India will need enabling policies during March–April period to sustain stock market’s ongoing rally, says Nimesh Shah, managing director of ICICI Prudential Mutual Fund. In an interview with Bijoy Sankar Saikia, he says bottom-up stock picking can generate good returns for investors from here on. Excerpts:

How do you look at the ongoing rally in the stock market? Many skeptics feel that it would fizzle out soon What are your views?

The recent rally has been more global driven than India-centric, given that it has primarily been a result of FII inflows driven by global liquidity easing. However, we believe for the rally to be sustainable, we will need enabling policies during the March–April period. Today, the major challenges for the Indian economy are infrastructure bottlenecks and fiscal burden that is becoming increasingly imperative to solve for sustenance of growth. However, amidst constraints, positive cues continue to provide optimism. Factors such as moderating inflation, a downward bias in interest rates from here on and the focus on growth could provide some tailwind to the economy and to the market in the second half. Most importantly, the biggest positive is that the home-grown challenges are within India’s control and historically India has tended to reforms systematically in periods of crisis.

Fundamentally, what has changed for the market to trigger such a bounce? FIIs are suddenly ready to overlook everything bad and are gung ho on Indian equities. Why so?

The recent FII inflow into India is due to a combination of LTRO (Long-Term Refinancing Operation) in Europe, which has been beneficial for all global economies and due to the domestic scenario of attractive valuations and high bond yields in debt.

In future also, liquidity-enhancing programmes in the western world are likely to help emerging markets across the world, including India.

Finally, long-term FII inflows are determined on the basis of relative attractiveness of different nation’s basis growth prospects. If India addresses the imbalances such as concerns over fiscal deficit and roadblocks in project implementation and creates a prudent business environment, FII sentiment can continue to remain a buyout. We believe FIIs continue to believe in the India story, but are clearly looking for cues like affirmative action on reforms and swift execution.

How do you read the December quarter numbers? Do you expect any more earnings downgrade from here on?

They have been in line with expectations that were already muted. We believe there will be no major downgrade in the near term unless there is further increase in crude price.

There is a fear that the lag effects of high inflation and high interest rates will be felt over the next two quarters as well. If so, could it be worse than this for a few sectors? If yes, which would they be?

The recent cut in CRR can have a lag impact and, thereby, reduce the interest rate burden to some extent.

Elections and the Union budget are being looked at the possible next big triggers for the market. What are your expectations?

The Union budget is clearly the most important trigger after the election outcome and will be keenly watched. Given the imperative need for fiscal consolidation, expectations from the government are going to be a clear intent and corrective actions towards fiscal prudence. This can be achieved through initiatives such as effective taxation and disinvestment. Also, infrastructure bottlenecks will have to be addressed with the government focusing on improving this through increased spending and quick project approvals. The budget will also be the key to providing further direction on the RBI monetary policy stance with initiatives for fiscal consolidation having the potential to reduce inflationary expectations.

How have you been playing the market of late?

We do not take cash calls in all funds, except for those that have a mandate to do so such as the ICICI Prudential Dynamic Plan. In this fund, we were now around 85 per cent invested as of January 30, 2012.

We have been opportunistically investing at corrections to build a portfolio with long-term returns potential. We believe valuations continue to be reasonable even after the rally, and barring a few defensive sectors, the market continues to demonstrate upside potential.

However, for the valuation upside to get triggered, the market will look for cues in the form of fiscal consolidation and monetary easing. To the extent that these events happen, attractiveness of the market will get reflected in stock prices. With valuations being attractive outside of a few defensive sectors, our investment strategy will be to focus on stocks outside the defensive sectors. Although they carry downside risks, there is equal or more upside possibility as well. This apart, a combination of top-down and bottom-up research will continue to help us generate superior risk-adjusted returns.

From a bottom-up approach, do you see any particular sectoral or market cap-based trend? Would you like to cite some instances?

We have seen a very big move away from defensives and that trend is likely to continue due to reasonable valuations of the entire broader market, excluding the defensive sectors. Mid-caps and small-caps specifically are positioned for further upside. Bottom-up stock picking is what we believe will generate alpha for our investors in this environment.

Which are the sectors you have been avoiding at this stage and why?

We continue to be underweight on consumption-oriented sectors such as FMCG due to valuation concerns. FMCG companies have been consistently witnessing strong upside over the past three years owing to strong demand for consumption and conservative outlook. While this a low-risk sector, the current valuation reduces the upside potential except in the case of select stocks across the mid-cap space.

The average investor is in two minds at the moment. What would be your advice to them?

We have always subscribed to the view that tiding the market is better than timing the market, and the best way to do this is through regular enforcement of SIP, STP and asset allocation. Core investment has to be in a pure large-cap fund (such as our Focussed Blue Chip Equity), which has a better potential to tide volatility. This apart, we believe volatility will continue to be a prominent theme and this has the potential to emerge as an asset class by itself. The scenario of expected volatility can present investment opportunity and investors can benefit from investing in funds that have the potential to capitalise on volatility.

bijoysankar@mydigitalfc.com