Value investing will work in all markets. But investors cannot buy junk stocks and expect them to pay off. One has to assess the big picture and decide where to invest, says S Naren, Executive Director and Chief Investment Officer at ICICI Prudential Asset Management Company, who is known to be a die-hard contrarian and value investor. He believes that over the next two years, it will likely be the non-consumer led industries that will do well. Excerpts:

Markets usually run up, hoping that profits will catch up later. Are we in a similar situation where most positives are priced in? Is there scope for markets to rally further?

There are both domestic and global factors aiding the current rally. From a global perspective, the zero interest rate regime followed by many central banks has pushed money into all other markets, elevating asset prices. So, if the US interest rate were to head higher than 2 per cent, then there is scope for a global correction. The risks of a downside are higher today because, post Brexit, investors believe that interest rates will remain lower for a longer time than expected.

From a domestic perspective, we believe that the economic cycle will improve over the next two years. Capacity utilisation will improve across sectors in the next two years and so will earnings. Hence, one should invest before the earnings cycle improves. Take, for instance, the recent uptick in the commercial vehicle and sugar segments. Investors who bought into these stocks after the recovery played out have clearly missed the bus. So one has to buy ahead of the economic cycle.

We don’t see any evidence of euphoria or panic at this point in time. As long as there are no surprises on the global front, investors can make decent returns over the next two to three years, driven by domestic factors.

Which themes are you betting on?

The market is a big believer in consumer-related themes and these stocks are expensive at this juncture. We have had a long cycle of consumption-based investments doing well.

But we believe that stocks outside of consumer-based themes are reasonably valued. And over the next two years, it will likely be the non-consumer led industries that will do well.

But everyone is betting on a consumer driven rally…..

The quality of business in the consumer space is good. And hence it becomes very difficult to gauge how long these high-quality businesses will command premium valuations. Even though we are underweight consumer, it is difficult to say with certainty that these stocks will not sustain high valuations. We are only avoiding sectors with steep valuations.

You’ve always been a believer in value-based investing. But in the last two years, markets have rewarded stability and earnings visibility. Would you still bet on value stocks in this market?

I believe value investing will work in all markets. As Seth Klarman says, “Value Investing is at its core the marriage of a contrarian streak and a calculator.” Investors cannot buy junk stocks that are available cheap and expect them to pay off. One has to assess the big picture and decide where to invest.

For instance, in August last year, there was panic in metal stocks. But these stocks have delivered well in the last one year. On the other hand, if one had bet on leveraged infrastructure stocks, one would be sitting on losses. In the current market too, one has to decide which themes to bet on.

We are betting on telecom right now, a sector many are sceptical about. The market has been worried about this space for a long time due to the threat of new entrants. But over the next three years, the leading players should do well. On the other hand, there are other segments such as IT where we believe that there is still some pain, going ahead. When the market was bearish on pharma stocks, we bought into some of them post correction, which played out well.

Hence, while there are value traps in the market, you can avoid most of them if you have done your ground work on macro factors.

What are your views on the banking sector? Most of your funds only have private banks in their portfolio, barring SBI. Aren’t PSU banks, trading cheap, good value bets?

We may be at the bottom of the NPA cycle but state-owned banks will have to work towards improving their competitive strength. Also, they have to invest further in technology. There is a lot of work to be done in the non-SBI public sector banks. The government, being the largest shareholder, has to create an environment that improves their competitive position.

What about other troubled sectors such as power…….

We have been bullish on power over the last one to two years. Within the funds I manage, the most overweight sector has been power utilities over the last two years. Currently the plant load factor (PLF) is 65 per cent, which we believe will improve to about 80 per cent over the next three years, without adding any new capacity. Hence this will lead to operating leverage. Coal production has significantly improved and there is no shortage. Today, swapping of coal allocation is allowed, which has reduced the need to transport coal, leading to lower costs. In fact, we have been bullish on the entire energy pack in the past year — oil, power and metals, to some extent. Commodities have had a good rally thanks to China, which has been the leading driver of commodity prices but understanding the Chinese market is not easy.

What is your view on other asset classes such as real estate and gold?

Over the last three years, both the RBI and the Centre have provided a good fillip to financial savings. Since gold neither delivers dividends nor investment returns, I consider it as a low ROI asset (return on investment). The rental yield in residential property is around 2.5 per cent all over India, which is much lower than the FD rates in the country and hence I treat it as a low ROI asset.

However, over the last three years, the quantum of money invested into financial assets has gone up, compared to traditional avenues like gold and real estate, which is good for the residual economy.

The debate on whether the new GDP number paints a realistic picture of our economic growth has been rife ever since it was introduced a year back. Do you think these numbers are inflated?

Some statistics I would like to bring to notice here is the growth in airline passenger (25 per cent rise in recent times) and petrol demand in India (registered double-digit growth) — something unseen in any other part of the world. Nobody doubts these numbers. So, if one has to look at the positives, there are enough indicators pointing towards growth. What has happened is, in 2007, extra capacities were built in sectors such as power, steel, etc, that have not been used up. In 2012, there was a big real estate bubble in most parts of the country and people mis-allocated money. That bubble is now deflating. Some of the lack of perceived growth is because of overvalued real estate and the problems because of wrong projects being implemented by corporates during 2007-2010.

The negative impact of two consecutive years of bad monsoon has also been felt in parts of rural India.

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