IV Subramaniam is Managing Director and CIO of Quantum Advisors, which manages one of India’s largest portfolio management schemes and advises foreign investors, apart from being the sponsor of Quantum Mutual Fund. Business Line caught up with him for a conversation on the market outlook.
Is value investing making a comeback?
Value investing is practised across market cycles, but opportunities for it either expand or collapse depending on market conditions. The opportunities in the last few years had started shrinking, because everything was looking more and more expensive, whether you looked at price to book value, price to earnings or asset values. But in the last two months, the value investing universe has expanded quite a bit. It started with financial space, and now we find it percolating to other sectors as well. This is not surprising. Earnings growth in India was very poor in the last few years, barring specific stocks. With no earnings growth and money flows coming in, valuation multiples expanded. There was no justification for that. Now, suddenly the micros are improving in terms of demand parameters, but the macros are troubling. As a value investor, our job has been always to look at the micros – companies and earnings. So, we are finding more opportunities today.
For the last seven years, earnings growth has been tepid and stock prices have been driven by a PE re-rating. What’s the outlook now?
Let us see the reasons for flattish earnings growth. We had a massive capacity expansion in the previous cycle which peaked out in 2011-12. Then you had demand coming down due to the GDP slowdown. So, you had companies with excess capacities, facing high depreciation costs, interest costs, while sales were slowing, leading to flattish earnings. India was on a natural recovery path from that cycle, by the first half of FY17. Then demonetization happened and slowed down earnings. By the time we started recovering from it, there was GST implementation.
However, now we do see prospects of a recovery. Demand appears to be picking up, Commercial vehicles are doing well, logistics movement is picking up and the sales numbers of many companies are strong. If capacity utilization improves, depreciation costs will be manageable and improve return on equity and earnings growth. For banks, by and large the bad loan write-off process seems to be peaking. I think that the new capex cycle is still slow because of the upcoming elections. People will wait till March-April to form an opinion about government formation.
How do you expect the election outcome to impact markets?
Historically, from the economy’s perspective, it hasn't mattered who forms the government in India. India has grown at a minimum of 6.5 per cent despite everything. But I guess a section of investors do come to the market based on political factors. In that case, if Mr. Modi does not return, there will be a disappointment. But I don't think there will be any long-term implications. As we have seen in 2004 and 2009, markets swung by 15-16 per cent over a few sessions based on elections, but then they recovered. We should expect similar reactions. This time the elections are coinciding with global liquidity issues, when FPIs are selling. So that is a double whammy.
This year, the bulk of FPI outflows — $8 billion of $12 billion — have gone out the bond markets and not equities. You advise a lot of FPI money, so what is the view on India?
The Indian bond market attracts a lot of short term flows. Until last year, India was the best bond market to own given its high yields. But after the recent currency depreciation, I don’t think a majority of bond investors have made money. India has disappointed the international audience. Factors such as high growth rates haven’t materialised and bond outflows are a reflection of that. But this is more a problem for people who had looked at India from a short-term perspective. We do have clients who are still looking at India with a 30 or 40-year perspective. They are not disappointed. We do tell them that you cannot expect India to deliver 8 or 9 per cent like China. It will grow at 6.5 per cent consistently. If that is their expectation, then they aren’t disappointed. They are willing to wait it out.
Some of the recent events have been quite disturbing like the IL&FS crisis and the governance issues at many listed companies. How are FPIs responding to that? And how do you prepare for such sudden governance risks as a fund manager?
As fund managers, we do prepare FPIs for the fact that the growth story in India comes with some risks. We tell them that there are managements here who don’t treat minority shareholders well. There are contractual terms here which are one-sided. There are projects where the fund-structures are not good. IL&FS is one company which has depicted all that could go wrong with infrastructure. It is getting attention because of its size, but there have been similar issues with smaller companies before. So, we do advice that investors new to India understand it well before increasing allocations.
From a fund perspective, I think it is critical to build institutional memory about investment mistakes over market cycles. Without any records, fund managers will keep changing and a new guy will make the same mistakes as the earlier one did in the previous cycle. At Quantum we’ve had a stable team. But we do keep writing a lot about what we did in 2006-07 with our portfolios, why we did it, so that the next fund managers would have that perspective. We have a good record of our investment thesis, what we learnt, why we bought a stock, why we sold it. We review last year's decisions – the hits and misses. We need that. Otherwise, lack of institutional memory is a big problem.
Do you think investors who come into equity funds in bull markets really understand the variability behind that 12-15 per cent return that they’re shown?
Not really. You see one can show pretty much any kind of track record by cherry-picking data on the start dates and end dates. So MFs typically showcase their trailing returns for 6 months, 1 year, 5 years and since inception. But if you look at a fund’s calendar-year returns, that often tells you if the trailing return is a fluke or not. The trailing returns can be influenced by just two years where the fund has taken on a lot of risk. At Quantum, we have adopted a global standard for displaying fund performances.
Are investors stopping SIPs in this market correction?
At Quantum we have not seen much churn. Our SIPs have been steady. The average inflow of our new investor today is, I think, higher than the earlier cycles. They have been investing regularly but not in larger numbers. In these two months, our liquid fund has gained traction because we invest only in government paper. Across the MF industry, the average holding period is 1 year, but at Quantum, our average holding period is close to 3 years.