Equities look good from three-year perspective: ICICI Pru

It is a good time for long-term investors but a very confusing one for short-term traders is the word coming in from S Naren CIO, ICICI Prudential AMC.
When asked if he saw a huge outflow from mutual funds due weakness in the market and lower foreign institutional investor (FII) inflows, Naren says funds haven’t really seen huge redemptions so far. In fact, they have been getting around billion dollars of investments per month, he says. Categories like the hybrid funds have become extremely attractive for investors, he says in an interview to CNBC-TV18.

He is comfortable with an investment perspective of three years into cyclicals, financial services, oil and gas and telecom because he does not see any major pick up in the economy from a one-year time frame. According to him next one is going to be difficult for markets. He also does not expect domestic investors to stop systemic investment plans (SIP) since the other assets like gold and equities are not giving substantial returns.

Although currently, the Nifty and Sensex seems to have underperformed midcap index going forward over a three year timeframe when the FIIs come back, the largecaps will outperform the mdicaps, says Naren.

He also likes the regulated utility space, private banks and auto space, which are spaces with lower risks and reasonable returns.Below is the verbatim transcript of S Naren's interview with Latha Venkatesh and Sonia Shenoy on CNBC-TV18.Latha: What is the Samvat 2072 looking like, are we going to see a lot more cuts before you start to see genuine buying?A: The year going ahead has to see a slow recovery in the markets given what has happened over the last one year and we no longer have the possibility of big rate cuts happening immediately. So consequently we think that this is a very good time for investors and a very difficult time for traders given the global environment of possible rate hike in December and poor earnings season and the slow recovery in the economy.So on the whole I would say that it is a good time for long-term investors in equity and confusing time for traders.Latha: Domestic institutional investors (DIIs) have also been sellers on several days. Why is that, is it that you are uncomfortable with valuations or is there any dip in the mutual fund flows, are mutual fund investors scared at all?A: There has been virtually no outflow from mutual fund, there has been huge inflow into mutual funds. So I don’t know where you are seeing the DII numbers because on a continuing basis, if you see we have been getting almost a billion dollar of inflows into mutual fund equity schemes per month over the last many months. So I would say that Indian investors have been very underinvested in equity and they are using the current slowdown in the markets to increase their allocation. We have not witnessed any slowdown in inflows so far and we think that categories like the hybrid funds are extremely attractive given that we are in a lower return equity situation at this point of time.Sonia: In the last one year, the sectors that rule the roost were the technology and the pharmaceutical sectors. In the next one year, do you think that baton could be passed to some other sectors and if yes, who could the leaders be?A: Over the next three years, many of the cyclical sectors like financial services, oil and gas, metals, capital goods, utilities, telecom all of them should do very well. The outlook for the next one year is not that clear because at this point of time, we are still not seeing any major pick up in the economy. So we are very clear that from a three-year point of view, the sectors to bet on are the cyclical sectors. However, on a one year point of view, as long as investors are patient for the next three years, the opportunity is in the cyclical sectors.We have seen a good correction in many of the individual pharmaceutical stocks so the sector is no longer overvalued across the board as it used to be a quarter back and technology has been reasonably valued except that the outlook for growth on high basis of each of those companies that have deteriorated.So I would say both these sectors look average to me, some of the stocks have corrected 30-40 percent and they no longer are as costly as they were a quarter back.Latha: One of the trends that we noticed in Samvat 2071 was that the Nifty and the Sensex didn’t go anywhere but individual stocks give great returns, the midcap index itself gave a 14 percent return, so is it that in the year ahead as well, growth will come but it need not necessarily be seen in the Nifty stocks but will be seen in various other categories?A: The biggest reason why the Nifty and the Sensex underperformed the midcap index was a fact that there was substantial selling by FIIs particularly in the last four months whereas on the domestic side we have seen continuous buying over the last one year. So I think that is the reason that the selling by FIIs were primarily directed at largecaps and that too the economy sensitive largecaps where people were counting on a huge fast recovery in the economy.I would say that going forward we have been of the view that largecaps are much more attractively placed vis-a-vis midcaps because whenever FIIs turn their view and start investing in equities, I believe they would invest in largecaps, which is why for the long-term we have been recommending pure largecaps over midcaps at this point of time.Sonia: I was going through some of the stocks in your portfolio and one of them that you have been bullish on for a very long time is Power Grid. Of course that stock has not given you much returns this year, it is in fact down 7 percent in this year but I just wanted to understand how this theme could play out in the next six-twelve months and is there still a lot of potential in the power or power utility space?A: We don’t talk on individual stocks but our view has been that we are in a more moderate return situation and any sector where the returns are regulated and have a reasonable outlook for the next three-four years, we thought it is beneficial to look at on the regulator utility side is one of the areas where for the near-term the returns are kind of capped. At the same time, we believe that we are in a more moderate return situation which is a reason for interest in sectors like regulator utilities, private banks etc because these are all sectors which are expected to give reasonable returns and at the same time, the risk in some of these sectors like regulated utilities are much lower than what you get in many of the other sectors.Latha: Do you expect with the NDA defeat in Bihar or because the earnings growth is getting postponed or because you are seeing these FIIs selling, the domestic investor to turn at all to plateau, to stop Systematic Investment Plan (SIPs), any such fears? A: The way the industry has developed the worry on SIPs and those kind of systematic investing products their inflows coming down is extremely muted and unlikely in our opinion. Having said that, the fact that there are no other asset classes which are also giving returns, gives a lot of scope for financial assets. If you look at the returns in gold or the returns in property across the country, they have been pretty muted for the last three years; gold is at a multi year low in dollar terms right now. So, if there were to be other asset classes which can give huge returns, I believe then the inflow into the financial asset industry like mutual funds can go down. But at this point in time, we are not seeing that risk because the physical assets look inferiorly placed compared to financial assets, and given that the reserve bank has managed to create a high positive real rate environment, we think that outlook for financial assets like mutual fund assets continue to be very good. Sonia: Another space that you are quite bullish on, and you have many stocks in that particular sector, is the auto space. I was going through your prudential dynamic plan and in that you have names like Tata motors, TVS motors, M&M, Apollo tires, all these stocks; what have you gauged from the last couple of month’s auto sector data? Do you think the worst is over for this sector and which are the pockets within the segments that can do well?A: If you look at the discretionary space, it is one of the few areas where you are seeing growth. In many other areas of discretionary, you are seeing low growth and in some of the other sectors, a lot of the businesses today that are happening through the online channels, are leading to lesser impact on the listed companies. So that is the reason for our interest in auto space and we think that in the near term the auto space looks to be one of the best on a risk adjusted return basis. Having said that we do not think that we are at the bottoms of cycle, if the rural sector improves, of course you are going to see a much bigger growth in both the tractor industry and the two wheeler industry, but aside from rural oriented automobiles, I do not think the rest of this sector is at bottom, it is closer to the top rather than at the bottom.Sonia: What do you do with a sector like telecom? I heard you mention that over the next three years, there could be an upside for telecom, but in the near term, it is posed with many problems and competition tops that list. Do you use every weakness as a buying opportunity in that?A: We are proceeding towards a period of fear and consequently we have seen in telecom that there are bouts where you have periods of fear which gives you good buying opportunity and there are periods where the regulatory environment and the competitive environment appears to be more normal and the stock do rise. So, ahead of a good disruptive launch, I believe that the sector does look reasonably interesting for a long term investor, but the investor has to be prepared to ride the volatility which can accompany any disruptive launch which is possible in this sector. Latha: Indiabulls Finance company actually raised money before making this announcement of investment; if you had been an investor, would you have been terribly upset today?A: We do not comment on individual stocks, so it is not possible for us to comment on this individual development.Latha: Generally on banks, you spoke about being positive about the finance space itself over a three year period. Would you not worry about generally the competition coming from payment banks? Even if cyclically we did well, are banks still a great investment? Or would everyone’s margins have to take a bit of take a bit of a brunt?A: If you look at the credit growth, the credit growth is so muted at this point of time, it is an interesting sector where people do not focus on the topline. Therefore what happens is, I do not think on a continuing basis over the next five years you are going to have credit growth of about eight percent, and out of that eight percent you will find that 90 percent of the credit growth has happened in retail. I believe over the next five years, if India has to grow, there has to be a much higher credit growth environment and over the next five years we see a good pickup there. We believe that models like payment bank are going to make it more interesting on the liability side, but the requirement to lend for the growth of the country is the period when banks do well. I believe that we are still in a corporate deflationary or deleveraging cycle, and when that cycle gets converted into a leveraging cycle, we are going to have good returns in banks. The question is when to time it? Are you going to see a big pickup in corporate book in the next six months? Almost everyone believes no. But over a three year period it is pretty clear that things should improve and that is the reason why I mentioned that banking looks good with a three year view, but not sure how good it is. Particularly the corporate banks on a one year view.