The macro situation in India is so challenging that it tends dominate people's thinking on the market says Dhawal Mehta, head- India equity investments, Reliance AMC.
While most FIIs are confident on Indian corporates and their businesses, Dhawal Mehta, head- India equity investments, Reliance AMC, says the country's tight macro economic situation is their main worry. India's widening current account decficit (CAD) is concerning investors he adds.
Mehta says the rupee has been one of the most important topic of discussion among investors. "The rupee move obviously does not inspire a lot of confidence and it spooks investors in a big way. That is the one serious challenge that continues given how bad the current account deficit (CAD) situation is," adds Mehta.
Also read: FII inflow into Indian stocks crosses $7 bn in 2013 so far
Despite having robust inflows in the months of January and February 2012, Mehta says this year is likely to be a volatile year given all the macro challenges that India has.
Below is the edited transcript of Dhawal's interview to CNBC-TV18.
Q: It has not been a great start to the year after such a good 2012. Do you think 2013 might remain this bumpy?
A: Yes, I think so. The past year, 2012, was obviously a good year. We ended the year up almost more than 25. A lot of that was because of the momentum that was seen September onwards.
This year has not been the best of starts. We have all seen what happened in the month of February. It does seem like it is going to be a volatile year given all the macro challenges that India has. Plus, there are uncertainties from the global space. So, I would think that we are set for a fairly choppy year.
Q: What is happening with flows because we saw such strong flows in 2012 but despite strong flows in January and February, incrementally the market is not moving higher. Why do you think this tiredness is seeping in?
A: A lot of it has got to do with the fact that there has been a large amount of domestic selling. I do not have the numbers but I am sure in the first two months, we have seen fairly strong selling from insurance and domestic mutual funds. So, that is obviously having an impact. However, I agree that incrementally, the flows from the foreigners do not seem to be helping the market in an incremental way.
Q: Do you think the supply of paper from the government might also be a factor?
A: Yes, absolutely. That is the other factor. You are right. We have seen so much paper come in the first two months both from the government as well as from the private sector. That is sucking out liquidity.
Q: What is the reality for India-dedicated products? Is it difficult to get a lot of inflows? Would you say that the money which has come in is coming through very different vehicles this time around?
A: Yes, absolutely. This is not just true for the last six months or one year, it has been a trend now. For a while, a lot of dedicated India funds, irrespective of whether it is long or long short or any format for that matter, have not seen flows. Infact, they have probably seen outflows and a lot of the money that has come in, is largely coming from the exchange traded funds (ETFs) and from regional and global funds that have probably raised India allocations. So, that is a bit of a worrying sign especially for people like us who are active India managers.
Q: Last couple of years, the rupee has taken away a lot of the money that you may have made in the equity market. Is that a disturbing factor as well that we have come down to 55/USD again despite a recent rally in the rupee-dollar?
A: Yes, absolutely. I think that over the last 18-24 months, that has been the single-most important topic of discussion. In meeting with investors, the rupee move obviously does not inspire a lot of confidence and it spooks investors in a big way. That is the one serious challenge that continues given how bad the current account deficit (CAD) situation is.
Q: What is worrying global investors right now? Is it the shape of Indian macro or is it the fact that earnings have just not recovered despite the hope two quarters back that earnings would have bottomed out and we will be on the up cycle once again?
A: The worry still has to do with macro. The fact is that most people have looked at India and the headlines have not been exactly very exciting. We have seen what is happened with the currency, the gross domestic product (GDP) numbers and last quarter we saw sub-5 percent GDP growth. So, there have been so many macro issues. Except for the last six months there has been a lot of policy inertia. So, I think a lot of these issues have hogged the limelight.
Most people are convinced that India does have a set of very good corporates and very good businesses that do well even in the tough times. Nobody is disputing that. We have seen that now over the years. However, when the macro is so challenging, it tends to dominate people's thinking on that particular market.
Q: Would investors get unnerved with the carnage that we are seeing in the broader market? While they may not own all of these mid caps, to see stocks breakup 25-30 percent a day, would it be puzzling global investors as well?
A: Yes, absolutely. It is fairly unnerving not just for investors but also for us because it again doesn't inspire a lot of confidence when people are looking at the big picture about India when people talk about mid caps and small caps as the exciting part of the market and if something happens like this then it is a big negative from that point of view.
Then investors tend to think that India is about being in the top-20 stocks and the broad market doesn’t really merit watching given with the carnage that we saw in 2011 and now over the first two months of this fiscal.
Q: Could it end up making the market even narrower and investors even more blue chip and high-end focused?
A: It is already happening. In last 2-3 years, quality stocks have hugely outperformed the number of sectors that have done well, they are very specific and few in numbers. Only pharma, private sector banks or consumers have done well and rest of the market has gone nowhere.
It has been polarised. Even, within the Nifty, only top 15 or 20 odd names have driven the performance while the rest of the market did not do much. It is not healthy. Anybody who is a serious India watcher will look through that and will not just look at the Nifty level and say we are fine. The broad market is not indicating anything pleasant.
Q: Do you see the market re-rating higher at all over the next four quarters leading up to the elections or do you think it will be difficult?
A: It will be difficult. A lot depends on the FII flows. India needs a risk-on type of environment to get flows. We are aware of the domestic problems and the issues that have dogged the market but a lot of it will depend on the flow and we really don't have a view on how flows would be. Thinks will look difficult till elections are out of the way.
Q: How are you tactically positioned right now. What do you think will work this year as a theme?
A: W always go back to old fashioned stock picking, we are very bottom up investors. Our strategy will be to pick up quality names and stock which will give confidence in terms of earnings. The market is in a fairly punishing mood and people that haven't performed, they have been brutally punished.
Our focus is to make sure that we get names correct, we stick to what we know, we stick to where we think we have a lot of confidence in terms of the delivery of earnings. We are very focused and have a very concentrated portfolio. At any point of time we don't have more than 20 stocks in the fund. We have a very stock specific focused portfolio.
Q: In the start of the year lot of people were feeling braver after seeing October to December performance and there was a gaining feeling that one should look at companies where balance sheets are not so great, because balance sheets will get repaired during the course of 2013. Those stocks have got hammered again in the last couple of months. Did you think like that at the start of the year at all?
A: Yes, I did thought about that because it is always very tempting to look at things that got battered and where one sees some possibility of change, obviously there one can make mega returns. So it has been tempting. We are still not trying to bottom fish here. We are not forecasting events or things that can turnaround.
We would rather go for certainty. We are obviously paying a price for it. There is obviously a flipside to that. But given the overall environment we have been cautious and we have been very selective on companies. We are still staying away from the sectors were beaten down, because we are still not seeing any visible signs of a turnaround. We are always counting for these things because we do realize that on a stock specific basis, if one gets the thinking right then there is a lot more juice there potentially. For now we are happy to play it safe.
Q: In last couple of years, FMCG and pharma were big trade, it had a great run. It had a great run. Valuations became expensive and there was a shift towards cyclicals. Cyclicals are not doing well and consumers are expensive. What bets would you take in this environment?
A: FMCG and pharma are overcrowded trade. I would pick private sector banks. Though they are expensive but they are fairly well discovered and they are bottoming out in terms of asset quality cycle. Structurally, these banks are doing well.
There is lot of certainty on earnings in terms of what they can deliver and as long as we are not paying much for them, I think one will be fine with them. I don’t expect to make a return of 40 percent on any of these names given that they are fairly well discovered and well owned. But, it is a nice way to play out this tough time. We are happy to be with the private sector banks.
Q: You do not expect large scale accidents to happen there?
A: I don't hope so. With the names we have we would be very surprised if there are asset quality issues and I think this is a big thing that one need to watch out for, especially when looking at banks because it is a determining factor between whether a bank gets traded at 0.8 times book or whether it gets traded at 3-2.5 times book. I think that is very critical that one need to keep clocking in those numbers.
Q: You have not been tempted despite 0.8 times book on the public sector banking path?
A: Not so far. I still do not have any exposure to the public sector banks because of the uncertainty on the asset quality cycle and not knowing what to expect. In my view the market is paying a lot premium for certainty. Call it quality, certainty. To my mind that is the premium selectively worth paying.
Obviously, one needs to look at the valuation, but I think that there is still a premium that you ought to pay in my view on these things. So we are happy to do that. For now we will stay with sectors that you mentioned, because I do not think the environment will get appreciably better in the next two or three quarter.
Q: IT started outperforming the broader indices. Do you have big exposure in that space?
A: We don't have any exposure in this space.
Q: What is your view on oil and gas sector because many people did not even touch that sector for 3-5 years and suddenly after Chidambaram took over there has been some more interest. Have you got in there at all?
A: We are not present in this space but things are getting lot better for them. People stayed away from this space due to policy uncertainty but after FM’s move on diesel, there is definitely some merit in looking at this space. This sector now needs to be looked more seriously.
Q: Infrastructure has been a dangerous sector. Anything related to that or real estate, though a couple of names have done well, have you stayed completely away or do you have some exposure there?
A: We completely stayed away from that space. We are clear where we want to be and where not. We stayed away from this sector because of the environment where interest rates have moved up in last 3-4 years. This sector is generally a capital guzzler, which requires lot of capital.
Q: You think it is still too early to get in?
A: I still don't see a lot happening but I will not ignore it. We have an eye on these companies and the sector but for now we like to stay away. Still it is not feasible for us to enter that space.
Q: How do pick stocks in the mid cap space now because if you are off on the management or there is a pledged share issue somewhere, you can just wake up and see 25 percent of your market cap gone. Does it make it difficult for a fund manager to take those stock specific bets in today’s environment?
A: Absolutely. The market is in a fairly punishing mood. So a small slip up like missing any particular quarterly earnings could very well happen. The market is fairly brutal. So, one has to be extra careful in these times. One has to stress test his portfolio to make sure that one is getting into right names, be more vigilant on corporate governance issues.
Look at everything that can potentially go wrong. See what kind of confidence one has on earnings. So, going back to the good old fashioned type of diligence in terms of what type of stocks one wants to have in the portfolio, so we are not looking at 100 names. We have kind of narrowed it down to a very finite set of stocks that we potentially look at because when one does these screenings a lot of names get excluded for one reason or the other.
Liquidity is another big thing. We all are aware to what happened to mid cap and small cap stocks in a downturn. The liquidity dries up completely. No matter how good the name you don’t want to be caught in that kind of a situation. So, there are lots of these things that become important only in a downturn.
The one theme I tell myself and my team is that we need to get into certainty. We don’t want to stay up in the reporting season and say what will happen to one of our stocks? Is the number going to be good, bad? Are we going to get a nasty surprise because given the kind of mandate that we run, we can’t have a stock go down 40 percent on us because of the way we are structured.
So, I am happy to make a little less money but I rather be in stocks where I know that hopefully I can’t lose too much. So, that has been the mantra. Not just a function of the market and the environment but also a function of what our mandate is and what are we supposed to do there. It is a strategy that has played out well in these times and for now I don’t see reason why we would want to change that in a very big way because most of the challenges are still around.