IDFC MF says invest in equities over other asset classes

Kenneth Andrade, head-investment, IDFC Mutual Fund says that one should not be invested in financial stocks right now, in tune with market sentiment.  

In an interview to CNBC-TV18, Andrade says, there is has been a reasonable amount of stress in the financial services sector and it has been an ongoing process for a couple of quarters now. Also read: Monthly Income Plans: Should investors put money in?

"What has happened in the last couple of months including the weakness of the Indian rupee and financials may not be the best place to be in atleast in the near-term," he adds.
Additionally, Andrade says he may give asset classes a breather and invest into equities to get better returns. Below is the edited transcript of Andrade’s interview to CNBC-TV18. Q: The IDFC Premier Equity Fund has a huge part of its sector allocation into banking. We are getting a lot of downgrades from the banking space in last couple of days. Would you be cautious on this sector given the kind of macro worries and asset quality issues that have cropped up for banks?
A: When it comes to something which is fund specific in premier, we have a couple of banks but it is not predominantly a financial sector product. Financials account for less than 7 percent of the entire portfolio and it has been predominantly a product which is reasonably overweight on the consumer spends. That is where we are as far as premier is concerned. It is a diversified fund.
There has been a reasonable amount of stress in the financial services sector, and it has been an ongoing process for a couple of quarters now. We got to realise that we are coming out of one very large investment cycle and a lot of assets have not gotten productive. We have an economy which is slowing down.
A significant part of that entire stress is with financial systems and that is essentially showing up on company balance sheets. One cannot wish it away and it is going to be around for sometime till the economy effectively stabilises. Overall, what has happened in the last couple of months including the weakness of the Indian rupee and financials may not be the best place to be in atleast in the near-term. Q: Besides banking one of your other top holdings is ITC. What would your call be on ITC and do you see further upside coming in this stock?
A: In the broad-based portfolio that we manage, ITC has been a large holding over a period of time. What is happening with the environment and the positioning that we have taken is that there are two risks that are playing out in the market. The first one is the valuation risk and second is solvency risk.
When we talk about solvency risk, it comes from the investment economy. Banks have funded the investments and the guys who have set up the infrastructure assets on the ground are going through a large churn. So, as a manager one has the choice to choose either bankruptcy risk and try and fish along the bottom or be pretty much happy with taking a valuation risk and that is what we prefer doing.
As long as one has visibility, the company is going to be around for the next couple of years. There is no stress to the underlying earnings which is why a lot of companies that form part of our portfolio are cash flow positive, they do not have significant amount of leverage on their books and they have held us good over a couple of years. So, we are just waiting for the environment to improve, get visibility in-line with what our fund objectives are and we would migrate the portfolio eventually. Q: Domestically, which is the biggest trigger or cue that you would be watching out for? Would it be something constructive coming out from the monsoon session or would it be any sort of further curbs on the rupee and in terms of priority as well what do you think would be the most market moving?
A: Going into the next 12 months is going to be reasonably challenging for money managers across a spectrum of assets. The environment is not stable. There are a lot of macro events abroad as well as domestically that can play out. So, our sense is to give asset markets a breather for the next 12 months, let them keep their head above water, just build portfolios and keep buying into companies that you believe will be around for an extremely long period of time and you will get reasonable amount of value.
We are getting into an environment which is very conducive for building portfolios and not really an environment which is geared for a significant amount of return at this point in time. So, in any of the asset markets it is just a matter of patience and things would play out in the conventional way post that.
It is not something that we have not seen in the past. The only thing is that we have not seen anything like this in the near-past. If we step back into the 90s, it was a very similar environment that we are actually facing. It did take sometime before things unwound itself to where we are currently and we have gone back again.
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In term of near-term events I think we are coming into an election period, a couple of policy decisions need to be taken. Everything can be resolved in India. There are number of things that can be resolved in India and if one takes a few of them and resolves them, we should be pretty much okay going into the next couple of years. Q: You have Sun Pharma in one of your funds as a holding but what would you do with a stock like Ranbaxy now? Today is an odd day when you see Ranbaxy up about 15-20 percent. How would you approach it?
A: It has not been a company on our radar for quite some time so if it is up 20 percent today we just let it pass by. It had a checkered past. Q: What would your call be on pharmaceuticals as a whole?
A: It is an industry which is reasonably stock specific. There is a very large opportunity which is there and most companies are present in that opportunity. While currency is in favour, it is not the only USP that these companies have. They have built their presence in the environment outside. They also come at fairly expensive valuations at this point in time. So, from a portfolio standpoint we are fairly neutral on that sector. We have a handful of companies that are participating in most portfolios. Q: When you say the next 12 months will be reasonably challenging for money managers, do you get a sense that this market could be headed much lower than where we are currently at? From a valuation perspective someone was making the point earlier on that 14 times forward is by no means cheap if you think about it. There is one portion of the market that is still extremely expensive which is the FMCGs, ITs etc. while there is another portion which is completely polarised. Going ahead how do you approach the market at a time like this when things are so polarised and do you see us head much below the 5500 level?
A: From a valuation standpoint, it is basically an average of what is cheap and what is expensive and that is what the average market valuations are currently. In terms of direction of the market, we have been at this level for almost 5 years. It is challenging in terms of delivering expected returns, it may not be challenging in terms of getting returns from the market.
Equities in the past five years has given higher single digit returns, but that is not what the underlying investor is expecting. The underlying investor is expecting a significantly higher return from equities as an asset class given the volatility it has.
On the other extremes, the fixed income market has also given an almost double digit return which is there. So, the case in point currently that we are making is that there are two asset markets. Both have given positive returns, but the expectation levels are completely different.
Fixed income is delivering with much below volatility, almost a double digit return and equities with much higher volatility could match those returns but they are not commensurate with the perceived risk that an investor is taking. So, when I say that it is going to be a challenging environment, it is challenging environment meeting investor expectations. There will still be portfolios that will fall into place. Companies will still grow and consolidate market shares. There will also be large industries payback debt capital. Q: So, if you had to name three-four companies or stocks where the opportunity is good right now what would they look like in your mind?
A: They would all be in our portfolio. If one has to put money in terms of priorities and where we are actually positioned as a fund house, we like every industry which caters to the end-consumer. So, we like consumer oriented businesses followed by businesses which have reasonably large exposure to the dollar and we are bottom-picking in the investment cycle. We have done that prematurely, it hasn’t worked out but we still believe that there is reasonably large amount of opportunities. So, in terms of ranking, that is how we would want to participate.