Daily Voice | This CIO says FPIs still believe in India story, will invest once the China reopening theme plays out

“There are opportunities in small-, mid- and large-caps, but nothing is available at a very low valuation,” he highlighted.

Meanwhile, A Balasubramanian, Managing Director & Chief Executive Officer of Aditya Birla Sun Life AMC, is of the view that the capital sector will definitely continue to remain the beneficiary of the government’s focus on infrastructure sector, especially after the recent Union Budget. Edited excerpts of the interview:

With manufacturing and infrastructure being the key highlights of the recent Union Budget, railways and defence-related announcements were keenly tracked. Despite positive measures being announced, the reaction of several railway and defence stocks was negative. Are we reading a bit too much into the stock movements or did we miss something?

Patil: Along with the focus on infrastructure and road sector, the railways also has seen a big increase in rolling stock. The outlay for the railways is high, but within that, rolling stock is where there has been a significant increase. The whole allocation is more towards rolling stock and not towards laying of railway tracks, which has more to do with infrastructure. Hence, companies which are manufacturing and selling locomotives and wagons should benefit. So (in) railway companies, which are more into infrastructure, construction and track laying, there was not much of an uptick. To a large extent, some of that was already expected because the orders for some of these locomotives were already in place. And from the market perspective, probably that was not a big surprise, which is why (there was a) fall in some railway stocks.

Talking about the defence sector, the growth or allocation was slightly lower than what the market had expected, because this is an area where the government has been talking about increasing its spends. However, I think, it is more about trying to indigenise imports rather than a substantial increase in the defence budget. Because a lot of the defence expenditure goes towards paying off salaries of the defence personnel. The growth of 13 percent would hardly leave something towards capital expenditure which could be the reason defence stocks reacted negatively.

So, the next question is, do you see any themes or sectors that are emerging, specifically after the Budget?

Patil: Focussing on capital expenditure, clearly capital goods, industrials and manufacturing are the emerging sectors. The government’s focus on manufacturing is visible in this Budget as well, with the industry being given some protection in terms of increasing the customs duty and at the same time reducing the import duty on certain key imports. Plus, I think, along with the focus on infrastructure and road sector, railways also has seen a big increase in rolling stock. Apart from that, I think the big negative was on the insurance sector. On the consumption side, there has been some amount of savings, with the change in personal income tax slabs. The rebate has also been increased. This would improve the purchasing power of the people, especially in the lower income group, and that should stimulate some consumption in a big way.

Balasubramanian: According to me, the capital sector, definitely, will continue to remain the beneficiary which actually contributes to the success of the infrastructure segment. More money in the hands of people, along with rural focus, should boost consumption. Rural-led demand could also trickle down to the automobile sector. The Budget announced that government-owned vehicles of more than 15 years have to get scrapped, which essentially means that government-led demand could also provide a fillip to the auto sector.

Moving ahead, is this the time for investors to put money in large-caps or is there some steam still left in mid- and small-caps as well?

Patil: From a long-term average perspective, the Nifty 50 looks fairly priced, whereas the price to earnings (PE) multiple or the price to book value (PB) multiple is near the long-term average. So, the large-caps look fairly priced, and there are pockets in certain sectors where valuations are still attractive and value still exists. In the mid- or small-cap space, valuations are also not exactly cheap, somewhere near the long-term average, and in the near term, the risks are probably because of the current market volatility and concerns about growth, which might not take them too far, but from a medium to three-year perspective, I think the mid-caps can exhibit a better growth rate and earnings growth. So, the forward multiples will start to look more attractive. There are opportunities in small-, mid- and large-caps, but nothing is available at a very low valuation; they are in the fair zone. And that's the reason why investors should really make the right asset allocation across the spectrum. From a near-term perspective, do I think large-caps will still be slightly favoured? Yes, because they provide more stability to the portfolio.

Some of your top holdings are banking names. What is your reasoning for that?

Patil: Banks are seeing credit growth picking up, which supports topline growth. The sector is witnessing an improvement in margins, because higher interest rate is leading to higher pricing of the asset side, rather than on the liability side; the increase is happening with a lag. Overall, the corporate NPA cycle is now quite benign and credit cost is at an 8-10-year low and that is what will drive the profit growth for lenders. Also, corporate credit growth is still weak, but is picking up slowly. It has been sluggish now for the last two-three years, but as the capex story picks up with the government’s continued focus on infrastructure and large projects, we should see corporate credit growth slowly improving, and that will really help sustain the overall credit growth, which is primarily driven by the retail at this point in time.

Moving slightly away from the topic that we are discussing, do you believe FPIs will get back in the game soon?

Patil: Overall, FPI ownership in Indian equities has come down, and domestic ownership has gone up in the last one year. FPIs have been positive on India, and last year, we saw a huge amount of outflows from emerging markets, and that impacted the flows, but India, literally did better. We've seen FII outflows being primarily because of the fact that Asian markets like China, Korea and Taiwan had corrected significantly last year, which made valuations attractive, and with China opening up trade, several FIIs are playing that trade from a short-term tactical perspective. That is the reason why the inflow figures to India have been negative. But I think most of the FIIs still believe in the India story. Long-term money will definitely come into India in two-three months once the China trade plays out, and we see that the valuation differential between India and the other emerging markets has also come down now. On the global front, overall investor sentiment and risk environment are now improving, and with dollar weakness, we should see more money moving into the emerging markets.