Equities to remain an inflation-beating asset class

Vidya Bala Chennai | Updated on September 27, 2011 Published on September 27, 2011

Mr Aneesh Srivastava, Chief Investment Officer, IDBI Federal Life Insurance

‘There is a possibility of more earnings downgrades as interest rate situation has not changed'

With a series of regulatory or tax-related issues pummelling some stocks in the market, there is no need for such knee-jerk reaction says Mr Aneesh Srivastava, Chief Investment Officer, IDBI Federal Life Insurance. Both the financial implication and corporate governance aspect have to be considered before arriving at a decision on such companies. He also discusses on the long-term prospects for Indian markets vis-à-vis other emerging markets.

Excerpts from an interview with Business Line:

Do you think markets are reeling under pressure more from domestic issues than global factors today?

It is certainly global factors that have a larger influence. Because you have to look at who has the bigger power to buy or sell. This power to buy or sell and decide the direction of the market today vests with foreign institutional investors. So basically their asset allocation call or their country allocation call has serious implications for us.

Having said that, just as global hygiene is important, the domestic factors need to be equally favourable to receive FII allocation. If everything is fine globally, and domestic house is not in order then that is a problem too.

So do you think India is favourably placed today as against other emerging markets in the FII asset allocation pattern?

Over a medium-term, yes. One, India is a consumption economy and is not too dependent on exports. To that extent it remains more domestic-centric than export-oriented. So India has a hedge against global slowdown. Now, when we look at other BRIC economies, Russia is much dependent on oil and as long as oil prices remain high, those markets will do well and hence global equity allocation towards such markets would depend on oil prices. Brazil, although an economy with reasonable consumption, is still largely a commodity-driven market. Similarly, China, as of now, is largely export-dependent. So these factors make them more vulnerable. Hence while much would depend on how the climate pans out – if oil prices remain high, then perhaps the relative interest in Russia would be there – India's inward-looking growth story looks less volatile.

However, locally if the current uncertainties in policy-making together with inflation continue (and it is), then a high interest rate environment would not be conducive for growth and hence for corporate profitability. That would suppress valuations and asset allocation calls as well.

You mentioned about India being consumption-driven. Now, quite a few indicators, whether it is the private final consumption expenditure or other indicators such as auto sales, suggest slowdown in consumption. Would this influence FIIs' allocation?

One should look at consumption from two perspectives: urban consumption and non-urban consumption. As far as urban consumption is concerned, it is impacted to some extent by the economic environment. Higher interest rates, higher housing prices do lead to a slowdown in urban pockets. But as far as non-urban consumption (which includes rural consumption) is concerned the demand environment looks intact. So for the country as well, while consumption will slow from the current pace, it may not slow substantially given the support from non-urban demand.

As far as stock markets are concerned, the consumption theme has been played for quite a while, pushing valuations to steep levels. Do you believe there is scope for the theme to give returns?

When you look at it over a one-year perspective, yes there would be issues in this sector. But then, when global fund allocation takes place, it is for the long-term say over a five-year perspective – because that is the time frame over which FIIs would look to play the India growth story. In that sense, they would still find these stocks okay.

This is because the foreign investors may be able to play an IT or telecom theme in their respective markets but if you want to play the India-consumption story then you would be looking at banking, auto and FMCG. So that is how the allocation will continue. Remember some of these are also defensive bets. So even in the medium-term, as long as there is huge amount of uncertainty and volatility in the market, investors will continue to be interested in these stocks.

There are a number of stocks that appear cheap but have earnings growth concerns. Is it easy to pick value stocks with some certainty about underlying fundamentals?

When underlying fundamentals are changing or the macro issues driving the sector are changing then it becomes very difficult to value-pick. For example, infrastructure and capital goods stocks have been beaten down as a result of poor spending in these sectors. So while there appears to be value in these stocks, you would not want to buy them unless you see a turnaround in the capex cycle. So if you are value picking you would have to wait for some lead indicators which would give you some sign of momentum which would later get reflected in the fundamentals of these companies with some lag.

Of course, when you say value you have to be ahead of the curve. For example, if you have to capture the opportunity in the interest rate cycle, at some point you have to be able to say that interest rates are peaking out and start building positions in say banking stocks at that point.

As a house call which sectors will you be overweight on currently?

On a tactical basis we are overweight on FMCG and telecom. Once we have little more certainty, we would move this money to relatively high beta sectors such as infrastructure, capital goods and IT. We are positive on banks also.

June quarter has seen earnings downgrades in a good number of earnings. Do you expect this to spill in to September quarter as well?

There is a possibility of some more downgrades because what has not changed is the interest rate environment. If you look at corporate results, the largest hits were coming from increasing commodity prices and higher interest rates. While commodity prices have to some extent softened, problems remain in items below the EBITDA. But second half of the year should be better than this.

With concerns over earnings growth, would equities manage to deliver inflation-beating returns over the next couple of years?

We expect nominal corporate profit growth of 13 per cent in FY-12 and 16-17 per cent in FY-13, that's an average 14-15 per cent. That's the kind of return ideally – plus or minus two per cent that investors can expect over the next few years from equities. That is certainly inflation-beating.

Are stock market reactions to issues such as income tax raid overdone?

The raid by the Income Tax department per se may be nothing and there is no need for a knee-jerk reaction. But it has implications when Income Tax challenges the company. There could be corporate governance issue on one side and financial implications on the other.

When you know there is a financial implication, you have to build that into the numbers, then assign a value to the company and see if the stock is attractively priced.

When we discuss with companies we come to know whether the company has done something illegal; it then becomes a corporate governance issue and you have to be careful about such companies and promoters.

What could be the implication of the land acquisition bill on industries?

Much would depend upon how smooth the process of land acquisition will be. Acquisition cost of multiple times the market value of land has certain implications on the cost of the project. So industries where land is intensely used for expansion projects could come under stress. That risk is certainly there. But at the same time it would be a reasonable justice done to owners of the land. But there are multiple aspects that need to be taken care of whether it is alternate land or accommodation or employment or payment of annuity – I am not sure whether the industry is required to give all of them or some of these.

It would be a relief if at least the process of taking over land is smooth even if cost is high.

Published on September 27, 2011
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