‘Many investors get excited by just volume growth’

They should also factor in pricing and margin environment, says PPFAS Mutual Fund CIO

In an interview with BusinessLine, Rajeev Thakkar, Chief Investment Officer and Director, PPFAS Mutual Fund, says that while the near-term outlook seems challenging due to a host of factors, the prospects for the Indian economy and market seem bright in the long run. Excerpts:

What could be the likely impact of the election cycle on the market?

Elections are very important in the near- or medium-term. But after a few months, it loses importance. People in the financial markets have probably the worst track record in, firstly, predicting the election outcome, and then forecasting the impact of the outcome on the market. This has been the experience in India as well as worldwide — whether it is the US elections, Brexit, or elections in India in 2004 and 2009.

For India, more than elections, it is macro-factors such as crude oil price, currency movement, deficits and inflation that make a bigger impact. General election is a six to eight-month story.

Earnings growth of corporate India has not been encouraging. The market has been on the back foot the past few months. But are valuations comfortable?

Valuations are obviously better than what they were before the fall, but they are not quite cheap. They remain at average or above-average levels, especially in the case of Indian consumption-related stocks.

On earnings, a lot of people get excited by volume growth or the prospect of volume growth. They don’t completely factor in the competitive intensity, and the pricing and margin environment. Two sectors where we have seen plenty of volume growth in the past are telecom and aviation. But they have not generated returns for investors due to the unfavourable pricing and margin environment.

Also, on earnings growth, the environment is different from a decade ago. The cost of capital has come down and competition has increased. Besides, in a low-inflation environment, nominal growth rate will be lower than before. So, it’s a combination of various factors.

One cannot assume that the past will continue. When real interest rates were high, equity returns in nominal terms were somewhat higher. When overall interest rates, inflation and cost of capital — everything is low, even a 10-12 per cent return in nominal terms is not that bad.

Where are the opportunities now? Which pockets could see more declines?

I think anything to do with the consumption space is somewhat in the overvalued territory. Industrials are looking cheap, given the recent significant corrections. However, profitability is not there given that the capex cycle has not picked up completely.

In financials, PSU banks have suffered for quite a while. However, risks still remain in terms of unfavourable mergers. But in the private banking space, the problems are now largely known and reflected in the market price; the problems now are gradually easing off. We are invested in private sector banks. NBFCs have seen steep corrections. A few good-quality NBFCs may present buying opportunities. That said, while the RBI closely monitors banks, NBFCs have been largely self-regulated. So the chances of problems there are higher. We are cautious about the NBFC space.

IT and pharma have had some trouble in the past. But given that the currency has somewhat weakened, they will benefit to some extent. Also, some of the past issues on quality are getting resolved in the pharma space. This is a space we have been selectively investing in.

We are looking across the m-cap space for opportunities. If something looks attractive, we go and buy. We are market-cap-agnostic.

How do you see the slew of regulations introduced by SEBI in the mutual fund industry?

SEBI has a mandate to work for investors’ interest and it keeps doing things in that direction. The only unsettling thing is that sometimes the pace of change is quite fast than what the industry can easily cope up with.

For example, on expense ratio, there was a 15 basis point reduction just a few months ago, and the new slab structure (with expense ratio cuts) will come in now. It will be helpful if changes come once every one or two years, and there is a certain element of gradualism.

Otherwise, there is no dispute with the argument that as scale comes to the industry, some benefit of cost efficiency should go to the investor. Also, a lot of work has happened in terms of reducing operational cost. Transactions are happening in the electronic mode now; there have been attempts to reduce the KYC complexity. On balance, it’s good. It’s just that one would prefer a slower pace.

What are your thoughts on the removal of the upfront commissions given to distributors?

It will be great if we can have uniform regulations across products. One has to look at second-order effects. If mutual funds are regulated in a certain manner and competing products are not regulated in a similar way, you might find distributors selling portfolio management services, alternative investment funds, ULIPs (unit-linked insurance plans), or sometimes completely unregulated products. One has to take into account those things and have a certain uniformity. That’s a challenge.

Otherwise, moving to a full-trail model is good. How the system takes it, needs to be seen over the next 12-24 months.

Also, there is a certain amount of clutter in terms of taxation of differently regulated products. Some uniformity will obviously help.

Where do you see the Indian economy and market over the next one as well as five years?

The economy will do well thanks to good demographic profile, low base and increase in literacy levels. Over the medium to long term, India is a good place to be in as an investor, and the economy will do well.

There will be a few challenges over the next year — elections, crude oil, currency, tariff wars. The near term is often a bit shaky, but the economy and the market average out over a longer period.

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