2016 will be about stocks and not sectors: Kotak AMC

Below is the verbatim transcript of Nilesh Shah’s interview with Latha Venkatesh & Sonia Shenoy on CNBC-TV18.

Latha: At this juncture what does it look like; will, in the first place your investors keep the faith? The year 2015 has been remarkable for the return of the Indian investor. Does 2016 be a follow through year for this trend?

A: I hope and pray that yes, as Indians we have invested a lot more in physical assets like gold and real estate which are slow moving trends and we have sold our equities consistently over last 20 years which is fast moving trend.

However, year 2015 was a very good break from that tradition, where Indian investors invested more than Rs 65,000 crore in equity mutual funds. In last 20 months we have collected more money than what we have collected in previous 10 years. So, the overwhelming support of domestic investors is very encouraging and heart-warming. More importantly lot of this money came by way of systematic investment plan (SIP), about Rs 25,000 crore is the annual subscription through SIP in equity mutual funds which is the perfect way to invest in equity. Obviously we owe a great amount a responsibility to this inflow. Their expected returns have not materialised and we need to engage with them to ensure that they remain invested over next two-three years by which their expected return will materialise.

So, very heartfelt thanks to all domestic investors and now we owe to them to engage with them to ensure that they continued investor in this phase where the returns have been a bit below their expectation. Hopefully we will make it up over next 12-18 months.

Sonia: This has been the big story this year in the pharmaceutical space where so many of these companies have just been plagued by The US Food and Drug Administration (US FDA) issues. Cadila Healthcare is the latest in the bracket. How do you approach this space now?

A: One, from an investor point of view, we will have to start differentiating between companies whose quality track record is superior compared to others. Second, we will also have to start providing for an opportunity in our portfolio to buy these pharmaceutical stocks when they are on the way down, courtesy this kind of event.

If you see our portfolios over last one year, we have been reasonably underweight pharmaceutical sector and we have started accumulating this pharma stocks especially when they have started correcting from their high valuation, courtesy and event risk like this. So, do provide for a margin of safety in your pharma allocation especially to take care of event risk like this which is becoming quite regular across most of these stocks.

Sonia: For a company like Cadila where 483 observations were made on the plant on this Moraiya facility in the past. So, perhaps there was some inkling of this issue. So, far it has not translated into an import alert but what do you do when there is some inkling of US FDA issues? Do you ditch these stocks completely or do you still keep the faith that these issues can be settled in the due course of time?

A: Most of the companies in India are cognisant of the fact that there are strict quality standards prescribed by US FDA. No management would like to take risk with those processes. It is also evident from the fact that while there are various warnings issued on to the factory, it has not resulted into product recall; it has resulted into future product not being introduced from that facility. It proves that the product quality is good but probably the environment which ensures the testing of product quality or which results into manufacturing of this product requires some modification.

So, we engage with the management to see what their opinion is about managing such alerts, managing such warnings and as I mentioned earlier it is time to keep some amount of margin of safety for averaging yourself down in case an opportunity comes in some of these stocks.

Latha: I had a slightly longer term question on equities and equity investors. When we started off 2015 the expectation was that debt will also give you lot of returns. We had not had any rate cuts at all and the expectation was some 200 basis points will flow and 125 basis actually flowed, 40 billion coming in from foreign institutional investors (FII) debt investors. There is no such hope for 2016. So, do you see a beeline from debt investors into equity investors in the domestic space?

A: Your question is very valid; however, most of the investors who are kind of fence sitters, who can move into debt or in to equity, will look at the past return and then take a call. On a one year basis neither the duration fund nor the equity has delivered such a wide outperformance or divergence that the fence sitters will choose one asset class over the other. My guess is that the debt investors will continue to remain within the debt. However, their shift may shift from duration fund like gilt and bond fund into credit accrual funds where the one year return, two year return, three years return looks attractive.

On the equity side, we will see people more moving into multi-cap funds where the returns are attractive and midcap funds where returns are attractive. So, the fence sitters typically look at last one year performance and decide their call and there is no great divergence between debt fund and equity fund to make that call going forward.

Sonia: What are the sectors that you would be bullish on for the year 2016?

A: One caveat is that 2016 is more likely to be stock specific year, rather than sector specific year. Within sector, there will be enough divergence like we saw in 2015. In 2015, in the larger sector of banking and financial services, we saw retail focused consumer bank delivering great returns. We saw corporate focused private sector banks delivering negative returns and we saw public sector banks delivering significantly negative returns. So, within the banking and financial services space, which stock you picked up delivered far better outperformance compared to just taking a pure sector call. My feeling is that in 2016, we are going to witness the same thing.

Therefore, with that caveat we believe that today, we are in a scenario where rural India because of the two consecutive below average monsoon is on the back foot. The private sector investment, courtesy the leverage enjoyed during the boom-years of 2008 onwards are also on the back foot and effectively that leaves the government spending in road, railway, defence and infrastructure sector. So, all non-leveraged companies which are enjoying the benefits of government spending in these sectors probably after having run up still provides reasonable opportunity.

We are also looking forward to the consumption sectors which will benefit from the Seventh Pay Commission revision which will be announced in calendar year 2016. So, urban consumption like automobiles, white goods, consumer durables, these are the obvious beneficiaries of the Seventh Pay Commission. We also believe ancillary sectors like cement might benefit as people pay for affordable housing equated monthly instalments (EMI).

Therefore, we are essentially looking at sectors which are driven by the government spending over the next 12 months and looking at the valuation and leverage, building the portfolio around that.