‘All ingredients are in place for earnings recovery’

All the ingredients for an earnings recovery are in place, but the meal isn’t ready yet, says Vetri Subramaniam, Group President and Head of Equity at UTI Asset Management Company, at a recent chat with BusinessLine in Chennai. Excerpts:

What are your views on SEBI’s proposed rules for fund consolidation? How are UTI AMC’s schemes impacted?

The rules have clear merits from the investor point of view. They achieve truth in labelling. There will now be a standard acceptable definition of what constitutes a large-cap fund, what constitutes a mid-cap fund and so on. They have also drilled it down further to define what is a large-cap stock, mid-cap stock, etc. We do believe that the definitions of market cap ranges are a bit restrictive, because this is a forced ranking system, which says that there can only be 100 large-cap stocks and 150 mid-caps. But to be fair, they have made sure that investors are not comparing apples to oranges when they compare within categories. Drift in fund mandates has also been contained. Schemes cannot start out as large-cap and then change colour to mid-cap funds midway through their life.

At UTI, we have internally discussed this with our Trustees and it will involve a couple of fund mergers and some repositioning of schemes. We also find some gaps in our product offerings which we may look to plug.

It has been about nine months since you took over as Head of Equities at UTI AMC. What are the changes you have made to the investment team and scheme structures?

The core research process at UTI AMC is very sound. A lot of hard work has gone into this and there was no reason to change this. The only tweak I found necessary was to create an internal syntax around stock selection. The two metrics that were emphasised across UTI schemes are the Operating Cash Flows and Return on Equity. We have now created a rating system for companies along these metrics and a clearly articulated investment argument as to change in these metrics, when we buy stocks.

You have traditionally been a contrarian investor. What trends have you observed in this particular bull market?

I think this time the outperforming sectors and stocks are far more diversified. Getting the stock selection right has been a bigger source of Alpha in this bull market than getting the sector selection right. This is a bit unusual from what happened in 2003-2008, when sector selection made a big difference to alpha.

The other trend I observe is that it is getting more difficult for mid-cap funds to outperform benchmarks. In my 25 years of tracking the market, I have seen everyone take for granted that mid-cap funds will outperform indices. But in the last 18 months, a good number have underperformed. This is very unusual in a rising, mid-cap dominated bull market! It could be a sign that mid-cap stocks are getting researched and discovered at a much earlier stage.

Do you see recent structural reforms such as GST, bank recapitalisation, etc, providing triggers for earnings growth to return?

Yes, all the ingredients for earnings recovery are largely in place. But that is different from saying that all the ingredients are already in the kitchen and I can produce a great meal out of that! The ingredients are there, but we are still not getting the meal that we want.

Some of the largest sectors in the market — IT, pharma and PSU banks, are at relatively low valuations compared to the rest of the market. Are there contrarian opportunities there?

I would say yes. On IT, irrespective of the metric you use on valuations — PE, price to book value, EV/EBIDTA, cash flow yield — it ticks the boxes on being cheap relative to markets as well as based on historical valuations. Pharma has been significantly de-rated compared to three years ago, but it hasn’t fallen to the depths like IT has.

On PSU banks, I would nitpick a bit to say that the continuing story is not very clear despite the boost from recapitalisation. I don’t see a strong liability franchise, customer acquisition franchise, ability to build brands, technology with many of the public sector banks. I would stick to a narrow universe there and look at private corporate lenders for opportunities.

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