MC Interview: Markets in boom phase, SMEs bubble territory, don’t ask me about defense stocks, says S Naren from ICICI-Pru

S Naren, chief investment officer at ICICI Prudential AMC

If you are looking to invest in a small or midcap mutual fund for the first time, be ready for lacklustre returns over the next three years. That is the word from S Naren, chief investment officer at ICICI Prudential AMC. A veteran who has seen 34 summers in the Indian financial markets, Naren’s advice to retail investors is to focus on asset allocation and not blindly chase returns.

In a conversation with Moneycontrol, Naren spoke about key market trends, his views on various sectors and the key skills that investors looking to manage their own investments must have. Edited excerpts:

There is a craze for mid and small cap stocks right now. How do you see it playing out?

Today, the challenge is that the markets are not cheap. Historically, we have observed that any area that attracts a lot of money is the area where investors don’t make money in the medium run. Consider people who invested in tech funds in 1999, in infrastructure funds in 2007, in small and midcap funds in 2017, and in new-age companies in 2021. None of them made money in the medium term. Now, people are again investing in small and midcap funds. The challenge is to convince people about this fact.

How do you define medium term?

Three years would be a reasonable assumption.

You are cautious on mid and small cap stocks. Isn’t there a risk that these stocks may continue to rise for longer than is rational?

Because of the size of funds that we manage, we have to be ahead of the trend. We may at times be ahead and have to wait on it for a while. But that is any day better than being late. You cannot act on a trend while in the middle of it. In 2018, we were cautious on credit and people said we were too early. That was fine. Because when eventually the defaults happened, we did not have any credit challenges. The same holds true for our cautious view on small and midcaps today. There is a risk that we may be cashing out early. But if we are late, exiting will become a problem.

What about large caps?

Clearly, large cap as a pocket is comfortable (valuation-wise).

How is the market as a whole looking to you at this point?

There are five phases of a market. Bust phase is when stocks are available at distress valuations. That happens whenever there is a big negative global event, like the 9/11 attacks, the Lehman Brothers crisis in 2008, and the more recent COVID crisis. If you invest money in a bust phase, you will make pots of money, because, at that point, most investors are afraid of investing.

Then there is the best phase just six months after the big global event. The initial shock has subsided but equities are available cheap. You can still make a lot of money. Then there is the boring phase, when it is possible to buy and make a moderate amount of money.

That is followed by the boom phase where everyone is eager to invest. If you invest in that phase, you may not make money in the medium term, but you will make money in the long term. Investors who invested in technology funds in 1999 may not have made money in the following three years but would have made money over the next 10-15 years.

The final leg is the bubble phase where if you invest, you will lose money.

Which phase is the market in right now?

We are right now in the boom phase. The only area of bubble right now, and where we are not involved, is the SME IPO. Every other day, I hear about an issue that has been oversubscribed 200 times or 300 times. I don’t know the fundamental picture because we are not allowed to invest in it. But whenever I see something getting subscribed 300 times, I am trained to think it is a bubble.

How are you managing these challenges, given that money continues to pour in despite expensive valuations?

Luckily, I became CIO after watching the meltdown of 2008-09. So we said that the best way to invest is to focus on asset allocation and focus on hybrid. Essentially, what we have done is focus on multi-asset, equity and debt, balanced advantage, and equity savings. All these are closest to asset allocation, investors have a lower chance of losing money in these products.

Thanks to the efforts of my colleagues at ICICI MF, we have managed to collect around Rs 1.3 lakh crore in such products. These are more defensive than an equity fund and well-suited to be defensive in all booms.

How do you view the ongoing frenzy in defence stocks?

All PSUs are in the boom phase right now. They were in the bust phase just three years back. We were investors in the bust phase and the best phase.

What explains the bullishness on defence despite concerns of overvaluation?

That is a question best asked to those who are investing right now.

Even if many sectors are overvalued, wouldn’t it be hard for you to ignore them altogether, because of strong inflows into your funds?

Agree, we cannot avoid sectors because we are managing other people’s money. That is why when people come to us asking where to invest, I recommend asset allocation; look at categories like multi-asset or balanced advantage, or equity and debt. Also, as fund managers, these products give us more freedom to do what we want to.

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What is your advice to people who are investing through systematic investment plans (SIPs)?

If you had done SIPs between 2006 and 2013, it would have delivered no returns. When I tell this to mutual fund distributors, they don’t even think it is possible. Where you invest is very important. So I ask them why don’t you do SIPs in more defensive categories. They tell me they have been investing for 20 years in an SIP. I tell them it is fine, but then you should do a SIP for 20 years. The problem is between 1994-2002 and I saw many people who stopped believing in equity investing altogether, let alone SIPs.

So, if someone can stay invested for 20 years, then small and midcap are good places to be in, otherwise multi-asset products are better. And it is so difficult to convince people that small cap and large cap are more aggressive than a large cap and flexi cap.

You sound almost bearish

We are not bearish on the market. India is a structural story compared to other markets because our economic growth, corporate earnings and demographics are much better than most global markets. But we believe that investors are better off recognising risks.

I have seen the market for 34 years. But most investors have come to the market after 2013. They have not seen a big fall. And because they have not seen it, they think there is nothing called a big fall. I agree the regulator and the industry have done a lot of good work over the years, but that does not mean we are in control of the markets. Everywhere in the world, there have been big falls, except in India.

What are the key risks that you are seeing on the horizon?

Risks are hard to spot. If I knew, I would tell you, but the fact is I don’t know. That is why I keep saying the best solution to manage risk is asset allocation.

Tell us about sectors, starting with banks. The mood appears to have turned cautious because of pressure on net interest margins from higher deposit rates.

Deposit rates are not higher than what they were in the 80s or 90s. Non-performing assets are at the lowest in a long time. Plus, you have a bankruptcy court, CIBIL and good digital infrastructure. Banks are in pretty good shape right now.

But companies are not borrowing enough, say analysts. And many companies are borrowing abroad because it has become easier to do that.

That is true, but at some point, they cannot borrow globally at low-interest rates. They will have to borrow locally. Today, the global risk-free rate on a two-year bond is 5 percent. So what rate will a corporate be able to borrow at? This will force a lot of companies to borrow locally. The challenge right now is over ownership. Look at the portfolio of any mutual fund. The top holdings will be financials.

The street is still divided on the IT sector. Which camp are you in?

If you look at the deal wins in recent times, they are pretty strong. The sector is doing good. You may not see the heady growth rates of 2020-21. But the market already seems to have factored that in.

What about pharma?

We were positive till March. The sector has done well since then. So, we are a little less positive now. But if you look at generic drug prices, there is a significant improvement.

Consumer sector?

We have been bearish on the consumer sector and we will have to see how this festive season develops. Some of the discretionary segments within consumption – hotels, travel, auto – have done much better and are the areas we have been bullish on.

Within auto, two-wheelers or four-wheelers?

Both. But stock specific.

Tractors?

We don’t have a strong view there.

Metals?

They will be China-driven and it is very complicated to assess China. From an India point of view, there is no concern. We are watching developments. It is not that we are very bullish as we were in 2020.

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What is your take on oil stocks, now that crude prices have once again turned volatile?

We are reasonably positive. We have been one of the biggest owners of upstream oil stocks (businesses involved in the exploration and production of oil). Our view is that oil has very low chance of coming down or crashing at this point in time, given that there have been no major investments made by any large upstream players, except what has happened in shale. It is a sector that not many people have been looking at. It is a contrarian call for us. Both oil and power are two sectors that we have been bullish on.

Are retail investors becoming a major source of competition for established fund houses like yours because there are so many more disclosures by companies, and thanks to fintechs, previously hard-to-get data is now available at the click of a mouse?

If the market is rising one way, then we have competition from amateur investors. But if there is volatility, like what we saw in 2020, most new investors would be at sea. Because navigating volatile markets is something they still have to learn.

Information and data may have been democratised but behavioural finance, contrarian thinking and ability to think of themes in advance are the more important skills in investing. These are what gives the capability to people like us.