The Indian market is at an "inflexion point", with the economy moving from high inflation-low capex--weak currency dynamic to a low inflation-strong capex-stable currency one, says ace fund manager Prashant Jain, CIO of HDFC AMC.
This, he says, has implications for active investors managing their own portfolios: "What's worked for the past five-seven years may not work now," he said at the Cafemutual Conference Wealth Management.
Sankaran Naren of ICICI AMC, also part of the roundtable, agreed with Jain's view, saying that capex should see a revival and this made market attractive from a two-three year view.
But he warned that central bank policies, which have pushed stocks higher, will also lead to high volatility.
Below is the transcript of the panel discussion with Anup Bagchi of ICICI Securities.
Q: Where do you think the economy is going ahead?
Jain: With the market cap to gross domestic product (GDP) of India it is now near the bottom of the Lehman crisis, so earnings are still not there, but profitability is again at a cyclical bottom.
I think next few years we should see a strong mean reversion in profitability and there are ample signs in last quarter numbers, so I am quite optimistic.
I also feel that these markets are in transition and last 5-7 years we have seen very high inflation, very weak capital expenditure (capex) and sharp currency depreciation.
I think going forward we should see low inflation notwithstanding some increase in agri prices, but these are very short term variations. Good monsoon vegetable crops are very short cycle crops, so generally we should have lower inflation. We should have stable currency.
Current account is now less than net FDI in the country for the first time in many, many decades and I think there are reasonable signs of recovery in capex. I feel that these markets are in transition and what has worked well for the last 5-7 years, may not work well and the converse should again happen.
Q: Your short view?
Naren: I think two years from now earnings should be better. I think capex should have revived, so given that framework clearly markets look good with a 2-3 year view. Having said that one should not forget that finally all markets move up due to what global central banks do, so in the last four months the global central banks have basically worked hard to create this rally across all the markets by the US Fed saying that I don’t want to increase rates so ensuring dollar doesn’t go up, the Japanese Central Bank and the European Central Bank not pursuing negative interest rates and pushing their currencies down.
The way the global backdrop is that they don’t want to have a market fall. They don’t want to have even big correction, the global central banks are there to backstop the market as and when it falls.
Also it means that markets keep going up they will have to do something to create some ammunition and that ammunition can create volatility.
While the two year outlook is good, but there will be intermittent periods where you will have fair amount of volatility.
On debt I think the reality is that the entire Indian industry has hardly invested in debt other than tax free bond at least in the mutual fund industry, so from an asset allocation perspective they still seem to be long real estate and short fixed income and therefore while I agree with Gopal that there may not be many rate cuts.
I think it’s an underinvested asset class which proved it value last year.
We believe that there has to be like we have seen a fair amount of credit growth. If you believe in crude oil going to USD 100-110, I don’t think fixed income is the way to go. Fixed income deserves allocation and I find that most investors I meet have no allocation except for the people who have invested in tax free bond two years back.
I believe that yes the bigger return or the very big returns are through with the last two years, but there should be an allocation, should that allocation be through investing in hybrid funds may be it, that may be the way to invest in debt at this point of time.
Q: One of the issues as a distributor, as an advisor we have is that instead of stock picking which is a direct equity method we have to also look at the portfolio of the client. From the fund management perspective also you have to construct a portfolio not necessarily pickup a stock. Picking up a stock is one step to the portfolio. From you experience what have been the best practises of making a wholistic portfolio? What are the do's and don'ts of making a portfolio because as I said this is our responsibility towards our clients.
Naren: You have to decide whether you are believing in a big bearish market or a big bullish market.
So, that automatically makes certain decisions very clear. Suppose you are a believer in moderate returns then you have a set of sectors like consumer or pharmaceutical or technology or utilities kind of sectors to be a good part of the portfolio.
On the other hand if you are positive on the markets, clearly there is a role for small cap, midcap in the portfolio. So, I think portfolio construction ideally I would like to do - basically a situation where there has been a fair amount of underperformance over a long period of time and where I trust the companies to actually do well over a period of time.
I think the difficult phase for a fund manager has been in big bull markets like 1999 and 2007 where you had clear portfolio choices. In 1999 to avoid maybe TMT or in 2007 to avoid infrastructure, however in those years to actually create a portfolio without infra or a portfolio in 1999 without IT would have been very difficult.
So, the right portfolio choice is respect valuations, respect cycle, respect where there is a bubble and invest, that would be ideal. However during those periods, I always keep worrying about bubbles and bust because in those bubbles is when I think the toughest part of our job comes in.
Similarly in big busts also tough part happens and over the last 6-7 years we have neither had a bubble nor a bust except maybe in real estate. So, it has made our job pretty easy.
Portfolio construction is difficult during bubbles and busts. Periods like now are much easier at this point of time to construct portfolios.
Q: So, suppose we were to take two clusters of clients, customers. One who are clearly towards growth, young people they must make the money work harder and then you have near retirement, where it is more moderate. Capital preservation is also one of the big drivers of the portfolio. In that is it a sectoral play or is it just different kind of funds, created for these two different kinds of customers and in that what would you say is the way to play interest rates?
Is it fixed interest because at the end of it tax-free gives an absolute return which can't be said about when you play a duration because it is not absolute return. It depends on the time of exit. So, how would you play this portfolio part, for let us say, two different personas of customer?
Jain: What I have experience in my opinion age is certainly very important factor in deciding this but if you answer two questions right, it most of the job. It is simply what portion of your wealth can one spare for 3-5 year periods. You will be 80 years of age or you may be 25 years of age.
If I have to buy a house I actually can't take much of risk and if I am 80 years and I have a lot of surplus money I can still take volatility.
So, what is the portion of ones wealth which can be spared for 3-5 years and on what portion of one's wealth can one take 10-20 percent temporary downside.
Whatever the answer to these question that the right asset allocation towards equities and the balance should be in fixed income and the fixed income whatever it offers we have to accept because equity is the key decision, that is my risk capital. Whatever is balance comes to fixed income and whether interest rates are 5 or 8 percent that is secondary.
It is not so much about sectors and specific funds. Asset allocation is the key and there have been few strategies which suggest that asset allocation delivers 90 percent or more of long term returns and securities allocation actually plays a relatively minor role.
One final point is when it has been experienced and most people will agree with this that when the majority gets down to selecting funds, particularly thematic funds they simply chase last three years performance.
So, IT funds were the most popular in 1999 and infra funds were the most popular in 2007. So, if one genuinely does not understand equities it is - simply to my mind - good to go for diversified equity funds.