Appetite for single-country investing is low: Eastspring

“The appetite for single-country investing is low,” he said, “as the dollar is a better hideout.”

FIIs flows were bad in 2016 and referring to forieng money in the new year, he said that 2017 will probably see some money being allocated into Asia/India. “India is a large market and it is not cheap which makes it difficult. India is the most expensive market.”

There may not be much growth in the next 12-18 months. The best outcome will be a flattish market which is optimistic, he said.Below is the verbatim transcript of Krishna Kumar’s interview to Udayan Mukherjee on CNBC-TV18.

Q: What do you think of the year gone by?

A: It has been a tough year, the global environment has not been favourable and everything has been bobbing around a little bit here and there. Looking into the next year, I am less hopeful because things the way they are shaping up it is not helping either the Indian cause or the way the Indian system is going forward. We have done few changes. There are few corrections; there are few remedial measures, which have been taken but honestly, I think it is going to be a very tough year going into 2017.

Q: Do you think it is only the first part of it which will be challenging as we wade our way out of this demonetisation thing or do you think even in this middle of the year once goods and service tax (GST) starts coming in that will present some challenges as well to the whole system, which might be another headwind for earnings to recover as you were expecting this year but which didn't happen?

A: The way I think about this is, it is not about demonetisation, GST; these are measures, which are constructive, these are measures which are possibly going to have a more substantial benefit over the long-term. The moment you say over the long-term, you must understand there is something in the short-term which we missed. The point that I am thinking about is when you take a step forward in terms of corruption and you want to address it systemically the impact is far longer than you can imagine.

The only case in point/reflection that we have of this nature of size is China when Premier, Xi Jinping took the step of taking corruption or rooting corruption out of the system. He started in 2014 and trust me it has taken him three years and all these measures take a long time. Now GST is equally disruptive and there is going to be a lot of informal businesses, which are going to be brought into the formal setup. So, when I say disruption, the informal business coming into formal business will render a lot of them out of business. You got to think about these two things when you think about whether it is a first half or second half. Honestly, I am not very sure whether it is a three year or a six month kind of a window when this corrective phase goes through.

Q: I remember our last discussion when I was talking to you quite many months back and you were making the point then that if capex does not pickup and it hasn't yet then this market will struggle to move higher and valuations on hindsight might appear quite stretched and capex has not only recovered in 2016, now the prospect of recovery might have got postponed with all that has happened. Does that make you nervous that after 5 years of waiting for capex, we have probably kicked the ball down another year, year and a half down the road?

A: Yes, I remember the conversation - we were hoping that capex come in to salvage whatever has been lost and the capex which has been very illusive - obviously the private sector is very reticent about capex and not willing to put the dollar on to the ground. The point here even now is that the state owned enterprises still have a lot of cash and the ball has to be set rolling by them rather than anybody else and it is in the realms of reality that this can still happen and it is not farfetched.

We have seen some semblance of capex on the ground, but which I don't think is going to be enough at least for now to kick-start. There has to be far more serious effort. You have to have that initiative in roads, ports, airports and a whole lot of them. I have not heard too much, but people keep talking - it is the Indian corporate world which kind of keeps hoping and dreaming that defence budget will go through the roof and infra projects will kickoff, but this normally has a 6 month lead that corporate are given a heads-up and I am still not seeing it honestly.

Q: What is the global backdrop and what is the sense you get when you speak to your end investors because in the last month or so it appears that the big boys are running US, Japan and people don't seem to have that much mind space about emerging markets with the way the dollar, the US bonds and the US equity markets have moved? Do you think we could be overshadowed, I mean people will not spend enough time looking through the pain in a small market like India when there are gains to be made in their own market?

A: The dollar trade is a consensus trade, the dollar trade is a safe haven trade and that is kind of getting completely consumed. People are shading other currencies and moving into currencies, which is more safer. Is that overdone? I wouldn't know, but the important point which I keep hearing from investors is they are very reluctant to buy country funds. So, even if they want to buy, they have to look for Asia funds and they want to look broad based investing styles. So, they don't look at country allocation which is now increasingly high risk for multiple reasons. One is the economies are not very strong; second of all the currencies are very volatile and they have become extremely volatile in these kind of conditions.

In the process, the allocation for country dedicated funds is increasingly minimal and so the global backdrop as it appears, that the appetite for a single country fund is very low and partly because of their own doing and partly because the dollar is obviously a better hide out.

Q: In 2016 we hardly got any money into the country in terms of dollar flows, FII flows. Do you think 2017 will be more of the same?

A: My sense is we get allocation into Asia funds and Asia funds then allocate into India. We have seen some flows; we have been on the lucky side where we have seen very strong flows this year in 2016. 2017 we have got early signals that we will get more money, which will get allocated to India/Asia. However, that doesn't mean much. It is like India is a very large market and you needs lots of money, lots of interest to kind of provoke a larger allocation. India is also not very cheap, which makes it more difficult for India to receive any money at all. In the backdrop that you can see with the other emerging markets, India is the most expensive market and it is pricing in a lot of growth, which is obviously very illusive.

_PAGEBREAK_Q: You are using the word expensive after a fairly significant correction in stock prices and may be not at the level of the Index yet but after this demonetisation thing, a lot of consumer facing franchises etc have corrected, but not significantly enough yet in your book?

A: No, I don't think so, there are multiple issues here. First is India is a growth market and we price in growth, P/E multiples whatever it is. When growth becomes illusive, this market should possibly trade lower and the effective outcomes could be multiples, which are significantly back to the median levels or may be one standard deviation cheaper.

When I say that the correction, which has happened is hardly a correction if you think about it this we have not seen any growth in last two years, we don't see much growth in the next two years. At least for the next 12-18 months there is not too much growth which has been factored in.

Consensus numbers are still sitting up there, which will need to be kind of downgraded. If these things happen the best outcome would be possibly a flattish market, which is very seriously optimistic.

Q: Did you use the phrase you don't see any growth in the next two years that would be a very scary outcome for the market? You think it possible that this market will keep on waiting and for two more years into 2019 fiscal you are not going to see any meaningful growth recovery?

A: As we stand - on this purge the answer is yes, but for the next 12 months 5-6 percent growth is not meaningful growth - that is not the price that you pay when the markets are trading at these valuations. When you are thinking about next 12 months and then thinking beyond rolling it over for the 24 months - the back off a couple of years of flat growth if you get about 15-17 percent growth it is going to be reasonable, but is not going to be spectacular and you wouldn't pay a premium, which is going to be very difficult to justify.Q: So, what do you do as an investor now? You are a professional investor, you manage portfolios, you put cash to work, what do you do in a scenario like this?A: Our job is a tough job. Making money in these kind of markets is going to be very difficult. However what we try and do is to sit away from consensus. Sitting away from consensus sometimes is a lonely trade but that is where the money is to be made. When I say that, we kind of look at names which are unfashionable, sectors which are reasonably beaten down and it is not kind of populist, you can kind of go and buy these sectors.So, we think about names which kind of are not in what is called as momentum or in the fashionable space. The other bit which I must add as a caveat is, we think that what numbers we use in our models are basically normalised numbers. We don't think about next 12 months, 24 months. We think about normalised numbers over the next 3-5 years. When you put those numbers you will see that value emerges and when value emerges you get opportunities.Q: When you say anti-consensus, what would fit the bill in the Indian context right now? Are you referring to something like IT which most people seem to be underweight on or that is not the kind of sector that you are alluding to?A: It could be. Indian IT is one of the sectors which kind of is not fashionable to be in for multiple reasons - margins are under pressure, US is constantly threatening  to be more patriotic, policy and tax laws will change, all that is fair bit of noise. When the negative news flow rises these stocks tend to kind of trade at close to zero implied growth which is the right time to kind of probably one to think about.There are a few more sectors which are very unfashionable, you can guess what I am talking about. There are opportunities there where people kind of see last two years and say that this basically a value trap. However when we normalise numbers you will realise that when it gets back to the trend line you will see opportunities.Q: What about things which had become fads maybe six months back - NBFCs- stocks were trading at 4-6 times book, they have collapsed since demonetisation happened from a lofty valuation levels admittedly. Many of them are down 40 percent. Do you see any value there or do you think these business models will now be seriously challenged?A: Banking and financial space is basically a space which is going through enormous amount of change. The premium that we used to pay for franchise, premium we used to pay for licenses, premium we used to pay for the ability to kind of lend, they are all changing. Things are changing, the paradigm is shifting very rapidly. There is no reason to pay multiples of 4-5 times book, things will normalise. The growth of 40-50 percent that we have seen in the segment is also going to normalise. When it normalises these things will start trading at more sensible valuations. I don't think they are anywhere close to sensible valuations.Q: Let me ask you another question about 2017, which is if you think monetary policy or interest rates will play any meaningful role in helping equity returns over the next four quarters?A: I am not so sure. The first thing is that whenever I talk to Indian corporate or Indian analysts, we kind of keep talking about rate cuts and monetary easing but I think the rate easing cycle is pretty close to done. There is very little room left. If one has to benchmark the inflation deferential or whichever way you want to cut it, the rate easing cycle is pretty close to an end. If that will be the scenario, you are left with only couple of options, that equity will be the way you end up making money. So, there will be equity flows which will mean that the money will probably kind of keep the markets flat and valuations will look stretched. It is going to be a scenario where till growth comes back or earnings revisions start happening upwards, you will see that any amount of monetary impact is going to kind of not help earnings.Q: Is that the scenario that you are leaning towards that you may not see a major price correction from here but you may have a prolonged time correction with stock prices being very sticky on the way up, do you see that kind of a phase - 1-2 years of an extended time correction for this market which will be frustrating?A: I suspect so. I think in the next 12 months if I were to look at crystal ball and think about the next 12 months, it is going to be a flattish market. Good news is going to be difficult to digest, bad news will get digested quickly and one will have to struggle the troubled waters or wade through troubled waters, corporates will find it difficult to make money because margins will kind of immediately come under pressure as GST and other anti-corruption measures keep rolling out. It is going to be a difficult 12 months as I see  it till the capex comes in, tax revisions happen, there is more money available in the system for capex to break the ground and also that translating to earnings is going to be a further prolonged process. So, I suspect that it is going to be a bit of a boring 2017.

Q: Can government policy change anything around because there is a hope that having stung the market with this demonetisation thing the government is now looking to salvage something and maybe rekindled animal spirits with it budget or before that (a) do you think it is possible and (b) what is possible or doable which can change sentiments or more importantly earnings around?

A: This is in two parts; first part is the demonetisation - those are jargons and details. The effort is corruption. The initiative is to remove/eradicate/curb corruption. If that be the initiative it is not over it is not over, it is going to be long drawn, it is a substantial drive - so that will keep carrying on. The counteract is basically tax benefits, if you are going to curb people from being corrupt you have to possibly ease tax measures, which is basically cutting tax rates back which releases consumption that is part one.

Part two is you have to kind of cleanse the system and allow easy business operations - so ease of business will have to be kind of first thought through and that will possibly be the two key initiatives that will be taken up in the next few months as we keep talking. My understanding is that the government is completely cognisant of these facts that first cleansing and/or clean growth is absolute imperative.

Q: Do you see politics playing a role in 2017. We have got some big state elections, does that cause any nervousness or volatility or does it have the potential of doing that?

A: Politics is being discussed by everybody and everybody is an expert in politics. The fact is that does it matter too much in the overall scenario - UP election will matter it is more sentiment driver. Does that change the game, does it make the centre or the government stronger - maybe sentimentally yes, but the centre has a mandate which is very strong in any case and the policies that are being rolled out is reasonably suggestive that they are in control.

The peripherals which are basically state elections, Budgets these are basically sentiment boosters, but do they change earnings, will they kind of drive the top Indian corporate to put the dollar on the ground, which we will have to wait and watch. The ease of doing business because of this political changes will that get impacted that is what we need to see. I suspect that there are several things that can happen; first is you will have tax rates cut, you will have ease of doing business - so there will be some more measures which will kind of attract FDI, then you will have UP election those are positive indicators but they could be positive sentiment drivers as well.

Q: How should longer term investors approach 2017? I am asking on behalf of a patient investor who is willing to look beyond the next 4-5 quarters. You understand there is pain, there is disruption and there will be no growth for the next 4-5 quarters but through this year if you get big dips in stock prices for whatever reason is it going to be a year of accumulation in your book or the case for buying stocks or franchise is not that compelling according to you?

A: India is a fantastic market. It gives you opportunities all the time. 2017 will be a year when there will be enough opportunities because bad news will get digested very quickly. If bad news hits the ground and possibly hits the tape and you get opportunities, you will get opportunities. I am very certain that the way the globe is turning out to be, there will be volatility as always and that will give really good opportunities in India.

Having said that, don't get me wrong, I want to correct the context here, 2017 is going to be a difficult year is what I am saying. 2018 possibly as a follow through could possibly bounce back a bit. However 2017 will as every other year you will get opportunities and the opportunities are there to be grabbed, it is for people to kind of hang in there.

Our investors have been very sticky and they have been hanging around, they have been making money over the last 3-5 years, so they have carried on holding. If there is a period of 1 or 2 years where markets get disrupted, slowdown, some of the measures are good measures, it will emerge as a far cleaner market and I think there is opportunity there.