Mutual Funds

‘Headwinds are now becoming tailwinds’

Anand Kalyanaraman Lokeshwarri SK | Updated on February 14, 2019 Published on February 10, 2019

The economy will get a push from the govt, consumption and investment: Kotak AMC MD

Things are falling in line from a macro point of view, says Nilesh Shah, MD, Kotak Asset Management Company, in an interview with BusinessLine. He says valuations have become fair because of corrections. Excerpts:

What’s your view on market valuation at this juncture? Do you see value in any pockets?

There might be value in a few sectors and stocks, but, on an average, the market is fairly priced. In January 2018, the market was at a premium to its 10-year historical price to book. On January 16, 2018, small-caps were at 33 per cent premium and large-caps were at 10 per cent premium. Today, we are just around the historical average.

There has been significant corrections in small- and mid-caps due to which valuations have become fair. From a macro point of view, we think that things are falling in line. Now, oil prices have stabilised, interest rates are coming down, banking liquidity is tight but not significantly, FIIs (foreign institutional investors) are occasional not consistent sellers, IIP (index of industrial production) numbers are improving, inflation is under control...

Urban and rural consumption is largely fine. The investment cycle had been subdued over the past few years. But now, we see green shoots emerging. If earlier, the economy was pushed by government and consumption, now it will get pushed by government, consumption and investment. Earlier, the economy was moving on an upward slope, so even if we were running, it looked as if we were walking. But now we will move on a downward slope, so even if we are walking, it will look as if we are running. Headwinds are now becoming tailwinds.

What does this translate into as far as earnings are concerned as the base is going to be higher, lower inflation will impact revenue and the number of downgrades are also more now?

In one part of the market, earnings growth has been consistent — FMCG, auto, private banks, domestic pharma, NBFCs, etc. In other parts, it has been fluctuating — public sector banks, corporate-focussed private sector banks, telecom, global export-oriented pharma and, once in a while, commodity companies.

We are coming to an end of the NPA write-off cycle for corporate-focussed banks; the RBI report is also pointing towards that. In telecom, there is no sight of the fight coming to an end, but at some point, they will rationalise prices. Also, some global commodity companies may start turning around.

So in FY18, telecom companies, corporate-focussed banks, global-focussed companies reported losses or muted profits. The earnings of these companies will stabilise in FY19 and jump in FY20. So, you will see that what was working against you in earnings due to these sectors will start working in your favour. We will see a massive jump in profitability of public sector banks, corporate-focussed private sector banks, generic pharma companies and, hopefully, telecom companies.

Isn’t the growth in the NBFC sector going to come down?

Undoubtedly. The NBFC sector moved into the space vacated by the public sector banks under the PCA (Preventive Corrective Action) framework. Because there was so much of opportunity to lend, NBFCs expanded crazily. But with high growth came asset-liability constraints. And then the IF&FS credit event created scare in the minds of investors, and those credits started coming under pressure and got accentuated into asset-liability mismatch.

Now, NBFCs are entering into a consolidation phase from an equity point of view — where some of them will raise equity capital, some will raise long-term debt capital and some will slow down their disbursement. This combination will result in consolidation. This phase can last 12-24 months. So, slowdown will happen, but it will still be positive growth.

What is your outlook on interest rates?

From a long-term view, inflation will be averaging 4 per cent with the RBI’s steadfast resolve to control inflation. If inflation is 4 per cent, repo rate will be 4.5 per cent — it can’t be 6-6.5 per cent. And if repo rate is 4.5 cent, the 10-year yield will be 5-5.5 per cent — it can’t be 7.5 per cent. So, the long-term direction of interest rates is on the softening side.

Also, today, the government spends the majority of its tax revenue on interest servicing. That doesn’t leave it with anything to spend on infrastructure or development work. This problem can be solved by lowering the interest rate and increasing tax revenue. From a near-term point of view, the inflationary expectations were way ahead of actual inflation. Now, fortunately, that’s getting sorted out. Globally, interest rates are stabilising. So, there is no pressure on Indian interest rates from a global point of view.

The IL&FS debt default issue showed that the mutual fund industry depends heavily on external agencies’ ratings. What are the steps you take to ensure that your debt investments are safe?

The accidents that have happened in mutual funds’ debt portfolio are by and large far and few between. Unlike bank NPAs, our NPAs are far lower. In a way, that’s an unfair comparison because banks lend at the higher spectrum of credit risk while we lend at the lower spectrum of credit risk. So, it’s apples-to-oranges comparison. That said, our NPAs are far lower compared with any other part of the banking system.

We have achieved this by remaining more liquid as we have open-ended funds, by remaining at the higher end of the credit risk (AAAs and AAs). Third, we also did our independent research on the ratings assigned by various companies. Ratings is the starting point, not the end point.

Based on the ratings assigned, we look at a proposal based on the company’s structure, governance and so on. That’s why, over the last 20-25 years, it has worked out quite well. It’s not that we have an unblemished record, but the blots are few and far between.

Going forward, we will have to tighten our processes even further. But we also need support from the environment. Now, the IBC (Insolvency and Bankruptcy Code) and NCLT (National Company Law Tribunal) has given tremendous powers to lenders. The results of these laws should also be visible on the ground — this is were the challenges lie. But if we overcome these challenges, we see the credit market developing and mutual funds playing an important role.

But liquid funds also had exposure to IL&FS paper. Doesn’t it reflect on some kind of failure on the part of MFs?

Out of the ₹90,000 crore of IL&FS, ₹6,000 crore is with mutual funds, and ₹84,000 crore is with a host of other entities. Yes, we should have predicted the IL&FS failure. But please remember that out of the 44 mutual funds, only a handful had exposure to IL&FS. In some parts of the MF industry, the credit process worked and in some parts, it didn’t.

More importantly, IL&FS was a call on the market promoters not allowing the company to fail. There were active talks on recapitalisation of IL&FS and that is where IndusInd Bank gave ₹3,000 crore of bridge loan. So, somewhere people took a call of faith that with this kind of market recapitalisation and the kind of promoters, IL&FS would survive. It didn’t work, but now it has made everyone else wiser.

Now, in such kind of cases where we have to take a call in promoters, we will insist upon something in writing. So, I think every failure is an experience to ensure that you don’t repeat it in the future.

What is your outlook on oil prices in the near and long term? Prices had reduced, but they are again increasing now, due to which the rupee is again weakening.

In the long term, if India, China and Japan play their cards well, oil prices can remain subdued for a long period of time. Today, OPEC (Organization of the Petroleum Exporting Countries) is able to curtail supply by taking a call that the future price of oil is going to be higher — ‘so, let us not dig out all the oil and put it into the market’.

If I can give the impression in their mind that 15-20 years down the line, oil prices will be much lower than what it is today — so it’s better for you to dig oil right now and provide it, rather than later on — they will start producing more oil, stop curtailing supply and that will result in more supply and less demand, and prices will be softer.

So, how do I convince OPEC and non-OPEC oil producers that the future of oil prices is so low that it makes sense for them to produce right now. I can do it by showing my reliance on or development of solar power, hydro power, wind power, nuclear energy. If I can bring down India’s energy import dependency from 90 per cent to 60 per cent, I can be reasonably sure that oil prices will be softer because we are among the top three importers of oil in the world.

So, in the long term, how we play our cards will actually determine the price of oil because we are among the largest buyers of oil in the world. If we can form an OPEC equivalent union with Japan and China, we can dictate terms by cutting demand. They (OPEC) can cut supply, we can cut demand and there will be equilibrium. In the near term, we think oil prices will stabilise between $60 and $70 a barrel. It won’t fall much because OPEC is cutting supply.

What is your outlook on the rupee?

The rupee should continue to depreciate depending on our inflation differential. Our inflation will be around 4 per cent on a sustainable basis, while global inflation will be 1.5 per cent. So compared with my trade partners, I should depreciate 2.5 per cent every year. Right now, the rupee is around its fair value. Here onwards, it’s depreciation should be 2.5-3 per cent a year. Now, whether we depreciate 3 per cent a year or 15 per cent in five years... who knows? That is the biggest challenge for the rupee — we normally consolidate for a period and suddenly give a spike. That’s why our volatility looks much higher than what it actually is.

If volatility continues, could there be outflows from mutual funds?

In December 2018, there was a large flow into ETFs (exchange-traded funds) and so your normal flows into mutual funds looked lower. The total mutual fund flows were about ₹17,000 crore including ₹10,000 crore into ETFs. But people focussed on pure equity flows, not the total flows.

There is no doubt that there is some amount of slowdown in equity mutual funds. This is primarily driven by the anxiety of investors to wait out. The year 2018 did not given any good returns to investors, so there is some amount of anxiety. Second, there is anxiety among investors about the election scenario. And that’s why we are seeing many investors keeping cash to invest rather than continuing to invest. Our guess is that if there is a correction in the market, flows will come back. They are waiting for the right level to enter the market.

But the good part is that SIP flows have maintained their momentum; ₹8,000-plus crore is coming through SIPs which is quite decent.

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