India-dedicated funds may see flows in 2013: IIFL Capital

Deepesh Pandey, Head of Investments of IIFL Capital advises investors to adopt a 'buy on dips' strategy as he expects markets to outperform in the near-term, citing fair valuations. India has been getting a higher share of the FII flows and the trend is most likely to continue if the government delivers on reforms, Pandey says.

Foreign investors have been betting big on Indian equities in the last few months on the back of a slew of economic reforms initiated by government, pushing up BSE benchmark Sensex by about 25 per cent in 2012 calendar year.

"Right now, India dedicated funds have not really seen a pick up in terms of inflows and one could see same trend in domestic markets, where domestic mutual funds or insurance companies, have not really seen strong inflows.

This is something, which is very critical for market to sustain this rally beyond next six months and I would hope that as economy gains momentum these flows will pick up and India dedicated products will start seeing interest from investors and I think that is very crucial to sustain this rally," Pandey told CNBC-TV18 in an interview.

In terms of strategy, Pandey is looking to play the current rally through banks and media companies. “It is still too early to bet on an uptrend in infra and capital goods company,” he says.

Below is the edited transcript of Pandey’s interview with CNBC-TV18.

Q: Do you see more upside in the near-term or has the market run up quite a bit already these last couple of months?

A: Markets have run up a lot in last few days, December historically has always been a strong month. In the last 10-12 years markets would have done extremely well in 8 or 9 out of those 12 years. There is more upside left and newsflow incrementally has been reasonably positive. Therefore there is more upside in the very short-term.

Q: Are you approaching the Indian market with a buy on dips strategy?

A: Right now it looks like that way considering that valuations still have not gone haywire. There is reasonable expectation on interest rate cuts coming up over next few months. Newsflow generally has been positive, at least in terms of policy framework, may not be in terms of economic data.

These things make me positive. There is a bit of momentum going on. Global markets are doing well. All combined together should result in strong performance for India in the short-term.

Q: How much are you betting on in terms of political policy to help this market along and how much of a catalyst do you think that is going to be?

A: That is a very strong or much needed catalyst in the short-term with the parliamentary session going on right now. We have seen a successful pass-through for the retail FDI increase and government has hinted at more bills and some of these bills will not face as strong opposition.

Government has again expressed its commitment towards reform process. I expect a smoother ride going ahead. The initial session has been good. Therefore, reforms and policy announcements will remain a very key driver for the market in the short-term. Initial trends are positive in that direction.

Q: How much of a role do you see China playing both in terms of what its recovery means for the commodity stocks in India? Also will it takeaway some capital from India in 2013 if that market starts performing?

A: India has historically commanded a high share of foreign flows coming into Asia. We have seen very strong trends this year. If India takes care of its fundamentals and growth wise it still remains one of the top three markets in terms of pure economic growth, then India should still command a reasonable allocation. I do not think we should be fearful of China taking away some of those allocations.

There could be some minor tweaking, but historically India over a longer time period has attracted large proportion of foreign flows. If we keep on delivering in terms of improving momentum on economic numbers, policy reforms, India should still attract sizeable flows going ahead into next year. Even this year, in spite of all negative news in first half, India did attract a majority share of foreign flows. So, that should continue.

Q: What is your expectation of how the market does at the start of 2013 through the January earnings quarter and getting close to the budget in February?

A: It is very difficult to really comment specifically on what will happen in short-term. Purely in terms of historical data, January is typically a weak month, so I would expect same to repeat. Coming into February-March we will see expectations for budget getting built up. One may see possibly a rate cut taking place for which there is a high probability in January. So, markets should remain reasonably buoyant.

Government is repeatedly reaffirming its commitment to reforms and there should be more policy announcements including National Investment Board (NIB) including some announcements on Goods and Services Tax (GST). The backdrop is reasonably positive - rate cuts, policy announcements.

First quarter should again remain strong, but as we approach second half of next year, there will be nervousness about election results coming up into 2014 and that will be interesting period to watch.

By that time, one would expect to see some momentum in economy picking up, some improvement in terms of growth rates. Right now it is very weak and one would hope that will pick up and that should drive the next phase of rally.

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Q: Do you hear of fresh money being raised for India specifically or long only money beginning to get invested or is this a scattered emerging market call where they are chasing performance via ETFs or otherwise?

A: I think the biggest puzzle of this rally, and this huge inflow into India has been that India dedicated funds actually have seen net redemptions year-to-date (YTD), and that is not a good trend. So, you could say that some of this money is just chasing momentum; some of this money is ETF driven, some of this money is global emerging markets driven, which basically maybe chasing momentum in this market. 

I would say that right now, India dedicated funds have not really seen a pick up in terms of inflows and one could see same trend in domestic markets, where domestic mutual funds or insurance companies have not really seen strong inflows. This is something which is very critical for market to sustain this rally beyond the next six months. I would hope that as economy gains momentum, these flows will pick up and India dedicated funds, India dedicated products will start seeing interest from investor. I think that is very crucial to sustain this rally.

Q: If you expect to see outperformance, tactically have you begun to switch to high-beta versus some of these defensives?

A: Over this year, we have been overweight on interest rate sensitives; primarily through banks, non-banking financial companies (NBFCs) and media sector. We are looking for more opportunities in investment led sectors like infrastructure, engineering companies but I think it is quite early to get onto those sectors. Right now, it makes sense to play this rally through interest rate sensitives; primarily banks, maybe media companies and some consumer companies. For infrastructure, engineering companies, it is slightly early to bet on this trend right now.

Q: You are sure if not in December then by January, the trend of interest rates coming down will be in place. You are not expecting a shocker from the Reserve Bank in January, saying that they will hold on for further and see more inflation data?

A: There are enough indicators of late, including comments which have been attributed to the governor that a rate cut should be expected and the RBI is cognizant of the playoff between growth and inflation. So, there is very high probability of a rate cut in January but one must remember that a small 25 bps rate cut would not really change the trajectory. You need to see sustained rate cuts. You need to see sustained policy reforms, so that there is appetite to invest.

A small rate cut will result in a short-term rally, but beyond that there will not be real impact on economic activities. So, the jury is still out, on how much impact a small rate cut can have on the markets and on the economy.

Q: How excited are you about the primary offerings, which are coming in both from the government and also from the larger private players like Bharti Infratel? Do you sense a lot of appetite or interest?

A: It is very issue specific and it is heartening to note that there are some reasonably high quality offerings which have come up in last few days, including some by private sector banks. Few more are coming up, and some of these are quite reasonably, attractively priced. Therefore, you could see a record interest in some of these offerings. It is very-very issue specific. Looking at the secondary market performance, clearly there is much more appetite for primary issues, and wherever pricing is appropriate, you will see very strong interest, especially considering the huge flows and huge appetite we have seen for such offerings in last 6-12 months.

Q: Are you feeling more confident given this backdrop that we have got limited downside gong into next year? Even if January is a more sluggish month would you say downside risk is limited for this market?

A: I would agree that the downside risk is limited. Stock prices and market has just caught up in terms of earnings performance in last 12 months. 2011 was a pretty bad year, 2012 has been a reasonably good year. It is not that we have done any phenomenal run in terms of two year performance in terms of stock market. So, I think downside is limited. We were extremely oversold at the beginning this year and market has caught on. Midcaps and small caps, were particularly oversold. I would think that there is limited downside unless there is some major negative event including early elections or something happening in Europe.

Q: You were talking about a couple of spaces like banks and media. Any other dark horse sectors that you are calling for 2013; spaces that seem undiscovered and undervalued?

A: As I said earlier, midcaps and small caps still offer a lot of opportunities. That is a space, which you cannot really break in terms of sectors, but there will be more bottom up opportunities there, so that is a space which I will look at closely. Besides that, government owned banks should reverse some of their underperformance, purely because there is this catch up trade going on right now where laggards are just catching up in terms of performance. That trend should also build on, so these are few of the segments. In the second and third quarter of next year, one could possibly look at engineering and infrastructure, but right now it is very early to look at those segments.

Q: What are your big avoids? If you had to segregate the big underweights that you have, what would those sectors be?

A: Consumer sector is one because valuations look very high over there. We are seeing some moderation in top-line growth in some of these companies, so that is one sector which will lag in a rising market. For IT services sector as well, especially for the large companies, this quarter is turning out to be quite weak. Therefore amongst the large cap companies, I would stay underweight in that segment. Next year would possibly turn out to be much less positive versus analyst expectations. We have seen Cognizant giving a reduced guidance for next year.

Beyond that, even some of the debt laden asset heavy companies in infrastructure segment remain avoidable for sure because they will take a lot of time in terms of repairing their balance sheets. Cement, also has had a fair run. Cement prices have been correcting of late and valuations clearly look very high at very high profitability. So, that is another sector where I would stay underweight.