looked at as a viable, long-term investment and the Rs 10 entry point should not really matter. But this will happen. First, there aren't too many alternative products that can give you inflation-adjusted returns of the kind that equity can give you. Second, we do see confidence returning to equities as an asset class.

If you look back over the past 15 years, every bull-run has only lasted 9-15 months. Every one of those times, by the time individual investors decided to enter the market, the market probably crashed. But this time round, we are already two-and-a-half years into this bull-run. Unlike in the past, there is little manipulation in the frontline stocks. This is likely to inspire confidence that stocks can make money for you over the long term.

The latest leg of the rally has been largely liquidity-driven. Isn't it likely that the FIIs who entered in the early stages will book profits on their holdings at some stage?

I think that the liquidity is only a confirmation of the strength and visibility of the India story. So we are not too concerned about the liquidity driving up the markets. As long as strong earnings growth continues and India manages a sustainable growth gap with the rest of the world, we do not have to worry.

There is already a significant growth gap between India and the rest of the world. We see several drivers that could help India sustain 6 per cent GDP growth — demographics, consumerism and infrastructure investments, to name a few.

What will push up this growth rate to, say, 8 per cent will be the external opportunities arising from outsourcing and capturing a larger share of international trade. If you look at history, every economy — Taiwan, Japan, China or Korea — has been able to boost its growth rates only when it captured a larger share of global trade.

We already see this happening in India through outsourcing, and increased global competitiveness across sectors. We have historical baggage; we keep expecting the bull-run to collapse. I think we need to shed that.

Is there a possibility that this liquidity is driving up valuations beyond reasonable levels?

We have some way to go before that happens. If you look at the 15-year chart of stock prices and the earnings of Sensex companies, you can clearly see that this bull market is completely different from the previous ones. Valuations have not run ahead of earnings, as they did in 1994 or in 2000. They have just about kept pace. So you are not paying more for the same stock and the same earnings.

In fact, the valuation of the Sensex basket has barely changed between January 2004 and now; it is earnings growth that has driven up stock prices. In January 2004, when the Sensex was at 6100, the price-earnings multiple of the Sensex basket was at 14 times. Now, In September 2005, with the Sensex at 8000, the multiple is still at the same 14 times. So a Sensex level of 8000 today is akin to the level of 6000 in the beginning of 2004.

But are these numbers relevant, because a large number of stocks outside the Sensex trade at much higher valuations?

I think the trend that these numbers capture would hold good for much of the market. If you include the mid-cap index, the valuations may climb to 16 or 17 times; but that too is reasonable. Yes, a number of mid-cap stocks are trading at ridiculous valuations.

In stocks where you do not have much institutional participation, valuations can climb to unrealistic levels. This happens in every bull market and this one is no exception. But at the same time, we do see attractively valued stocks in the mid-cap space as well.

Prices of quite a few mid-cap stocks have declined sharply in the past two weeks. Do you see this as an overdue correction in valuations or as a buying opportunity in mid-cap stocks?

We probably have not had a genuine correction so far in this bull market. But we do not think it works when you try to time the market. So we believe in sticking to our knitting. We try to get the stock selection right and that helps us to weather a correction quite well. We've found that Chola Mid-cap fund has fallen much less than others during these periods, because of the focus on stock selection.

You are rolling out a new tax saving fund Chola Tax Saver. Will this fund focus on mid-cap or large cap stocks?

We have decided not to bind ourselves to any specific market cap strategy; we would rather allow the fund manager to find the best stocks, irrespective of the market cap. We think the tax-saving fund is a good product because it compels the investor to stay with the fund for at least three years.

We actually did a study of rolling returns on diversified equity funds over the past 10 years with respect to the holding period of an investor.

We found that an investor who stayed with a fund for one year earned an average return of 31 per cent per annum; but the returns could swing between a negative 61 per cent and a maximum of 128 per cent. When you lengthen the holding period to five years, you can considerably reduce the volatility in returns.

The average return for a five-year holding period was 21 per cent, but the returns swung only between 10 per cent and 32 per cent.

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