Daily Voice | What makes banking and financials, realty and allied sectors interesting, shares Mahesh Patil of Aditya Birla Sun Life AMC

The numbers present a picture of steady recovery in the economy. On year-on-year basis, the headline number came higher than what the market had estimated, helped by very negative base of -7.4 percent contraction last year. On a two-year CAGR basis, which is a cleaner way to estimate, since it removes the base effects of last year, growth improved from -4 percent in Q1 and returned to the positive territory at 0.3 percent, which is quite respectable.

Importantly, both industry and gross fixed capital formation returned to positive territory after negative numbers in Q1 and there was a healthy rebound in services as well, though it still remain in the negative zone. Nominal growth stood at 18 percent YoY and 6 percent 2-year CAGR.

Remember, these numbers are from July to September and, at least in the first half of the quarter, COVID was still having a big impact in the economy. Since then, most high-frequency indicators suggested that the recovery momentum has gained steam.

We expect the sequential growth momentum to keep improving and an upward revision in market consensus estimate of growth for FY22 (currently at 9.2 percent as per Bloomberg). However, we are closely watching the evolving omicron situation, which is a key risk to growth upturn.

Do you think it’s time to increase exposure to debt and go slow on equity, given the expected change in the central bank’s stance?

Given the low interest rates, returns from debt will be low in the current environment. And, considering the fact that central banks are expected to raise rates going forward, it would not be advisable to increase exposure to debt as the value of a bond goes down when rates increase and hence returns get impacted.

At the same time, we have seen a 10-12 percent correction in equity markets over the past couple of months providing a potentially good entry point. Hence, it would be better for long-term investors to maintain their target equity allocation.

Investors who want to put in incremental lump sum amount can invest in a Balanced Advantage Fund or an Asset Allocator FOF as the decision to switch between asset classes is then taken in the fund.

What are the two sectors that one must have in the portfolio now to get healthy returns by end of 2022?

To capture the overall economic recovery, we like the banking and financial services sector. Banks have taken provisions for potential NPAs (non-performing assets) and raised equity capital. Asset quality has also improved. Since the bank balance sheets are in good shape now, they should benefit from the pick-up in credit growth. Since banks and NBFCs have corrected, their valuations have also come down to attractive levels.

We also like real estate and allied or dependent sectors like building materials and home improvement. After facing some headwinds for the last 5-7 years, some recovery is visible in housing demand, triggered by genuine demand. Lower interest rates and stagnant property prices have resulted in faster absorption of housing inventory. Organised funding to the sector has increased after RERA (Real Estate Regulatory Authority) implementation because the lenders are more confident now, and this has brought down the borrowing costs for developers dramatically.

The IT story is expected to remain solid going ahead, but is it time to reduce exposure to the segment as the number of positive surprises have reduced?

The IT sector has seen a run-up over the past 1.5 years. This sector should continue to see steady growth going forward, based on continued spending by corporates for their digital and cloud migration. It offers reasonable visibility to growth. And even in case the uncertainty due to COVID rises, the IT sector should continue to do well. So, we would maintain neutral exposure to this sector versus benchmark.

What are the biggest events to watch out for in the rest of FY22?

Two big factors to monitor over the rest of FY22 are the spread of new COVID variants and the trajectory of Fed tapering and rate hikes. New COVID variants like the recent omicron can spread quickly across the globe, leading to travel restrictions and lockdowns. This can have a negative impact on the economic growth and earnings growth which are key drivers for equity markets.

Given the strong economic growth in the US, the Fed was expected to accelerate tapering and rate hikes. However, with the new COVID variant coming into the picture, we will need to see whether it will slow down the Fed’s tapering and rate hike plans.

Have you changed your earnings estimates for FY22-FY23 after the September quarter earnings season?

The Q2FY22 earnings season was better than expected, driven by sectors such as technology, private banks, commodities and consumer and retail. However, there has been no change in our earnings estimates for FY22-FY23, given the uncertainties created by the new COVID variant, which can potentially impact earnings in the second half of FY22. Our estimates for the Nifty earnings growth continue to be 35 percent for FY22 and 15 percent for FY23.

You have recently launched a business cycle fund. How is this fund different and where can it fit into an investor’s portfolio?

As we know, any economy or sector goes through a cycle, which has four phases – expansion, peaking, contraction, and slump. And, different sectors perform well in different phases. While non-defensive sectors like consumer durables, retail, real estate, cement, banking and financials do well in the expansion phase, defensive sectors like FMCG, pharma and IT do well in the contraction phase. The key point is that the difference in returns between the top-performing and bottom-performing sectors in any phase can be as high as 25-35 percent.

So, in the ABSL Business Cycle Fund, based on our top-down view on the phase of the business cycle we are in, we will be taking relatively aggressive calls on being overweight or underweight certain sectors as compared to diversified funds. The idea is to capture the difference in returns between the top-performing and bottom-performing sectors in any phase. Also, instead of having a fixed template, we will understand the cycle of each industry to decide which sectors to allocate to. The fund also has the flexibility to invest in International stocks as well as in Fixed Income.

In terms of risk-reward, the ABSL Business Cycle Fund will fall between the diversified multi-cap funds and thematic funds. The fund has full flexibility to invest across sectors and market caps and will be a bit more aggressive than a typical diversified fund. At the same time, it will be less concentrated than a typical thematic fund. So, though the fund is classified as a thematic, it can be part of investor’s core diversified allocation.

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