Invest cautiously through dynamic asset allocation
Lokeshwarri S K
There are no pockets of cheap valuation. The only segments where there is some value at this juncture are technology and software, pharmaceuticals and PSU banks. If we look at each of these sectors, in technology, growth has slowed down.
Stocks in this sector have priced-in this slowdown, but if there is an acceleration of growth or a sharp rupee depreciation, stocks can rally.
Pharma stocks have specific issues with regulators; when the issues get resolved, you can get good returns. But there is uncertainty regarding the timing of this resolution. In PSU banks, the NPA issue is continuing. Whenever this issue is put behind, there can be good upside. Aside from these three areas, there are no pockets of cheap valuation at this point in time.
So are you saying that investors can start buying these contrarian bets now?
Our view is that you should slowly start increasing your allocation to these contrarian bets. For instance, in the pharmaceutical segment, it is impossible to pinpoint the time when the FDA issues will get resolved. You can take a position now, provided you have the patience to wait.
As far as the IT sector is concerned, we have had four years of rupee appreciation now. Rupee was at 66 against the dollar in August 2013, it’s at 65 now. So the possibility of rupee depreciating is higher now. Even if growth does not pick-up, rupee can depreciate and when this happens, the sector can do better. But reversal in growth rates does not appear likely as of now.
Of the three, we are most convinced about pharma.
With Sensex trading at a trailing PE multiple at 23 and one-year forward multiple of almost 20, what’s your view on the market? Is the rally getting overdone?
At the top of the market cycle, you need to have earnings growth, credit growth, capex happening, irrational ways of valuing stocks and you’ll have theme funds collecting money. This combination has not yet been reached.
In my view there are four stages in a market cycle — the best phase to invest, boom, bubble and burst. The best time to invest is over and we are now in boom. From boom we will go to bubble and then to burst. Unless some unknown happens that we do not know about, the rally will continue.
But this will be a liquidity-driven boom, not justified by any rational valuation model. Fundamental analysts will be cautious from here on. It’s the technical analysts who have to call the top for this liquidity boom.
What can bring an end to this liquidity-driven boom?
There can be a correction in the short term because many in the market think that the rally over the last two weeks is due to P-Note unwinding. But I believe this is a large bull market driven by liquidity.
It has to be some unknown event that brings this rally to an end. Events such as Janet Yellen slowly turning cautious or Draghi slowly pulling out stimulus, etc, will not cause a fall.
But once a big fall happens, money will stop coming. That’s because, in the second half of the boom, people who are not supposed to be taking a risk will start putting money into the market. This is already beginning to happen.
The current boom phase is similar to the 1994-95 boom that was pretty huge, too. What I keep telling people is that you have to be rational, you have to believe in asset allocation and you have to invest in cautious products from now on. Even if this boom goes on for a couple of years more, investors should follow these rules. They should invest cautiously in equity through dynamic asset allocation funds.
* * * * *
Migrate from mid-cap to large-cap funds
Parvatha Vardhini C
“Global markets such the US and Japan are trading at peak valuations. Thus while Indian large-caps are relatively better, they can still be impacted by a global sell-off,” says Anup Maheshwari , EVP and Head – Equities and Corporate Strategy at DSP BlackRock Investment Managers.
Is the stock market in bubble territory?
There are some parts that are clearly overvalued and some parts that are still reasonably valued. We are concerned about the lower end of the market cap chain where we see a lot of strong price performance and higher valuations. These businesses will eventually go through a cycle. So it is the small-cap space that we feel is in bubble territory.
If your starting point of investment is a very high forward multiple, then the chances of making above-average return over, say, three years or five years, is unlikely. You could make returns if things continue and there is no disruption, but you are unlikely to make anything close to what you made in the last three years. That is one of the reasons we shut down the DSPBR Micro Cap fund because when looked into the portfolio, the ROE (Return on Equity) and earnings growth characteristics had not changed. But the stocks had moved from a valuation of about 1.5 times price to book value (PBV) to about 7. Starting at this level of price to book, you will not be able to make huge returns; you will also be exposing yourself to risk.
Are mid-cap and large-cap stocks relatively better bets?
Across the entire chain of midcaps — the good, bad and the ugly — there has been a re-rating. So, as a category, they are overvalued. Large-caps are not cheap in absolute terms but relatively, they look better. The risk to larger-caps is more external . One thing that bothers us is that a lot of developed markets are at peak valuations right now. The market cap to GDP in the US is at 145 per cent and it was exactly this number in 2007. Ditto with Japan. We are still at 90 per cent. This is why we get the feeling that we are comfortable with large-caps.
But if globally there is a correction, it will have some effect on large-caps too. Assuming that globally markets stay sensible, then at an index level at least, we are comfortable.
So, are you following a bottom-up approach right now?
We are bottom-up with an obvious bias for companies that will not implode in the next five years. We have to walk into these names well aware that we are overpaying for them by a year or two; but we know that the business will deliver growth over a five-year period and towards the end of it, we will be better off with it than what we are today.
What we have to be super careful about is where we are paying a high valuation even as the business could be going through a down-cycle somewhere. This way, you could lose both on earnings and on the cyclical PE valuation.
What is your advice to investors?
We are telling people to migrate upwards from mid-caps to large-cap oriented funds. We are not turning people off from the asset class. It should be exited only when valuations reaches an extreme.
On a forward basis, the PBV is 2.6 times now. Throughout our history, it has been somewhere between 2 and 3 mostly.
So I think we are not awry on a PBV basis, especially at a time where earnings are going to pick-up, ROE is likely to rise and interest rates likely to fall.
They can stay invested in equities if they have a long-term perspective and can tolerate a 30 per cent erosion in value in twelve months — which could happen, as per our historical volatility analysis of the markets.
* * * * *
Lower your returns expectations
Dhuraivel Gunasekaran
Mahesh Patil , Co-CIO, Aditya Birla Sun Life AMC , says that investors can bet on private banks, NBFCs, consumer durables, metals, oil & gas
With the markets scaling new highs but corporate earnings yet to catch up, how comfortable are you with the current valuations? Do you think the market is overheated or see more upside?
The question itself has the answer in it. One of the most widely used valuation metrics is the P/E ratio, which looks high as the denominator (earnings) is low.
The last few years have been muted in terms of earnings and we believe that FY18 could see the rebound. This is at the back of stable global macro leading to stable metal prices, decreasing provisioning from corporate lenders due to steps taken by the RBI and, most importantly, the revival in the economy.
The revival is at the back of rural recovery, good rainfall and interest rate transmission. When one considers other metrics like P/B, P/S, Dividend Yield, Market capitalisation to GDP ratio, these are all near the long-term average.
Mid and small-cap stocks have had an excellent run for some time now. Do you think the party is over?
India is a growing economy and hence having a strategic allocation is recommended. If you take the mid- and small-cap indices, they trade at 30-32x in terms of trailing P/E ratio.
However, removing the loss-making companies, the ratio falls to 22x, which is in line with large-cap index. So, the headline numbers do not reflect the true picture. It is true that the run-up in mid-cap and small-cap stocks calls for caution and moderate allocation is recommended. This allocation has to be stock-specific.
The recent rally has been led by cyclicals, banks in particular. Do you think there is more to go?
Cyclicals, which have underperformed until a few months back, have picked up in terms of stock price performance. The recovery is not broad-based but in pockets.
The government capex is also more in certain sectors (roads, railways, etc.) compared to history, and other sectors. There are opportunities that have scale to achieve and available at reasonable valuations.
Due to the RBI’s focus on identifying stressed accounts, PSU banks and corporate private lenders have done well. Among financials, we are focusing on private banks, NBFCs and select corporate private lenders.
Which sectors would you be overweight/underweight on?
Apart from financials and industrials, we are overweight on the consumer durables.
We are also overweight on metals due to favourable supply-demand equation due to supply rationalisation by China and the rest of the world. Oil & Gas also looks good.
We also like automobiles, especially passenger vehicles. We are under-weight in telecom, apart from IT and pharma.
What would you advise investors at this juncture?
Investors should revisit and rebalance their portfolios to their strategic levels in their asset allocation plan. The recent performance of the equity markets has been spectacular. In light of this, investors should bring down their expectations of returns in the near term. The premise of India being a good investment destination to deliver double-digit returns (lower teens) remains. India has strong macro fundamentals. Corporate earnings could rebound this year.
The global macro picture is also looking up in terms of data points, with central bankers resisting the temptation to unwind the monetary easing. Possibility of more rate cuts, good rainfall, rural revival, etc., augur well for the equity markets.
* * * * *
Exercise caution in new listings, mid & small caps
Anand Kalyanaraman
Rajeev Thakkar , Chief Investment Officer, PPFAS Mutual Fund, says that valuations have run up. Edited excepts from an interview:
With the bull market raging on, are you comfortable with valuations? Do you expect the rally to continue or foresee a correction?
Valuations are clearly ruling at above average levels. The numbers tell the story. The one-year return in the Nifty 50 is 14.88 per cent and its price-to-earnings (P/E) ratio is 24.23.
For the Nifty Midcap 150, the one-year return is 29.26 per cent and P/E ratio is 39.86, while the Nifty Midsmallcap 400 sports a one-year return of 29.74 per cent and P/E of 50.97.
In fact, some mid-cap/small-cap indices such as S&P BSE Small cap index are showing valuations as high as 76 P/E.
Broadly, the valuation excesses seem to be more in the mid- and small-cap space and in select areas such as new listings, NBFCs and so on.
The stock price momentum is clearly upwards and it is difficult to say if and when the price correction will happen. There could be another scenario where the price rise takes a breather and earnings catch up.
What is the asset allocation strategy now in Parag Parikh Long Term Value Fund?
With a multi-cap and multi-geography approach, we are working to deploy funds in attractive opportunities across sectors and market capitalisation.
Given the excessive valuations in the small- and mid-cap space, we are finding it difficult to find new opportunities there. Our cash holdings and arbitrage positions have increased.
From 10.17 per cent in June 2016, it is about 17 per cent of the portfolio as of June 2017. This is not a market timing or a strategic call.
We are working to deploy the funds as and when individual opportunities are available.
How has been the performance of your foreign portfolio (nearly a quarter of the portfolio) vis-a-vis the Indian one? Have you upped allocation to foreign stocks?
Broadly, the performance of overseas stocks has been satisfactory in rupee terms except for the last 12 months where it has lagged the Indian indices to some extent. Even US indices are hitting record highs. The focus remains on individual stock selection rather than making market calls.
Our allocation to overseas stocks is more or less steady. Currently, our allocation to foreign stocks is 26.18 per cent versus 28.31 per cent in June 2016. Valuation of foreign stocks (net of cash balances) seems undervalued compared to comparable quality Indian stocks.
We remain excited by the bottom-up stock picks that we make or continue to hold.
While an increase in allocation is not ruled out, it will be subject to a maximum of 35 per cent of the portfolio.
Which stocks and sectors are you now betting on? Which ones are you avoiding?
The last additions over a few months were Dr Reddy's Labs, Bajaj Holdings and Investment and Apple Inc. The last sale was in MT Educare.
* * * * *
Dynamic duration funds are more suitable now
Radhika Merwin
Rahul Goswami , CIO-Fixed Income, ICICI Prudential AMC, says that he expects the RBI to move towards an easier monetary policy stance
In the previous June policy, majority of the members of the MPC had voted in favour of holding rates, citing uncertainty over the sustainability of the April inflation as one of the reasons. With May and June, recording consistent fall in inflation, what could be its rate action in the upcoming policy?
The RBI’s change in policy stance from accommodative to neutral clearly indicated that the central bank is cautious on inflation and is likely to maintain a cautious monetary policy stance till it gets room for further easing monetary policy.
With inflation on a downward trajectory, we expect the RBI to move towards an easier monetary policy stance, which is likely to happen at least by end of the second quarter of FY18.
With the regulator tightening the noose around credit rating agencies and recent downgrades impacting a few debt funds, how would you play the accrual theme? How would you manage the credit risk?
We believe performance is a function of risk. As a result, when it comes to investing in corporate bond funds, it is important to manage three key risks — credit risk, liquidity risk and interest rate risk.
When it comes to managing credit risk, at IPAMC, we have a structured process of asset selection exercise. We consciously avoid concentration risk by putting in place investment limits coupled with tenure restrictions in case of each issuer.
What is the duration you are maintaining on your long term gilt funds? Do you see more upside?
As on June 30, 2017, the modified duration maintained in long term gilt fund is 11 years.
We believe there is room for further moderation in yields.
What type of debt funds should investors choose now in the current market, as bond yields have gone down by 50 basis points in recent months?
Given the evolving market conditions and economic scenarios, dynamic duration funds are more suitable on a risk-reward basis.