The Hindu Business Line : `Services add flavour to your portfolio' — Mr Nilesh Shah, CIO, Prudential ICICI MF

At 8800 Sensex levels, some stocks in the services space were expensive and it was harder to find value in them. With the market correction, we find a lot of great investment opportunities opening up for those seeking to invest into this fund.

Prudential ICICI Mutual Fund has unveiled a new fund offering in the Diwali week — PruICICI Services Industries Fund. As a theme fund, how appropriate is this for long-term investors? How different is the stock selection going to be, compared to other diversified funds? Mr Nilesh Shah, Chief Investment Officer of the fund house, took some queries on the fund and on stock market valuations.

Excerpts from the interview:

The difficulty with piggybacking on specific investment themes is that investors lose out when the theme or sector enters a down-cycle. Where is the services industry poised in its business cycle?

The Indian services sector has grown at 7.5 per cent annually since 1990. We expect it to maintain or improve its growth trajectory. So far as the risk of a down-cycle is concerned, it is important to note here that Prudential ICICI Service Industries fund is not a sector fund; it is a multi-sector, diversified fund.

The fund will capitalise on investment across various industries constituting the services sector, making it less risky than a typical sector fund. The fund manager will manage any possible concentration risk by seeking diversification across various sectors within the services industry.

Second, the services sector provides fairly secular growth potential, unlike agriculture or industry, where growth could be cyclical. We believe that the high and secular growth potential makes the services sector a promising theme for investors looking to add flavour to their portfolio.

Using an analogy of an average person's diet, while a sector fund would constitute dessert and a diversified fund would constitute dal and rice, the Services fund could be like a serving of Chinese food or pasta. It can be consumed in more quantity than dessert, but still can't substitute dal and rice.

How big is this fund's investment universe? Do you have a shortlist of stocks that will be considered for this fund?

The fund will invest in companies across service industries including banking and financial services, consultancy, healthcare services, tourism, auto components, media and entertainment, trade and retail, transportation IT and IT-enabled services and telecom.

Within this space, we have identified around 150 companies with good growth prospects.

Which sectors within the services industry seem most attractive now on the basis of valuations and relative prospects?

We find select stocks in software, retail, pharma research and healthcare and financial services attractive at this point in time. At 8800 Sensex levels, which was `fair value plus' zone, some stocks in the services space were expensive and it was harder to find value in them despite the promising earnings growth potential.

With the market having corrected, we find a lot of great investment opportunities in this market opening up for investors seeking to invest into this fund. We believe that returns will come from quality stock selection rather than sector selection.

Valuations of a good number of mid-cap stocks have fallen sharply in the recent correction. Do you view this as a buying opportunity or as an overdue adjustment in valuations?

Last year, two different categories of mid cap stocks witnessed a boost in terms of valuations. These included midcap stocks with the numbers and midcap stocks with the stories. Both these categories were trading at similar valuations last year. However, with both the categories having undergone correction on the bourses, we believe that it is now safe to hang on to those midcap stocks with the numbers backing their performance.

What is your view on the broad market direction, after the recent sell-offs by FIIs. Will 2006 see the stock market attracting liquidity flows of the magnitude seen in 2005?

We believe that the capital market is unlikely to attract as much FII interest in 2006 as it did in 2005. This is because of a rising trend in US interest rates that generally result in a reversal of flows from emerging market equities. Indian stocks are no longer cheap and the re-emergence of Japan may be another factor at play.

However, we do believe that FII inflows will continue to come into India because of the fact that the fundamental story here hasn't changed. India continues to be a robust economy with strong fundamentals, benefiting from structural, demographic and macroeconomic changes. Having said that, it is domestic demand that will drive the Indian capital market. After all, equity as an asset class is highly under-owned in India and this aberration needs to be corrected. We also believe that investors should not expect similar returns as last year, going forward.

Last year, we were re-rated from an undervalued market to a fairly valued market. Now at fair value levels, investors should expect growth broadly in line with the earnings growth of companies.

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