Indian equities good long-term play: KKR

The US Federal Reserve will be pumping USD 85 billion as QE4, but worries of ‘fiscal cliff’ are still weighing on investor sentiment.

In an interview to CNBC-TV18 Henry Mcvey, managing director, KKR shared his reading and outlook on the US markets. He says, with the extension of quantitative easing three (QE3), Fed is basically is trying to create a buffer to prevent deflation and also prepare the markets for risk taking in 2013.

Henry believes that regardless whether the fiscal cliff takes place or not, growth will be very slow in the Q4 and in Q1. Fundamentally, he is cautious on US GDP growth for the near-term.

He feels in the second half of 2013 and 2014, US will see good growth on the back of housing, energy revolution, autos rebounding and good manufacturing activity driven by competitive wages and lower input costs.

Meanwhile, Mcvey is bullish on India's long-term story and feels that on structural basis, Indian equities are good long-term play. 

Below is the edited transcript of his interview on CNBC-TV18

Q: The Fed has now made it clear that they will be pumping in USD 85 billion every month that is QE4 (Quantitative easing). What can this do to risk appetite and how do you see risk assets in the first half of 2013?

A: I think the Fed statement is very significant, they are essentially tying their policy to unemployment and inflation and they are making it explicit, that's point one.

Point two is that they are actually now buying even more bonds. So it is an extension of QE3, so this is a big deal. My base view right now is that a lot of the market headlines and action will be dominated by what's happening with the fiscal cliff but I think the Fed is trying to create a buffer to prevent deflation and also prepare the markets for risk taking in 2013.

Q: How do you see the first quarter of 2013 panning out in terms of risk appetite assuming that the fiscal cliff issues will be resolved in some fashion by then? Do you think that a risk-on will then resume?

A: Well the market has actually not done that bad since Barack Obama’s re-election. Regardless of whether the fiscal cliff takes place or not, our prediction is that growth will be very slow in the fourth quarter and in the first quarter. We see this as somewhat of a mid-cycle slowdown.

On the fiscal cliff, our best estimate right now is it should add about 1-1.5 percent drag to GDP in the near term. So coupled with our fundamental view that growth is slowing in the near term plus a fiscal cliff, we are quite cautious on GDP growth in the near term.

Importantly, as we look towards the second half of 2013 and into 2014, we see some pretty good growth. One is driven by housing. Two is driven by the energy revolution we are seeing in the US. The third is autos are still rebounding and the fourth thing is we are actually seeing some good manufacturing activity in the US now driven by competitive wages and the benefits from lower input cost.

Q: What will smart money chase in the first half of 2013 and will the asset allocation change in the second half of next year?

A: Our base view in 2012 is we wanted to do two things. One was not own government bonds and own credit because we thought credit would be a decent performer and with less volatility than equities. And second is we were very focused on income producing inflation protection assets; energy, oil, oil producing fields, things like that, real estate.

At KKR we do a lot of different things, we are a global firm, we have USD 65-70 billion in client assets, we take a long-term view. We do everything from taking companies private to providing lending to small to medium size businesses, to buying equities. So there are a lot of different opportunities we see in the market. We are still constructive on the Emerging Markets (EMs) particularly on consumption that’s a story we will talk about in India. We still like parts of credit; in particular we like lending to small businesses where we can partner with them and help them grow.

Then there is just an assortment of other relations and business opportunities that we see in the US, in Europe, across a variety of assets. But one area in particular is we remain very confident that we want to buy income producing inflation hedging assets. So we have been doing a lot, buying oil fields, natural gas fields, and real estate.

In KKR we have a USD 7 billion balance sheet, so most of the time we are investing right alongside our clients. So while there is a lot of macro headwinds out there, it is actually a pretty interesting time to deploy capital where you see these imbalances being created by downsizing in the financial services system or some type of macro dislocation.

_PAGEBREAK_

Q: Do you expect the recent rally that we saw in Indian equities up until a couple of weeks ago will continue in the first quarter of 2013?

A: I think Indian equities are good long-term play. Again we are not trying to short-term time the market. My base view is you will get some dislocation in 2013, as people make different pledges about the elections and so it could be a little more volatile. But on a structural basis, equities in India right now seem to be about fair valued to slightly under valued. I think they were depressed coming into 2012, they had a nice rebound but we still like the long-term story.

One thing we should talk about is Ithat ndia does need to tackle some of its macro headwinds and number one on that list would be infrastructure and number two would be inflation.

Q: What about India’s growth trajectory, do you expect it to get back to the 8-9 percent pace or do you think it will remain at the same 6 percent mark for a protracted time as your report seems to hint?

A: Let me give you my logic. India has a labour force growth of about 2 percent, they have been running with productivity around 5-5.5 percent and that’s got you GDP growth of 7.5-8 percent. Right now the labour force growth is still growing at 2 percent, that’s a good thing but the productivity is coming down from lack of investment. So the economy just reported a 5.3 percent GDP year over year. That is about a structurally low as the Indian economy can go.

It is essentially telling you are getting labour force growth plus a little productivity. Right now we haven’t seen fixed investment or infrastructure investment go up enough to drive the productivity back up. So unless the global economy really accelerates I think 6-6.5 percent is a reasonable number. To get much higher you need to see one, inflation come down, but two, more importantly you would need to see investment in infrastructure.

Ultimately, when you look at the big dominant EMs, we are talking about China, India, Brazil, where India can change and leap for some of its competition, if the government as well as the private sector create greater efficiency through the infrastructure investment and that’s not happening right now. Our view at KKR is that obviously it’s a significant opportunity.

India has got a huge demographic tailwind, there are only a couple of countries that I visited around the world where half the population is of the age 30 years or under, and India is one of these countries. We think the urban middle class is going to grow and there are a lot of opportunities there. But we need to get the base block building in place to allow that growth. What I am talking about is more infrastructure and they need to take it up to 25-30 percent of GDP.

Q: India has allowed foreign indirect investors (FIIs) to buy a lot of local debt USD 25 billion of government debt and about USD 50 billion of corporate debt in particular infrastructure bond paper, do you see a lot of appetite for this corporate-infrastructure bit from investors like you?

A: We as a firm, do not do a lot in that area, so it is probably not an area of expertise for me. Getting back to the same premise, one is you have to create a framework where investors think they can earn a decent return and two, is their capital is not at risk. Recently, they changed it but we had some problems with the Vodafone situation in foreign capital.

I hope I am saying a similar message, which is it is about creating long-term incentives whether it is local capital or private capital, you need to create incentives where you can earn a decent return not an excessive return and then the capital has to feel like it is protected from some massive change. I think whether you look at foreign investment coming in and the changes recently in terms of are you going to allow foreign direct investment (FDI) into things like retail or what you are talking about that type of uncertainty again it raises the cost of capital. It is a same type of impediment that something like inflation does. So it is about creating certainty in the environment.