India a stock picker's paradise, safety in large-caps: SBI MF

Giving his outlook on the domestic market he said that India is a stock picker's paradise and sees higher margin of safety in large cap stocks.Below is the verbatim transcript of Navneet Munot’s interview to Latha Venkatesh on CNBC-TV18. Q: Is it going to be a festive year as well, will 2073 prove to be a profitable year for equities as – year-to-date (YTD) 2016 has been? A: Looks like. For us a good Diwali is when our investors make more money, so, in this financial year so far investors have made good money in equities, they have made good money in bonds. Overall, I think looking at the pace of reforms, looking at the overall environment and even where the problems were, things are bottoming out and looks like things are moving in the right direction. Next year hopefully should be good. Q: What is different in 2073 Samvat vis-à-vis 2072; at that time also we feared the Fed rate hike, at that time also we were believing that the second half results will be good, is this materially different? A: I think a lot of concerns about the global economy, global markets, global politics, of course we saw some volatility in the month of January and February, but China has stabilised and overall things have been normal globally so far. The other thing in terms of the reforms, there were question marks whether goods and services tax (GST) would happen, whether the bankruptcy code will come, what will happen to overall banking sector reforms, what will happen to some of the other reforms; on that front I would say it has been quite a good year from the overall policy reforms perspective -- every single thing that you look at. Corporate profitability, of course I remember last year I would have said that I think by June or so things would bottom out, I think it has taken another quarter or two. However, I think most likely we are at the fag end of the earnings downgrade cycle. Hopefully from next quarter onwards we will have an upgrade cycle. Q: What is your take on the earnings so far, are you getting a sense that things have improved? A: More or less in-line with expectations. The sectors that were not expected to do well, some of these challenges for example with the IT sector where you have got, I think market was expecting that. Some of the other, particularly in the financials, I think they have been better than expectations. Overall I think that things are bottoming out. There are clear signs of that. Q: One big macro that is staring at us from the global space is US elections. Is it going to be damned if we get Donald Trump and damned if we get Hillary Clinton or is it going to be the other way round? A: I don’t know whether finally it will be Hillary who will trump into the white house or whether it is Trump who will have the last hilarious laugh. One should not write off Trump I would say. Of course the opinion polls and generally all the experts are saying that she has a clean ride but I think looking at the world in last few months and as somebody I keep repeating these line, you are living in a world where if you are rich you get bailout, if you are poor you get handout, if you are somewhere in the middle you get left out and that left out feeling is what is reflecting in the Brexit or Donald Trump, or Marine Le Pen in France and all. I think there seems to be some anger in the middle class particularly in the western countries. So, I would not write off. However, one thing I am very sure of, whether it is Hillary or whether it is Trump, the next year, the only way out for US is to embark on a huge fiscal reform which is particularly spending on the infrastructure. That I am pretty sure because I think the monetary policy is hitting the limit and next year going forward whether to create jobs, whether to improve productivity, whether to increase the growth potential, whether to increase the actual economic growth, and to ensure that pension funds are able to deploy money where they can take care of the older people, for all these reasons I think infrastructure is the way out and I am very sure about that. I don’t know the starting time looking at the overall house composition, whether it will be 2017 or 2018 but that one call I am very sure of. That is the way out for the western world. Q: What does it mean for me as an investor in the Indian markets, what does it mean on November 9th, either numbers, and for the year ahead? A: I think a Trump victory would lead to volatility, some uncertainty. People really don’t know the actual views particularly on the economy, on the global politics and all. The views have been changing in his case. There would be volatility. Also, as of now I believe that there is a good likelihood of a Fed rate hike in the month of December but post that once people start believing that, I think the fiscal incentives, the fiscal reforms are coming from next year onwards, I think that can change the view. In last couple of years we have got used to a world where it is only the monetary easing that pushes up asset prices. I think we need to move towards another world where the economic growth and higher corporate profits that move the equity market, not the cheaper liquidity. So, discounting rate going down, pushing up equity market, I think would be behind us and we are moving to a different world. It is going to be a transition, a little bit painful in the interim but structurally it will be good for the world. Q: That is my Indianomics debate, our stock investors want something else, until now whether it was Donald Trump or whether it was a Brexit or whether it is the Chinese devaluation threat of January, all dips if bought have made money. Can we work with that thumb rule on November 9th as well? A: So far that has worked. In last couple of years, if you have bet, whether it is Chinese geo-political concerns, whether any concern in the world, the next day if you bought when the market was down, ultimately it turned out to be good. I think there would be a time where this complacency which has set in the market, that central banks will come and take care. They have written a put option, you don’t have to worry about it, I think it is some point in time that it will undergo a change. Volatility will increase but ultimately my view is that once you start getting the fiscal reforms, once you start getting the fiscal incentives, the world could be slightly different than what we think today. So, I think bond yields globally may go up, they have already seen the bottom few months back, but whether it is going to be very bad for equities, I am not sure of that. Q: How will it be for Indian equities mainly? On a near-term basis 8,500 has proved to be very resilient, so, would we say we will be outperformers even in an underperforming equity scenario? A: From a global perspective, of course in this year some of the other emerging markets that were quite beaten down, the likes of Brazil and Russia, have done far better than us. However, going forward, from a structural long-term investor perspective, I think India really stands out in terms of the policy reforms that are happening, in terms of ease of doing business, attractiveness for the FDI, the monetary policy reform, the fiscal reform, I think overall India looks quite better compared to most of the other emerging markets including China, including some of the other commodity producers. I think the interest in India will continue but in an environment where you US bond yields go up, in an environment where I think dollar will strengthen, the FPI flows maybe slightly slower than what we have witnessed in last couple of years but I think the FDI flows is something that I am more confident about. Q: We may see a tapering of FPI flows with the ebb and fall of risk in global markets, will DIIs be a counterweight? A: Absolutely, that has been our view for last couple of years that I think that domestic flows would continue to surprise on upside. Look at the SIP book which is now close to, if I know the number correctly, Rs 3,500 crore a month. I am very sure in next maybe couple of quarters we will touch a Rs 5,000 crore per month coming in from SIPs from retail investors. You add the amount which is going to come from EPFO and the other provident funds, you add the amount which is NPS and looking at their flows and if they invest one quarter or so in the equities, you add all these amounts and the insurance companies, I think the overall domestic flows would be a good counter balance in case there is any vulnerability on account of global reasons. So, if tomorrow you have a risk off because of Trump winning or let us next year we again have some challenges in Europe or let us say Chinese currency or something, I think India’s vulnerability to some of these events would be far lesser than what it has been historically. Taper tantrum in 2013, I think we fell the most. Will next year, would it be a similar fate, I don’t think so purely because of the domestic flows. I think there will be a good counterweight. Q: In the past especially in the years since 2009, we have seen physical assets, gold and land take away a chunk of Indian savings. Is that changing for good, for the medium-term? A: It is changing big time. I travel across the country and I am clearly seeing that investor psyche is changing. He thinks that financial assets are likely to deliver better returns than the real assets. A lot of people have had a very bad experience in last couple of years on the real estate side. Gold has not really made money. I think overall, the interest towards the financial assets is clearly increasing and we are seeing a huge retail interest coming into the equity and this is nowhere close to what we had seen in 2007 or what I saw in 2000, what I saw in 1991-1992. We have a long way to go where we really see a mass revolution in the retail savings coming into the equity market. We haven’t reached there but we are moving towards that and at a very good pace. Q: The markets have not done much at this point in time, still flat but give us an idea of how you expect the midcap-largecap debate or movement here on, do you think the midcaps will continue to hold this huge lead that they have built up over the last couple of years? A: India’s largecaps are global midcaps. If you believe in a long-term structural story of India from the growth perspective next few years, several new interesting businesses are now coming to the market. For the first time I think there are lots of opportunities even in the midcap space. We have discussed the same last year and the year before last where the consensus view was that midcaps have rallied a lot more compared to largecaps; of course the margin of safety is higher in case of largecaps because midcaps have run up quite a bit, valuations are rich. However, having said that, the ability of stock picking, the ability to generate alpha in the midcap space is always there. As a fund manager, you need to pickup maybe 15-20 good companies where you think the power of compounding will work in your favour and I think India is a stock picker’s paradise. So, I would still say that in next one to three years, if you are in a bull market, the opportunity of picking up good midcaps that can do better than the overall market is still very much there. Some of these disruptions, if the way of doing business is changing, if the ease of doing business is there, the way technological changes are there, the way logistics is changing, the way factors of cost of production is going down, they all augur well for some of the more nimble players. I think agility will have as much value from building a business perspective as much as let us say stability. So, I think that is very critical and that part people miss out when they compare largecap versus midcap. Q: Let me pickup one that has been the absolutely outstanding performer, NBFCs. One could see the writing on the wall on April 2nd perhaps when the surplus liquidity theme was ushered in by Reserve Bank of India (RBI) but they have run up crazily, would you still bet on NBFCs? A: As a house we have benefitted a lot. I think we were one of the early ones to look at that space and the stocks have done very well across NBFCs, housing finance companies (HFCs), some of the MFIs. Q: No bubble there, HFCs? A: I think at some point in time we have seen that the history of markets is that whenever capital chases a particular space, whenever the growth looks very easy in a particular space, a lot more competition is going to come because of the digital finance, because of the no NPAs on the retail side, I think the sector has become very attractive but that will attract a lot more competition, that will attract a lot more capital. At some point in time this will lead to dilution in under writing standards, this will lead higher competitive intensity which will reflect in lower margins as well higher credit cost. However, I think structurally looking at the under leveraged household balance sheets, they have a long way to go. However, having said that, one needs to be cautious in term of choosing the right player. I think the people who have the right kind of risk management policies along with the growth plan, they would stand out. At some point in time we are going to see challenge in the sector, particularly with some of the players who will grow aggressively without putting the right kind of risk managements systems in place. However, overall, structurally the place looks good. Q: Now even NBFC has become a universe, you rattled out HFCs, leasing companies, the pure NBFCs, what about the small banks, the guys who straddle the MFI small bank area, the returns from an Equitas and SKS – Bharat Financial have been phenomenal and some more will list. Will you go with that category? A: Overall, one of the greatest thing that this government has done in last couple of years, along with the RBI is the financial inclusion, the digital finance and because of that the penetration of financial services is likely to increase substantially at a hugely under leveraged household balance sheet. Savings I think, a large part of the savings has been discussed before will come to the markets and I think the ability for several of these players to grow the market is going to be enormous. Having said that, I would repeat the same point, we will look at those managements who have the right kind of risk management, those who have the right kind of processes, the right kind of credit appraisal and the credit monitoring skill set; that is as critical as the ability to grow because the growth I have been looking at, the overall size of the economy and the under leveraged household balance sheets, it could be very easy. However, that easy growth has led to and I have seen that in 90s -- that movie is going to play again; there is no doubt about it, in next few years. So, one needs to be cautious about that. Q: Cement has been a disappointment with some numbers, Ultratech Cement was good, ACC was seriously disappointing, is that a theme to play? A: Overall, if you believe that the investment cycle particularly driven by the government infrastructure spending is likely to take off, it is already happening in few of these sectors like roads and railways and to some extent in some other urban transportation and all but probably it is going to become more widespread. Affordable housing is something that I think will take off in very big way in next couple of years. We can discuss that separately. I think overall, relative to when you want to play the cyclical, cement looks good. However, as I said earlier, I think the valuations across the board would be rich and I think looking at the overall, the way let us say the yields are coming down, the cost of equity coming down, and if you want to play the cyclical recovery, some of these plays will look richly valued but I think we have to bet on the continuing growth over the next couple of years.