Rally confined to few largecaps; bet on tyre cos: HSBC AMC

The current rally, which is driven by foreign funds, has been confined to few large cap stocks only and for it to extend to mid and small cap stocks retail participation is a must, believes Dhiraj Sachdev of HSBC Asset Management.

"The difference in the form of returns between the mid and small cap index vis-à-vis the BSE 200 itself is as high as 10-18 percent," he said in an interview to CNBC-TV18. Also read: Oil retailers plunge on export parity pricing talks Reiterating the fact that retail participation in Indian equities has been poor, he added that returns on other assets like gold, real estate and bank fixed deposits are expected to soften, so retailers may return to equities ahead. On sectors, he is positive on tyre companies and expects them to benefit from falling rubber prices. "We like tyre companies on expectation of positive earnings momentum of lower rubber prices and costs as well as better cash flow generation over a period of time." On the flipside, he sees export pricing parity (EPP) as a negative for oil marketing companies if it is implemented in the current form. The fund house continues to have exposure in infrastructure and banking themes, he added. Also read: Dimon clings to JPMorgan chairman title, after fight Below is the verbatim transcript of his interview to CNBC-TV18 Q: You have managed the midcap and small cap funds at HSBC as well. What is your sense of how that part of the market might look given what you have seen with earnings and given the fact that the market has been fairly narrow in its up move so far? A: Your observation is fairly correct that given the Foreign Institutional Investor (FII) flows the rally has been largely confined to few select large companies. I think the difference in the form of returns between the mid and small cap index vis-à-vis the BSE 200 itself is as high as 10-18 percent. Generally that is typical of a market rally. The first stage of the rally is generally confined to the large caps. As the rally gathers momentum and becomes more mature the subsequent stages of the rally comes into the mid and small cap. However, for that obviously the retail investors also have to join the party in the market. But at this stage the rally is largely confined to few select large companies. Q: From the universe that you guys track and benchmark your midcap positions with, what has the earnings performance been so far because that as well has been lacking? A: It has been mixed so far. The private sector banks obviously stood out in terms of asset quality. There have been positive results from FMCG and pharmaceutical companies. On the other hand the public sector banks have somewhat disappointed on the asset quality and NPA issues as well as restructured books besides the cyclicals, metals and commodity oriented companies. So, obviously this has been mixed bag, but by and large the results have been better than the consensus which was at the beginning of the results season. Q: What is your observation on what Domestic Institutional Investors (DII) are doing at this point both mutual funds and the insurance guys? Why is the selling figure so large? Is it to make place for the Offers For Sale (OFS) that are going to hit the market or is it the sign of the caution there is in the domestic market sentiment? A: This has not got to do only with the OFS. In the last two years and very longer periods we are seeing retail and domestic outflows. Whereas, FII flows have continued to be very strong. Obviously the global central banks have low interest policy and relatively the emerging markets provide better growth opportunity. So FII flows have been pretty strong, whereas the retail investors in the last two years has been largely in the asset classes like gold, real estate and high interest bank fixed deposits. If we believed that the yields or the returns on these asset classes are likely to soften which includes gold, real estate and even bank fixed deposits post-tax returns. Eventually we believe, expect and hope that the retail investors should come back to equities given the fact that the last three or five years equities have underperformed these asset classes. Q: You had looked at the L&T numbers yesterday. Does it inspire confidence about the infrastructure space as such or are you underweight there in your funds? A: We do have an infrastructure fund, but the fact is that there are near-term risks and issues in the form of margins of many of the companies. There are execution delays which are on the ground level given the fact that there has been weak investment on capex cycle in the last two years. As the project clearances happen over the next few months and given that the valuations are fairly reasonable over a period of time we do expect some of the well managed capital goods companies with lighter balance sheets in the form of leverages should come back. _PAGEBREAK_ Q: You have got a progressive themes fund. What kind of exposures are you running in terms of your top holdings in these funds? What according to you are the big progressive themes now? A: Largely we are still playing infrastructure theme, banking theme and progressive themes. Given the fact that the valuations across these themes are far lower and there is a gap between the valuations of defensive sectors like pharmaceuticals and Fast Moving Consumer Goods (FMCG) companies. We believe that the eventual mean revision should happen across these old economy businesses. Q: You have also got exposure to some of these offshoots from the auto industry, things like the tyre stocks etc. where numbers were not inspiring this time. How would you approach that entire segment of the midcap universe? A: We are playing anti-commodities theme. We believe that most of the tyre companies will benefit out of lower raw material and rubber prices and besides the fact that there could be replacement demand. When you look at some of the tyre companies in the BSE 200 basket you get a sense that their valuations are cheaper compared to some of the other businesses. As well as their Return on Equity (ROE) is pretty high. So, we like tyre companies on expectation of positive earnings momentum of lower rubber prices and costs as well as better cash flow generation over a period of time. Q: I notice you have some exposure to oil and gas as well across some of your funds. What leg of it do you like and what did you make of all the developments yesterday? A: This export parity pricing if implemented in the current form obviously is negative for Oil Marketing Companies (OMCs). There will be a refining margin hit of close to USD 1.5-2/barrel for OMCs. Given the fact that this could be about Rs 180 billion of hit, it could lead to eventual bankruptcy of OMCs. However, we do not expect that government will allow it to happen and eventually they will have to compensate for these losses. So, it may appear that if the government is compensating and not allowing OMCs to fall apart. It could be a non-event for OMCs and I think yesterday's reaction could be an overreaction. Q: How are you approaching public sector banks now? The numbers have been up and down. A: Yes, it has been fairly mixed even for public sector banks. The fact is that if we look at the history of last 7-10 years, despite all the Non-Performing Assets (NPA) issues creeping up time and again, these banks have compounded given the fact that India is a capital starved economy and money lending is a great business of compounding. So, PSU banks quoting at about 0.5-0.7 times with dividend yields of 3-4 percent are attractive in terms of valuations. Our view is on declining interest rate trend the banks should do well and outperform the market.