With a decreasing allocation to emerging markets seen in global allocations in August, it appears that there may not be much appetite for Indian equities by FIIs in the interim. In an interview with Falaknaaz Syed, Tushar Pradhan, chief investment officer at HSBC Global Asset Management India, said several domestic negatives such as continued softness in corporate earnings, a longer than expected impact of the disruption caused by GST and a political upheaval can damage the prospects of the ruling party’s efforts to get re-elected in the 2019 polls. Excerpts:
How do you read results of this quarter? Are there any sign of revival?
The Nifty 50 Q1FY18 earnings (ex-financials) declined 13.7 per cent while on a combined basis fell by 7.5 per cent. While this quarter was expected to take a hit due to implementation of GST from July 1 and the resultant de-stocking and lack of activity, the earnings hit is quite significant especially from the point of view of whether the year-end consensus estimate of 16 per cent growth can be achieved.
There was a sharp compression in margins for firms in auto, energy and pharmaceuticals and volume growth declined across a range of consumer staples and consumer discretionary companies. Interestingly, there have been upgrades in earnings estimates after results that indicated revival in earnings. Earnings upgrades are seen in auto, financials, IT and metals.
What’s your outlook on foreign fund flows into India with the looming Fed hikes?
While foreign flows have been, on the whole positive, August saw a significant outflow. The net inflow into equities now stands at $6 billion. As a contrast, FII interest in Indian fixed income has seen significant inflows in excess of $19 billion so far. Equity inflows from domestic MFs have far outstripped FIIs this year and hence the volatility in FII inflows is not that significant from a market perspective.
With a decreasing allocation to emerging markets seen in global allocations in August it appears that there may not be much appetite for Indian equities by FIIs in the interim. But these are fast moving flows and are subject to change at a moment’s notice. The possibility of Fed hiking rates does not appear to be a significant factor for FIIs going by their penchant for India fixed income.
The market is at new highs…
While the market is at record highs the valuations are not at record highs, i.e. valuation ratios as measured by P/E ratios have been much richer at times in the past. A lack of earnings pick up may dampen sentiment, however, increased local, both retail and institutional participation can sustain valuation in spite of these headwinds. It’s difficult to estimate a downside to the current scenario. But if the market reverts to the historical mean valuation of around 15X one-year forward earnings a 5-7 per cent correction cannot be ruled out.
How do you see the valuations now and where do you see the index in the next 12 months?
On a full-year basis, the consensus earnings expectation for FY18 is still at 16 per cent growth on a YoY basis. This discounts FY18 at roughly 19 times and with an expectation of 23 per cent rise for FY19, one year forward at 16 times. But historically the market has been given a multiple based on both macro as well as micro factors. Earnings are a more sustainable factor as far as valuations are concerned but despite earnings growth sometimes the market moves on reforms expectations or interest rate movements. Given these expectations valuation may have been re-rated and hence may then appear fair given the improvement in the overall economic backdrop. But lack of demand and earnings growth will shave off the premium if the promise of better growth prospects fuelled by reform do not fructify. As of now I believe given the improved economic and taxation scenario and with some faith in consensus earnings estimates valuations appear in fair territory.
Which sectors are you bullish on? What are the big themes you are betting on?
We have remained bullish on financials, consumer discretionary and materials. We are playing the theme of lower interest rates and the expansion of the NBFC space spreading to a large swathe of the economy hitherto not catered to. The lowering of interest rates and resultant increased affordability for housing is also a positive. Metals globally are recovering following a modest increase in global GDP and the stronger rupee is helping in keeping imported input costs down hence increasing margins.
A certain amount of protection in this space is also keeping competition out. Export-oriented sectors like IT and pharma may face headwinds and our portfolios are currently underweight on the same. We are also underweight on the telecom sector that has seen significant disruption in recent times.
What’s going to be your stock picking strategy?
We have been investing in global equity markets for more than 4 decades. The characteristics of markets, and our understanding of them, have evolved over this period, as has the technology and tools available to our research analysts and portfolio managers. Stocks are identified as investment candidates by our screening & ranking tools and are further investigated by research analysts to either veto or validate the signals. We seek to identify stocks that provide the tempting combination of good profitability and attractive valuation. That’s the bedrock of our investment philosophy. A universe is then generated with a focus list of stocks for further rigorous fundamental research. Portfolio managers then use portfolio construction tools to select stocks and manage risks. The use of proprietary research tools have improved our efficiency of asset management resources across equity funds and have led to a disciplined approach to risk and return.
Should investors look at buying gold? Also what’s your outlook on dollar and debt funds?
Gold is a commodity that is not exactly a return asset. It is used in some portfolios to reduce the overall risk as the price of gold has a lower correlation to financial asset prices over the long term. But in India gold has an emotional connect and thus stays a popular investment option. The substantial improvement in the current account deficit, reduction in the fiscal deficit as well as lower inflation has caused the currency to appreciate significantly this year. The rupee will stay stable with some affinity to appreciate in the near-term. The lack of growth, lower inflation and a high real interest rate may propel interest rate lower, but not sharply enough to allocate serious amounts of a capital. A prudent asset allocation strategy with an emphasis on risk mitigation should allow for a healthy allocation to equities and fixed income for any investor.