Much like its larger peer in the asset management business (Franklin Templeton), another company Sundaram AMC has also chosen to locate itself away from the grind and noise of Dalal Street.
CNBC-TV18's Latha Venkatesh, Anuj Singhal and Sonia Shenoy spoke to S Krishna Kumar, CIO - Equity at the Chennai-based asset manager to get his views on the equity market, and specific stocks and sectors as well as whether he believed midcap valuations have gone ahead of fundamentals.
Below is the transcript of the interview on CNBC-TV18.
Ekta: Do you think that the midcaps are already in bubble terrain or do you think that they did so badly for so long that they have legs to go?
A: What is happening is that like any bull market, the first year or two of the bull market you see a lot of mean reversion from a valuation perspective. As the risk gets played in, the beaten down names in the small and midcap are typically available at 7-8,9 times, when the bull market starts so that is where the investor gets interested in and you see a near normalization of price-earnings (PE) multiple to 14-15 times whereas large companies, the Sensex, it is already at 13-14 times and it moves to 16 times as it has done in the last one and a half years.
So, the return differentials are quite stark to see and that is why probably the question that you asked, ‘is it in a bubble territory?’ whereas if you do look at any bull market- 2003-2008 also, you would see that from the second year as earnings start to come in, the small and midcap segment starts to outperform not only due to a PE multiple rerating but also due to earnings growth starting to catch up much faster because these are the companies which have been hit more by demand contraction, seeing utilization levels going down to 50-60 percent after investing into expansions in the last cycle and they are bogged down with heavy debt.
In addition to that, you also see that with higher inflation in the system, the interest rates have been going up for them and with the inferior credit rating, they are suffering more from a higher interest outgo. So, both these will unwind in the next three to four years and I would very firmly believe that the mid and small caps have very strong legs to go in the next three to four years as we see economy coming back to normalcy in terms of growth and interest rates softening over the next couple of years further.
Latha: S Naren of ICICI Prudential was with us earlier today and he was saying that yes, we saw the midcap rally. Now it is time to get defensive. You would think that we are entering danger territory and now better be left to the savvier guys to pick stocks and the individual retail investors should either give it to the mutual funds or stay with midcaps?
A: As a advice to investors, more so the retail investors we always maintain that mutual funds offer an excellent vehicle to create wealth for oneself over a longer period of time. One needs to navigate through different trades of undervaluation and euphoria and overvaluation, poor earnings growth, high earnings growth etc and it is very difficult for an investor to manage midcaps and large caps on its own.
So, historically we have seen that equities can give you a 15-16 percent kind of long term return whereas actively managed funds can deliver upwards of 20 percent CAGR over a long period of 10-20 years and midcap funds can do better than that within the hands of good fund managers. So, I sincerely believe that not only now but as an investment philosophy money should be invested in a very disciplined manner, systematically and steadily into equity markets across all times with professional fund managers.
Anuj: I was also looking at your select microcap series and the theme that stand out is MNCs. You have so many MNC companies stocks in your portfolio. Is this a delisting theme that you are playing, is this a scarcity premium that you are playing. What exactly is this as far as some of the MNCs are concerned?
A: There are a couple of things that we do in our midcap stock selection. We go for companies in the emerging businesses and sectors given the changing dynamics in the Indian economy and the Indian consumers which will give you long term secular growth be it in the areas of things like multiplexes, in the areas of hospitality, healthcare etc.
The other area that we also look at is companies which have a very strong parentage and have sustainable competitive advantage from a technology perspective or from a brand or from distribution. So, if you look at our five years approach into investing which is basically simple business, scalable opportunity, sound management, sustainable competitive advantage through a brand or technology which all results into the fifth step which is sustainable cash flows, profit margins and high RoEs which are all essential to create value.
The MNCs clearly figure there given that they are having great technology age and a monopoly in terms of various segments. So, that is where if you look at our holdings we have about 25-30 percent in MNC midcaps which really have shown ability to grow secularly over a period of time be it Bosch earlier or a WABCO or FAG.
Sonia: I was also looking at some of the other sectors that you have invested into and one of them is the home improvement theme, so we do have names like Hitachi Home, Whirlpool etc., but these are stocks that have risen multifold and have been the big multi-baggers of last year and some of them have actually cooled off this year. Is this a theme that one can still invest into and what are the other pockets within this home improvement theme that you would recommend?
A: I will not talk specific stocks but just to take on the question- with income levels going up in India and the urban consumer particularly starting to change his lifestyles, it has become very important to look at your house and also the interiors and the way you live life.
So, the building materials or interior improvement section is a big area of growth in India and as consumerization increases, that is going to benefit and as all of us know, India is highly underpenetrated from a housing perspective and also from the kind of interiors that we have, we see that there is a huge opportunity for consumer companies in the building materials space and also from a consumer durables space, as lifestyles change, as conveniences become more important and the ability to pay comes in, we will see a huge exponential growth in all areas including air conditioners to refrigerators to kitchen appliances and what not.
So, a year of underperformance or a slow growth is something of an opportunity for people to get in rather than to get worried about because on a three to five year trajectory, we are very confident that the Indian consumer is going to come back with a vengeance again and we are seeing already that the urban consumer is well positioned even in the last quarter.
Latha: Actually this the running theme. Anand Radhakrishnan of Templeton was with us earlier today and he was pointing out that there is a difference between the rural growth which we experienced from 2008 to 2013 and the probable urban consumption growth which is now the story. His point was consumer staples did well in the previous five or six years because that is what the rural consumer would first get into when he is in the money. Would you agree with that theme, is that why you have no consumer staples here or is it because there are not too many small caps in consumer staples?
A: As fund managers also we have been a little bit underweight on consumer staples even in the large cap funds. I would like to second Anand. Definitely the consumption pattern was shifting more into the discretionary space and if you look at the semi urban consumer he is probably looking more at premiumisation within the staples and within consumption he is looking more towards the discretionary part and that is where the big opportunity is opening up for you. Even the focus that parents of Hitachi, Whirlpool etc have on India gives you a very clear indication about where they think the growth is going to come from. So, increased focus on India as a market is something that is an indicator to growth potential basically.