Ace fund manager Prashant Jain of HDFC Asset Management feels retail investors are making a mistake by constantly redeeming from equity funds. The year 2012 has been a good one for stock markets. Many mutual funds have done quite well but investors are still not putting money into equity mutual funds.
Historically, Jain says, the bulk of the money, almost 80-85 percent, always comes in at higher than 17-18 (Sensex) price-to-earning multiple (P/E) multiple. "We never see inflows at low P/Es and when markets begin to recover. Instead we see outflows because people who feel they have been trapped, and now some returns are there, they are taking out money," he told CNBC-TV18 in an interview. He says that is why investors get disappointed with equities time and again.
Investors seem getting more and more cautious as the market is approaching 20,000-mark. The general consensus is that this is a level where one should be booking out and not making the mistake of getting into another high. However, Jain thinks otherwise, "When you look at the history of the Sensex, it has delivered 15-17 percent compound annual growth rate (CAGR). It started off with 100 way back in 1980. At any point of time, we thought 1,000-2,000-5,000 was high. It was a wrong way to look at the markets".
The correct way to look at the market is to focus on the P/E multiples, Jain says. "Investor should simply practice low P/E investing and whenever P/Es are below average, they should keep on investing with two to three-and-a-half year's view. They should either reduce allocation to equities or not invest more money when P/Es are high again with a two-three-four year view. That will lead to better timing than what they have historically been able to achieve," he reiterates.
Below is an edited transcript of the interview on CNBC-TV18. ALso watch videos.
Q: Do you think retail investors are making a mistake by constantly redeeming from equity funds instead of putting money in now?
A: I have been in this market for 20 years and I have seen three cycles now. Unfortunately, in each of the cycles, the timing has been quite bad. The bulk of the money has always come in at higher than 17-18 P/Es and we have seen that repeatedly. Almost 80-85 percent of the money comes in above 17-18 P/Es. It is probably unfortunate, but in my opinion, these are the signs that history is going to repeat itself again.
Q: Are you beginning to see any nascent signs of that in any fund because it is the midcaps that have begun to perform etc? Are you beginning to see more interest perking up in some of these sector-specific or vertical funds?
A: Broadly, the industry has been losing money. We never see inflows at low P/Es and when markets begin to recover, we see outflows because people who feel they have been trapped and now some returns are there, they are taking out money. Almost 80-90 percent of the money over a cycle comes in above 17-18 P/Es and that is why investors are time and again disappointed with equities.
Q: The feeling from a lot of retail investors seems to be that we are approaching 20,000; this is a level where you should be booking out and not making the mistake of getting into another high. Is that kind of an approach a mistake?
A: I think so. When you look at the history of the Sensex, it has delivered 15-17 percent compound annual growth rate (CAGR). It started off with 100 way back in 1980. At any point of time, we thought 1,000-2,000-5,000 was high. It was a wrong way to look at the markets.
The correct way to look at the markets to my mind is to focus on the P/E multiples. Investor should simply practice low P/E investing and whenever P/Es are below average, they should keep on investing with two to three-and-a-half year’s view. They should either reduce allocation to equities or not invest more money when P/Es are high again with a two-three-four year view. That will lead to better timing than what they have historically been able to achieve.
Q: The problem with a lot of investors is that they look at the rear view mirror and they say last five years have not been great and therefore we should not be buying this asset class. Do you think that having seen so many cycles, we have just gone through a bad cycle, which is about to turn for equities?
A: Equities are very hard to forecast over short-term to medium-term period. You should take a two-three year view. That is what I would see; I am coming basically from low P/Es. Interest rates are peaking out and India’s growth also should improve next year. Oil prices seem to be stable. Therefore, the pressure that rising oil prices put should start reducing. The worst of current account fiscal are behind us. Improvement is slow but we are improving on that front.
Overtime P/Es have room to go up and earnings are in any case growing. Yes, I would agree with that view that if you look at last five years, that is an incorrect way to approach the markets. In fact, you should do just the opposite. When market do not do well for last five years that is when P/Es are low and that is when you need to allocate more to equities and vise versa. Unfortunately, what happens is just the opposite.
Q: Can you say that with confidence though; that you are seeing signs of the earnings troughing out? What kind of earnings performance would you pit for next year if you expect to see better returns?
A: The accurate forecast of earnings is not possible but I do not think it is very important either. Earnings estimates are between 12 percent and 18 percent growth—anywhere. So earnings of Sensex could be Rs 1,350 or Rs 1,400. I do not think that is the key issue. The key issue is that P/Es are broadly at around 14 odd times—could be 13.5, could be 14.5.
In one year from today, we will be focused on FY15 earnings and that is the way to think that those P/Es will look in one year maybe 12 odd times and that is why I think the risk-reward in the market is favourable and the downside is limited to my mind.
Q: Some market watchers also point out to the urgent need to improve the domestic liquidity environment, i.e. more front-ended rate cuts. A big chunk of your exposure is to the financials. Would you agree with that that the linchpin is what happens with rate cuts not so much the rest of it?
A: I think we need to do lots of things and now the direction is right and government is clearly focused on improving the policy framework. Fortunately, the oil prices are stable and interest rates also have a role to play and overtime interest rates will move lower. How much and to what extent and when exactly that happens, I would not like to guess that but it is safe to say that one year from today, interest rates should be lower than where they are currently.
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Q: On this point about low P/E investing versus high P/E investing, how do you look at the P/E of a typical fund like yours? You have got a combination of some, which are trading at more than 30 P/E and some which are trading at sub-10 P/E. Is averaging that good idea for an investor to look at what kind of P/E he is entering at?
A: I think average P/E is very relevant for telling an investor how the broad markets are valued. In any markets whether it was 1999-2000 when technology was booming or 2007 you had pockets of the market, which were very expensive and pockets of the market which were very cheap.
But nevertheless, average P/Es are a good barometer for future broad market performance. I think you have raised a very relevant point. In this market, the quality stocks are very expensive and in a way that is good because if less quality stocks become expensive then the risk in the market is very high. I think quality is expensive, that is how it should be but that also poses some challenges for people like me who want to outperform the markets and that means that you will have to take some risks in the portfolio because quality is not cheap in these markets.
Q: Even for investors, does it make sense for them to look at maybe, even aside of diversified fund, some funds that are very low P/E at this point in time, like maybe infrastructure funds or specialized offerings or to look at diversified funds, which have a significant share of higher risk stocks which are low P/E today?
A: The key issue in India is that investor allocation to equities itself is miniscule. That is the key issue and key challenge and we need to increase that. Within that if there are some set of investors who think that they understand markets better, they understand individual sectors then they can go for sector specific funds.
But my broad recommendation, my broad approach has been that one should stick to diversified equity funds. How do you know when to move out of a sector? The fund manager probably has a slightly better experience and he will move around and I think in India we have large number of equity funds, which have delivered index beating performance over medium-long periods of time. So my clear preference should be for diversified equity funds.
Q: Are you beginning to make that switch in a lot of the low P/E or ignored sectors as well? Just to going with your infra fund as an example. Your highest allocation there is to financials, things like engineering and utilities—between 6 percent and 16 percent. Are you making that switch within your own funds and giving higher reference or preference to these sectors now?
A: Infra fund is a wrong example to discuss that because if you look at the offer document of infra fund, we have defined financials as part of infrastructure. So we say three parts to infrastructure, infrastructure financiers, owners and the asset creators i.e. the engineering companies. But having said that, we are very watchful, we are very alert and as and when we see that the environment is becoming more conducive in steps slowly, we will want to increase risks in the portfolio.
Q: It is a very wide basket in a very wide term but would you say the greater opportunities in terms of spotting these low P/E high value kinds of stories are higher in the midcap segment right now and that is the space people should be looking at more carefully?
A: By and large, the market is fairly valued. We do not see bubble; we see quality as being expensive whether it is in the largecap space or it is in the midcap space. Whether you call it select bank, cyclicals, infrastructure companies—that is where there is room for rerating. But in this space, you have risks. These are operational risks, financial risks, environmental risks, commodity risks, so I think one has to be very careful in how you go about increasing risks in the portfolio. But at a broad level, I do not see either midcaps or largecaps any meaningful gap between these two spaces.
Q: What are you doing with these high quality or high P/E names now as we go into 2013? Are you beginning to trim some of these positions?
A: We must also be aware that these are large parts of the benchmark and they are very high quality names. So quality can be expensive, that is where it should be. I think we are basically maintaining a balanced view of the markets. If you look at our allocation, we are broadly in line with the markets at this point of time on a sectoral basis.
Q: What do you do with largecap plays like IT, which have been large part of your portfolio or any diversified portfolio for a long time, but they are going through challenges? Like an Infosys, which can be found in pretty much every diversified fund with a large weightage but that has been a big underperformer. How do you approach some of these blue-chips which are going through a difficult phase?
A: I do not think there is any clear answer to this and you will get different views on this. I have said this earlier also that we are not very clear what kind of growth rates will technology companies deliver over the next few years.
Having said this, these companies are globally comparative. They are generating huge amounts of free cash flows and they are also meaningful parts of the benchmark. Some of them are not expensive at all in terms of P/E multiples unless growth rates become negative. I think in view of all this, we do have exposure to these names and as I mentioned earlier, on a sectoral basis our portfolios are fairly balanced and that is the case for IT as well.
Q: What about the entire PSU basket that has represented in the market because there will be many more coming by way of OFS issues? We saw one go through quite successfully, is that a part of the market that you are beginning to look at carefully?
A: I do not think we distinguish between public and private and we approach each business on its merits, how it is valued. Yes, we study each of these FPOs that come to the market.
Q: How would you recommend doing it as a fund manager, if you had to advice someone on how to split up their investment or exposure in terms of which funds they should allocate the most two or the least two, how would you do it between equity, fixed income, gilt?
A: I do not think there is one answer to this but as I said investors should follow one simple thumb-rule i.e. whenever P/Es are low, take a 2-3-4 year view of the markets, keep on investing patiently and over time you will be rewarded, you should be rewarded for the entire holding period. How much to invest of one’s personal money is a very individual decision. As a thumb-rule, I would say that whatever part of money you do not need for 2-3 years, on whatever portion of your wealth you can tolerate some volatility. That is the right amount of allocation towards equities.
Q: In my questions on largecaps, you have been referring to the index weightages which you need to adhere to loosely, do you find that limiting because in 2012 if you just picked 5-7 good quality stocks, they would have done much better than the index because performances have been very disparate, the fact that you need to have some weightage in names which are largecap weightages because you cannot just go off the index completely, do you find that limiting for performance?
A: Yes and no. I think we must appreciate what is the objective of mutual funds. To my mind, the objective of mutual funds is to beat the benchmarks. Benchmarks in India by themselves have been delivering around 15-17 percent CAGR returns. If we beat that by 1-3-5 percent a year, we are talking of 20 percent kind of returns annualized. These to my mind are very healthy returns. I think any fund to the extent they feel it is desirable to be in the benchmarks to reduce risks against the benchmarks, they should be doing it. I do not find that particularly restrictive because if you look at our funds, we have managed to beat the benchmarks between 3-5-7 percent and even 10 percent per annum over medium to long periods of time.
Q: You spoke about taking a little bit of an extra risk right now to generate higher returns, which are the pockets you think which can deliver supernormal or better than average returns, would it be forgotten sectors or ignored sectors like infrastructure broadly, what will generate the alpha in your eyes?
A: At a broad level, it is the consumer and the pharmaceutical. I think more consumer and less of pharmaceutical, where scope for rerating multiples going up, to my mind, is not there. Other than that most sectors will have scope for multiples going up overtime.
Q: A big fear for retail investors who probably got in five years back and then got significantly burnt in the market is the kind of or the depth on the downside risk there was in the market. At this point, when you talk about reasonable returns or earnings performance, can you confidently talk about a floor that this market has put in place even in terms of valuations?
A: If you look at the history of Indian markets or P/Es have seldom gone below 11-12 times even in extreme situations. Whether it was in 2008 when globally there was serious stress in the system, even at that point of time P/Es did not go below 11 times. Today, markets are trading 14 times one year forward. If you want to think one year forward, markets will then be focused on FY15. On FY15 basis markets are trading at 12 times.
I would say, there is always a downside in the markets but going by past experience. I would say the downside is limited. Let us not compare this with 2008 because in 2008, the P/E multiples were very different. In fact, we have gone on record, we said so in a very long note that why index is likely to disappoint over medium to long periods because P/Es were extremely high and in those markets on the other hand, quality was at a discount. The risk was extremely high in those markets, I think these markets are not comparable to 2008 at all.
Q: Give us one word on a sector that is extremely high representation in weightage but performance has been lacking, oil and gas?
A: Yes, you are right. I would fully agree with that and we have investments there. I think what has happened is: the oil prices have gone up manifold over last 10 years and consumer prices have clearly not been able to keep pace with that. Whenever we get to an environment where oil prices become flat for two-three years or more or they come down, I think that is when these subsidies should go off or reduce meaningfully.
That is when the sector should perform. When that will happen, we do not know but we are also waiting for that.
Q: Talking about the last few years, it has been a series of earnings deceleration and maybe even P/E compression. Do you hope in the next couple of years—you cannot predict a P/E expansion in the future—we have a reasonable chance of P/E starting to expand in India once again?
A: I would say yes because it is to my mind quite simple. When will P/Es derate? When there are some issues, when there are some challenges, when there are some problems. If everything is good, the P/Es will not be low and that is why investors are getting it wrong time and again. When the newsflow is extremely bad and there is some stress in the system, in the economy, that is when you get low P/Es. That is when you get poor market performance.
India is a secular growth story. We are facing issues of high fiscal deficit, high current account deficit. To my mind, corrective steps are being taken. The worst is probably behind us. We also hope if oil prices come off —we do not know for sure— things could improve very rapidly. But I have seen this: Whenever P/Es are low, there is some or the other challenge. So I have been optimistic that overtime P/Es will improve.