‘Stock selection is more challenging than last year’

Not one to get carried away by bull markets, Vetri Subramaniam, Chief Investment Officer of Religare Mutual Fund, has always struck a cautious note on Indian markets.

In a conversation with Business Line, he talks about the view on the markets as a whole and explains what was behind his funds’ performance this year.

Valuations of the small and mid-cap indices today match or exceed that of the Nifty. Do you see a risk of correction?

I think from the valuation perspective, the index itself is trading slightly below long term averages. On a trailing basis, we see that mid-caps are slightly cheaper than large caps. Therefore valuations aren’t giving very strong signals either way. The risk to the market comes not from valuations, but from the question of how long this phase of low earnings growth will persist.

Last year, we saw only single-digit growth in earnings. We now expect that this will pick up in FY14. The question is, what if doesn’t? What happens if the economy continues to grow only at 6 per cent? More than a year or two of single-digit growth will mean that long-term averages may not hold.

What is your current view on rate-sensitive stocks that have gained in this rally?

We can look at this theme in terms of two areas — financials and cyclicals. Wholesale funded institutions and banks with weaker liability structure will benefit from any declining yields in the short term.

But for the medium term, our preference stays with institutions that have better asset quality and liability franchise. Our view on the financials space is that, asset quality concerns have not fully dissipated.

We don’t yet know what will happen to the large infrastructure exposures of banks, for instance. The focus so far has only been on non-performing loans to small and medium businesses and certain high profile restructurings. A significantly large number of infrastructure projects are likely to experience stress in repayments.

In cyclicals, our preference is for Industrials that can survive and grow over the long term. Our preference is for consumer facing cyclical businesses — they may benefit more from the rates rolling down.

Most consumer facing businesses seem to be trading at high valuations. Where are the opportunities?

Consumer staples are at high valuations — but we have been able to focus on areas such as automobiles and consumer durables, where valuations are reasonable. The other opportunity is in de-leveraging. There are companies seriously going about the task of de-leveraging and if interest rates come down, they would get a double benefit. Such opportunities exist across sectors and would be a better theme to play lower interest rates.

Your large-cap funds, Religare Equity and Religare Growth, have not been in the top quartile in the mutual fund rankings in the past one year. Can you tell us why?

If you break up their performance, you will find that we have been underweight on financials, which was one of the strong movers of the year. Within the sector, we have been more focussed on companies with good asset quality and a strong liability franchise — and these have been the best performers in the sector. But in the last 12 months, institutions which have a weaker liability franchise have done well due to expectations of interest rates easing and hence we were hurt by the aggregate underweight position in the sector.

Another factor is that FMCG stocks have been doing well in the markets. But we have been continuously reducing exposures to these stocks over the past 12 months on valuation concerns. If you see, a big chunk of the underperformance came in the first quarter of the year when markets moved very violently. Thereafter, we have more or less kept pace.

How has this rally been different from that in 2009?

Corporate behaviour has changed since then. Then companies had not woken up to the challenge of de-leveraging and were in growth mode. Now, companies have woken up to this necessity. That’s why you see many companies selling parts of their businesses or even controlling stakes, to protect the value of the franchise.

What is your view on commodity company stocks, given their low valuations?

Our view on the global economy is quite muted. So from that perspective, we are not particularly positive on commodity stocks. We tend to look at commodity stocks from the point of view of valuations. Whenever we are able to see valuations that are low in relation to book value, we would buy those commodity stocks. We are not overweight on this area.

How are you repositioning the portfolios of your mid and small cap funds after the recent rally?

Some of the small and mid-cap stocks have done very well in the past year but not in 2010-11. Most of these companies tend to be quite capital hungry and do not do well during a rate hike cycle. At that time, mid-cap performance deteriorated very strongly.

The out-performance this year too seems to be on the expectation that rates will decline and these pressures will abate. But having said that, the way we run our small and mid-cap portfolios, is with a growth bias. We have increased exposure to financials which has helped performance.

What is the outlook for the markets?

Valuations at the start of 2012 were 15-16 per cent cheaper than the long term average. That was reason enough to ignore the macros and make a strong case for investing in stocks on bottom-up considerations. Not that we ever expected the markets to do as well as they eventually did in 2012. But today, after a 30 per cent gain in markets the benefit of a big discount to average valuations does not exist.

Stock selection has become difficult because you are being asked to pay for expectations of a recovery. In our opinion, this year is more challenging for investors because the outlook remains challenging, but valuations are higher. That said valuations are still in line with long term averages and are not yet in expensive territory.

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