Mrinal Singh, Deputy Chief Investment Officer- Equity at ICICI Prudential AMC, takes questions about value investing in the Indian markets, the outlook for corporate earnings and the fund house’s popular flagship fund - ICICI Pru Value Discovery.
ICICI Prudential Value Discovery has been a top-performing multi-cap fund. But with its assets at over ₹12,300 crore, is it becoming too big to adhere to the ‘value’ mandate?
The current asset size is a function of the mark-to-market value of the investments made by the fund in the past many years. In fact, as we practise value style through a contrarian philosophy, size isn’t that much of a constraint. We usually tend to bet against the Street both on the buy and sell side in terms of our stock and sector choices for this fund. So, our ability to manage scale is far better in Value Discovery, than funds that try to be with the Street. The entire listed space is a hunting ground for this fund and that helps too. Had this been a mid-cap or theme fund, it would have been very difficult. I am not saying that size will never be a constraint. We would be worried in this fund if the valuations of the market become so expensive that we can no longer find enough value opportunities.
I would say that returns in future may not be as high as in the past. This is just a guess, based on the fact that risk-free rates seem to be trending down over time. Equities have to offer a 300-500 basis point premium to risk-free options. If you remember, in the nineties, bank deposit and bond options used to offer 15-16 per cent returns. Then equity returns were 20 per cent plus. When interest rates fell, equity returns moderated to 15 per cent or so. In future, as the risk-free yields keep changing, equity returns will change. But equities will continue to be the best compounding vehicle for investors, relative to inflation.
Investors believe that value opportunities are to be found mainly in mid- and small-caps. But today, ICICI Pru Value Discovery has over 60 per cent exposure to large-cap stocks.
We no longer see the mouth-watering valuations in mid- or small-cap stocks that we saw in, say, 2013. A good portion of the incremental flows we have received in the last year has been invested in large-caps because that is where we find potential for good risk-adjusted returns. This is not to say that we will never have higher mid-cap or small-cap allocations. In 2013, the space offered many attractive opportunities and we did invest. Today, the Midcap index is at a 20 per cent premium to the large-cap index. Within many sectors, mid-cap stocks are trading at a premium to larger stocks. Therefore, value investors like us have been automatically drifting more towards large-caps. In November to February 2016, the selling that we saw in the markets was large-cap dominated. So, we saw more value opportunities emerge in that space and acquired them.
In the last six years, value strategies have been underperforming growth globally. Will this cycle turn?
I think the reason for these global distortions in the capital markets are the zero interest rates prevailing in many economies. What this has done is change the cost of debt and risk-free rate of return that global investors expect. Today, global investors walking into India are willing to come in for higher certainty and lower returns. For instance, I met someone from Japan recently who said that if they put money in banks they would lose capital. Therefore they are fine with any investment where there is certainty of not losing capital. In the past, we have never seen a world like this, where preservation of capital is the primary objective! But domestic investors tend to look for higher returns. I think the situation can normalise when zero interest rates come to an end, maybe when the US Fed raises rates.
Are you seeing a recovery in earnings from India Inc in the March quarter?
In the last three years we have seen Corporate India cut costs with a vengeance. Even as sales haven’t grown much, savings on costs have helped companies’ margins. Then there are sectors that have benefited from de-leveraging.
But we are yet to get to a situation where we have a strong, demand-led recovery.
For a real improvement in earnings, the revenue trajectory has to look up.
The topline is particularly a problem for export-reliant businesses. But we do see a pick-up in domestic demand and are betting on domestic cyclicals which we see benefiting from this demand.