MUTUAL FUNDS

In the medium to long term, the Indian equity market will be primarily swayed by the trajectory of earnings growth<
08-Dec-16   16:41 Hrs IST

Mr. KarthikrajLakshmanan
In an interview with Anjali Raulgaonkar from Capital Market Publishers, KarthikrajLakshmanan, Co-Fund Manager, BNP Paribas Mutual Fundsaid, Demonetization would pave the way for GST implementation next year and help in financial inclusion. Hence, while the short-term disruption is likely, we believe the long-term potential benefits of the move outweigh.

Excerpts:

1. What will the key driving factors for markets going ahead? How are your funds positioned in the current market conditions?

The key driving factors over the next one year for the domestic economy will include:

  1. Stable Inflation
  2. Low Interest rate regime
  3. Implementation of multiple reforms i.e. Demonetization, GST, etc., to aid shift from unorganized to organized

We believe this government has a long term approach towards strengthening and resolving domestic variables. Union Budget to be presented in Feb 2017 will be another key milestone to watch. In past Union budgets, government has mentioned about its intent to focus on infrastructure spending lead economic recovery, predictable and low corporate tax regime & balance focus between rural and urban population.

While we all expect interest rates to decline, it will be interesting to see the pace and timing of the same. The likely slowdown of the growth engine in the aftermath of demonization can force RBI's hands and we could see a 50 bps cut sooner rather than later. We expect 50 bps rate cut by March 2017.

We believe, BFSI sector is likely to be one of the biggest beneficiary of economic recovery, lower interest rates & stronger credit growth.  We are overweight on private banks, which have shown a good track record for profitably gaining market share, have a good mix of retail and corporate loans, and are well capitalized. We are positive on select PSU banks.

Among retail asset financing NBFCs and Housing Finance companies, the high valuations that prevailed earlier have corrected post demonetization and look more attractive. In the short term, there may be some increase in loan slippages but may not end up in significant higher credit costs. Once the new currency notes circulation becomes adequate in coming months, the collections should normalise for these companies. There may be a few months of lower growth for them. However, the structural story remains intact.

Another sector that we are positive on from a 2-3 year perspective is cement. Here some of the large and efficient players continue to add capacity. Demand is expected to improve over this period, while supply will be more restricted.

We are underweight information technology sector. Besides, we are also underweight on Auto, Oil & gas and Consumer non-durables.

2. Has the change in government proved beneficial to economy so far? How?

The government has taken various reform measures in last couple of years which include Jan Dhan accounts for financial inclusion and facilitation of direct benefits transfer, crop insurance, low-cost housing scheme, improvement in ease of doing business, passage of bankruptcy code, encouraged competitive federalism amongst states,  Goods & services tax bill and Demonetization of high value currency recently. Of these, Goods & services tax is one of the most important measures with long term structural positive potential to bring the informal sector into the tax ambit, increase tax buoyancy and eventually reduce tax rates. We believe demonetization would pave the way for implementation of GST as it leads the economy to move towards cashless transactions.

3. How do you perceive the government's demonetization move? What are negative and positive implications?

Government's move to demonetize higher denomination currency and replace with new notes would have a positive impact on Indian economy on a structural basis. While In the short term, the consumption sector might get impacted due to high cash usage, property prices may see correction and overall economy would miss out on some regular business leading to lower GDP and earnings growth for FY17, the longer-term positives will be many, in our view, if the new currency is rolled out to a sufficient level in next month or so to ease the cash crunch being witnessed currently. In the process of demonetization, we believe some portion of the demonetized currencies deposited with banks may stay in the form of CASA (Low cost) deposits which will add to their topline (Net Interest Income). We believe the deposit accretion due to this move could lead to further lower interest rates in coming months. Out of the total high value currency, the amount that does not come back to the banking system will be extinguished and would be a surplus for the government. Besides, some of the unaccounted income might get reported leading to better tax revenues this year. The move to focus on bringing more people under the tax net would lead to better tax buoyancy and provide room to lower tax rates in the medium to Long term. Also, this would help the formal industry as it gains share. Demonetization would pave the way for GST implementation next year and help in financial inclusion. Hence, while the short-term disruption is likely, we believe the long-term potential benefits of the move outweigh.

4. What are the essential traits for the stocks to be in your portfolio?

At BNP, we follow the investment philosophy known as BMV (Business- management- Valuation). As per our philosophy, we analyze the business of the company for secular trends, uniqueness of business model and other advantages like strong brands, low cost production advantage, license in a regulated business, network effect, etc which provide sustainability and higher visibility to the company's earnings. we also evaluate the management's execution capability and corporate governance. Besides, clearly being growth focused, we buy companies with higher earnings growth at reasonable valuations.

5. How are the market positioned to face global clues?  Share your views on global economies and their impact on India?

The global equity market are expected to be influenced by certain developments going forward. These would include the performance of the Trump administration, the likely hike in interest rates by the US Federal Reserve and the developing political scenario in Europe.

Overall developed market economies i.e. Europe, USA and Japan will continue to exhibit low growth. In the USA, if President Trump follows up on his campaign promises, we could see a fresh round of investment in the country's infrastructure, lower individual and corporate tax rates and increased trade protectionism. This has the potential to lift US economic growth prospects some time down the line. The probability of a Fed rate hike in December has gone up substantially and has led to the US dollar strengthening. As a result, most emerging market currencies are correcting. Another interesting development to watch out for is the developing political climate in the EU.

While global cues are always important to gauge the direction of foreign fund flows, in the medium to long term, the Indian equity market will be primarily swayed by the trajectory of earnings growth. 

6. Is India still an attractive investment destination?

Barring the short term impact of demonetization on growth and the emerging market sell-off since US Presidential elections, we believe India offers a good growth opportunity as most of the macro-variables are moving in the positive direction, local currency has been stable in last few years, reform measures are likely to contribute positively and State governments' increasingly focus on development as a way to get re-elected . India continues to be amongst the fastest growing economies globally with favorable demographics in terms of median age & working age population. India is relatively less dependent on external trade compared to other emerging markets.

7.Which sectors you are considering attractive from investment point of view and why and which sectors you are avoiding and why? What kind of stocks never enters your portfolio? 

We are overweight on the banking and financial services space. In the case of banks, as their CASA ratio improves, interest rates will go down. People will come into the formal banking system from cash system leading to higher growth. And as some of the cash economy people develop a banking track record, it will be easier for them to get funding from the organised sector. This will give a fillip to retail sector lending.

We are overweight on private banks, which have shown a good track record for profitably gaining market share, have a good mix of retail and corporate loans, and are well capitalised.We are positive on select PSU banks. 

Among retail asset financing NBFCs and Housing Finance companies, the high valuations that prevailed earlier have corrected post demonetization and look more attractive. In the short term, there may be some increase in loan slippages but may not end up in significant higher credit costs. Once the new currency notes circulation becomes adequate in coming months, the collections should normalise for these companies. There may be a few months of lower growth for them. However, the structural story remains intact.

Another sector that we are positive on from a 2-3 year perspective is cement. Here some of the large and efficient players continue to add capacity. Demand is expected to improve over this period, while supply will be more restricted.

We are underweight on information technology. These are good companies, with good management and good return ratios. However the growth outlook is muted for the next couple of years. We follow a BMV framework: business, management, and valuations. And in business we look for growth focused businesses. Where growth is lacking, we tend to avoid those sectors. That is why we are underweight on IT at present, where the visibility for growth is limited.

Besides, we are also underweight on Auto, Oil & gas and Consumer non-durables.

8. Donald Trump's victory and impact on India, how you will explain it?

Indian Information technology (IT) sector is significantly dependent on the United States. While US election results add to mid-term uncertainty on IT spending into FY18, FY17 guidance remains unchanged for most Indian IT services companies.

Based on President Donald Trump's views during his campaign, it is believed that his policy will be expansionary, focus on infrastructure spending, lower taxes and He may also go in for a policy of trade protectionism. The probability of a Fed rate hike in December has gone up substantially and has led to the US dollar strengthening. The dollar index is at a multi-year high. Most emerging market currencies are correcting. While the Indian rupee has been steady for the past couple of years, it has participated in the recent correction as there have been FII outflows.

India has also been impacted by the broad emerging market sell-off. Trade protectionism may affect India less on a relative basis to other emerging markets because of lower direct trade exposure to the US and it is also more of a domestic consumption focused economy. Besides, India's macro-economic situation is much better today than it was in 2013.

9. Has the inflation started to fall again? What will be the RBI's move in coming policy amidst global and domestic events?

Headline CPI inflation has been moderating for last few months and the latest reading was lower at 4.2% for October 2016 led by lower food & fuel prices. However core inflation has hovered around 5%. With demonetization impacting demand too, CPI inflation may be lower and may be around 5% levels by the end of the financial year. We believe the RBI may cut interest rates by 50 bps till March 2017 in order to boost growth especially post the short term disruption caused by demonetization.

10.How often do you re-balance your equity allocation?

We do not actively take cash calls. If Business fundamentals of any company deteriorates we sell it and invest in other ideas that fit in our philosophy.

11. Kindly share your investment strategy with us. Are you making any changes to your scheme's portfolio as we witness change in market?

Our investment style is to buy companies with a long term investment horizon, which is reflected in our bias towards B2C companies and structural themes like consumption / retail financials in India.

As highlighted above, we are overweight Financials and Cement while we are underweight Information Technology, Oil & Gas, Auto and Consumer non-durables.

12. What would you like to advice to the investors in the current scenario? What strategy would you suggest the investor to adopt at this point of time in the market?

Given the lower interest rate scenario, likely movement of some savings from physical to financial assets due to demonetization and higher earnings growth visibility in the medium term, prospects for equities as an asset class looks positive from a 3 year perspective and hence we believe long term investors have good opportunity to make healthy returns by staying invested in the same.

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