The Hindu Business Line : ‘Current valuations are a fund manager’s delight’

Several good businesses are going abegging.
I would rather raise funds today than at 21000 Sensex levels. Our team is on the streets today, looking out for good opportunities.

PARAS ADENWALA, CIO-EQUITY, ING INVESTMENT MANAGEMENT

Aarati Krishnan

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Calling current stock market valuations in India a fund manager’s “delight,” Mr Paras Adenwala, Chief Investment Officer-Equity, ING Investment Management, holds the view that the Indian stock market is bound to pick up once risks from commodity prices and political “events” are out of the way. He believes that the global slowdown is bound to temper commodity prices sooner rather than later.

Excerpts from an interview:

ING in India, has been making a strong case for diversifying overseas. What’s your view on Indian stocks right now?

We think the recent decline in Indian stocks is not a bear market; it is a correction in a bull market. We think Indian equities will do well over the long term.

My sense is we may see (Indian) GDP growth slow to about 7.5 per cent and if you really want to stretch it, at 7 per cent. I don’t see a likelihood of anything below that.

Once the current phase is over-inflation concerns, political concerns relating to elections, I see business as usual, assuming we find a government that sustains for five years.

We have had 8 per cent GDP growth for the past two years, despite having a fragmented polity and a virtual halt to the reforms process. Business too has done well. It follows that if we have a very stable government at the Centre which re-starts the reforms process, that will be very positive. In the short to medium term, for sure, the markets will be range-bound, probably in the 10-15 per cent band. But for the long term, the potential remains the same as it was a while ago.

We’ve seen sectors and stocks with high PE multiples such as infrastructure, media and capital goods de-rated sharply. Is some of this decline permanent, as investors have become more value conscious?

This happens in every large market correction-take 1994, May 2000 or May 2006 or now. Whenever the market is doing well, expensive stocks become more expensive as everybody wants to own the stocks with the highest potential.

On the downside, it is those stocks that have performed very well that plunge sharply. It is the out-performers that people like to unload. That’s because if you have to sell, you are usually inclined to sell something that is making you a lot of money.

So I’m not all surprised about the hammering in media, infrastructure or capital goods stocks. These are the very sectors that have tremendous potential. Once things stabilise, and I believe we are very close to stabilising, and the first good news on the economy begins to trickle in, you’ll see these very sectors doing well.

India is widely regarded as a “growth” market. “Value”-based strategies such as dividend yield investing haven’t worked in recent years. Do you see this changing now, with investors turning more averse to risk?

I think the distinction between ‘growth’ and ‘value’ is largely theoretical. To me, there are two ways of buying stocks.

One set of stocks where you see a lot of growth momentum over the next few years. Another set where the price is lower than the replacement cost of business. In either of these scenarios, you can make money.

To give you an example, not long ago, fertiliser stocks were out of favour. Then you saw a huge run-up in their prices, with PEs going up from 6-7 to 17-18 times. All this when there was no change in earnings or fundamentals and there was virtually no growth. The run-up was driven by policy expectations.

You also saw a bull run in oil refining and marketing companies. These events are clear proof that investors do find “value” in stocks. Yes, India is a growth market, but there will always be a certain set of investors who will buy into stocks for value, if there is the prospect of making money.

There has been a deceleration in earnings over the past two quarters and the IIP numbers too indicate a slowdown. What is the sense you get from companies you talk to? Is there is a slowdown?

For a change, most companies are seeing strong business visibility. But the problem is with execution. Capital goods and engineering companies, for instance, have visibility on business for the next four years, based on their order book. But they cannot show sales growth if the other segments of the same business do not supply the goods on time, for completion of projects.

Issues such as this have resulted in a delay in completion of projects; which is also reflected in the sales turnover. Is there a deceleration in demand? Of course not. In infrastructure, how can India have a deceleration in demand? Therefore, capital goods (as a sector which supplies to infrastructure) too cannot have a deceleration in demand. It’s a case of execution rather than lack of demand that has led to the earnings slowdown.

Is there a case of companies being unwilling to raise funds for projects at current interest rates?

Probably for a few businesses which are highly leveraged. But fortunately for corporate India, most investible businesses are not as leveraged as they can be. Therefore, the ability to fund projects remains high. I think if there is one risk to business growth, that is execution right now.

What about commodity price inflation, isn’t that a risk to margins?

It definitely is. I also believe that most sectors lack pricing power, because of intensifying competition. I believe you will see very good volume growth for Indian companies going forward, and sales growth, but profit growth may lag as margins may decline. However, I don’t think commodity prices will continue to be as strong as they are now.

If global economic growth is slowing down, global demand for commodities has to slow down and this has to reflect on commodity prices. What is currently happening is the injection of a huge amount of trading money into commodities because there is lack of opportunity for investments — equity is down, bonds are down, real estate is down; and therefore something has to move up. That money is being channelled into commodities.

But, at some point in time, commodities have to drop; that can lead to an improvement in corporate margins. My sense is that we are very close that point — a peak in commodity prices. If the deceleration in global growth continues over the next six months commodity prices should decelerate. That should be very beneficial for several businesses.

Between January and now there has been a wide divergence between sectors. IT, pharma and FMCG stocks have risen sharply in these months while infrastructure, capital goods and realty have declined. Should a recovery begin, will sector rotation take place? Were your funds well-positioned in these sectors before the recovery?

That is bound to happen. Sectors like IT, pharma and FMCG were grossly under-owned before this rally and you’ve seen buying there. Capital goods and power were grossly over-owned and you’ve seen selling there.

This is why it makes sense for fund managers to be optimally diversified. At ING, our Contra Fund was very well-positioned in IT and healthcare and that has reflected in the fund’s performance. In realty, we never liked valuations and therefore kept away. That has helped us too. Therefore, we were well positioned before the market fall and that is reflected in the performance as well.

Indian equity funds typically deliver big out-performance in a rally but also are unable to contain declines to index levels, during a correction. Why is this?

You must be looking at performance over a short period. In the midst of a bull run, every correction seems like a buying opportunity. During the initial fall, fund managers may keep buying and increasing the fund’s Beta. This makes the funds’ NAV fall faster than the market.

It takes a while for the fund manager to realise that he is in a prolonged correction. By that time the fund would already have underperformed the market.

That is why funds under-perform the market in the short run. But I do urge you to look at performances over longer time-frames, with a minimum of a year.

Are you comfortable with current stock valuations?

They are a fund manager’s delight! Several good businesses are going abegging. I would rather raise funds today, than at 21000 (Sensex levels).

Today, the market certainly affords a lot of opportunity to fund managers to thoroughly analyse a business and make a well-considered decision about stocks to own or sell. Our research team is absolutely on the streets today, looking out for good opportunities.

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