Interview: UTI AMC's Leo Puri mapping India’s SIP culture

Q: First up I wanted to ask you about this Systematic Investment Plan (SIP) culture itself. Do you think it is here to stay?

A: It seems to have now settled down. I think there are fundamental drivers, we have all talked about financialisation, reallocation from gold and real estate which is quite a fundamental driver, rising affordability compounded with middle class tendency to save is another factor, and then of course the shock of demonetisation bringing further liquidity into markets. So there have been number of things which have coincided here which I think have altered this.

Over and above that is a much higher level of confidence, partly due to the political changes that happened three years ago. So the macro backdrop, the governance foundations are stronger today. So the middle class seems to have a high degree of optimism around where the reforms process is going as well. So all of this has conspired.

It has helped obviously that returns have been good because that reinforces this virtuous cycle and it is in fact about Rs 5,000-6,000 crore which is coming into equities every month at this point in the form of SIPs but that is a very steady sort of flow because that gives you that Rs 60,000-70,000 crore a year which is a very large sum of money and supporting the markets. So, so far certainly the story has been very positive.

Q: Let me first get this immediate factor in, is it that this large amount of money as a whole that the mutual fund industry got was inordinately due to demonetisation and therefore should we look at some of the money as one-off?

A: No, I think demonetisation was an added driver of some of the additional liquidity that we got. However, the underlying factors are those that I have mentioned – financialisation, and the sense of underlying optimism around the reforms process, combined with global liquidity keeping prices steady. So these are the factors ultimately.

However, I don’t think we can underestimate demonetisation -- money came first into the banking system and into CASA accounts, and from CASA accounts in search higher yields, there is no doubt that some of it has found its way into mutual funds and this is true of small and medium enterprises, commercial enterprises, as well as households.

Q: Just a little more on this financialisation trend. We had some advantages, in the sense our macros were very good, the monetary policy committee (MPC) has committed to keep inflation down, and that also meant fixed income is not that attractive, real estate not that attractive, and therefore money has come. If the cycle were to turn for whatever reason, and gold and real estate again became expensive, do you still see Indian investors keeping the faith in mutual funds?

A: I will have two nuances to what you just said. One, some of the financialisation is the fact that gold and real estate as a haven for black money are less secure than they were earlier. So it is not all about relative yield. Relative yield has been the other factor, the economic driver, because relative yields have been low -- volatile in the case of gold and low in the case of real estate; so no doubt about that.

I think actually it would be a healthy thing to the extent that with asset allocation, people in a normalised real estate market, post RERA, better organised, a clean market, do come back and start allocating to real estate; that is a good thing to happen and I hope and I expect it to happen.

Gold is a more complex asset because of the emotional content and people can debate how rational it is as a store of value, but gold too will somewhat come back into favour. However, the laundering aspect of those asset classes will be much diminished in any case and I think that will not return at this point in the country.

Q: There are people who keep telling us, fund managers and even non-fund managers, that this is only the flow that is coming to mutual funds, the stock of Indian investments is still in real estate and that might shift. So there is another wall or wave of money that could come. Do you agree to that?

A: That depends on how you look at the stock of Indian real estate actually. I would not draw that simple correlation. I think that is a little bit of cheerleading and optimistic thinking. A lot of the stock in real estate is obviously in land which is put to various forms of use; so a lot of it is agricultural land as well. There is a small component of speculative investments that were in the real estate sector; unlocking those is actually going to take some time. I don’t think it is going to come back in a hurry into financial markets. So I think this is more a game about flow than about stocks.

The other thing that is happening is that a lot of money is coming into fixed income as well actually. We have seen very healthy gains in fixed income markets because of the rate cuts that have happened hitherto. People have made healthy yields, and double digits yields out of fixed income investments. So we should never underestimate the importance in the mutual fund industry of the role fixed income has been playing in addition to equity.

Even today you can get let us say 8.5 percent from good quality corporate bond funds which is maybe 1.5-2 percent above fixed deposit yields and that is a pretty healthy return. Around the world people are having to think of what normalised returns might be in a world of lower inflation and if you believe inflation is going to be plus or minus 4 percent in India, then really yields of 8 percent from fixed income are very attractive and we must learn to look at it that way and not shy away from that.

Q: Let me come to the other ubiquitous question. Do you worry that markets are overvalued?

A: all around the world, all asset classes at this point are trading at higher valuations than their historical median and they are trading at higher valuations in a synchronised fashion. So there is a debate going on globally at this point as to whether the number one worry at this point is asset inflation and should we indeed be focusing on that and therefore be thinking of a more aggressive approach towards managing a steady set of weight rises to deal with asset inflation or should we worry about the fear that secular growth has slowed and therefore, continue to keep rates low regardless of the fact that we are feeding asset inflation?

For now, the balance has tilted towards the view that said let us run with the risk of asset inflation and not take the risk of destabilising what is already a potentially below median growth rate just at the point that it looks like we have recovery particularly as most of the recovery has been jobless with serious political implications around the world. So the political balance for now, seems to favour at the margin, the trend towards keeping liquidity going even though it is well understood that this is driving asset inflation. The Faustian pact, if you ask me, as to where we are going to end up.

A lot will depend on who the next governor of the Fed is. There is a range of candidates. Some are clearly more hawkish than Janet Yellen. You could see a period where that debate will tilt towards worrying much more about asset inflation, many voices are being raised saying that the threat to the world's financial stability, we have been there before, to again higher debt levels and debt has been rising across the globe along with asset inflation because it costs you nothing to repay it is going to outweigh the risks of lower growth.

And I think we must be ready for that scenario. My personal view is that I expect this trend to reverse at some point in the next 6-12 months and I think we will enter a period of tightening rates. We will then start to see that indeed some of the asset prices will start to correct at that point. But the only way you can deal with that, if you like is to at all times, be conscious about asset allocation, the level of risk you have and reassess that. But I think it would be foolish to get into the mindset of saying, we have a clear runway for another three years.

So nobody leaves the dance floor and the whole Jack Prince point, no one wants to leave the dance floor while the music is playing. That would obviously be irresponsible and it is better to be a little safe than very sorry later on. But frankly, that is the central global debate. Of course, asset prices are overvalued. The question is they could stay overvalued for a long time to come if central bank policies stay on the consistent trend it has been.

Q: Let me come to the same valuations question from an Indian angle. We get two scenarios. One saying that Indian earnings will pick up very soon because we have spent 3-4 years putting in good macros in terms of lower inflation, lower current account deficit, direct benefit transfer and of course, the goods and services tax. Just a matter of time before it fires. And then another segment that says that no growth has been slowing for the last five quarters sequentially and this process of GST or demonetisation has actually taken away informal sector jobs and aggregate demand could actually crunch. What is your sense?

A: I would agree with the statement what we have a very strong macroeconomic foundation and that is the reforms that we have undertaken despite the initial glitches are broadly supported of future GDP growth. We made probably a couple of mistakes. One is that we over communicated how well we were doing when we were not perhaps doing as well as we thought and it is not surprising therefore that now we sink into pessimism and an extreme pendulum like fashion as well although we are not doing as badly as some of the critics would make us believe. We are in the middle of a 3-5 year recovery which began, I would say, a couple of years ago, and it is going to take its time. So the earnings recovery will happen slowly. It is not going to happen in a hurry.

There is no pent up demand if you like, waiting to be satisfied. It will happen alongside the natural continued growth in affordability and investment cycle which will also in turn help feed demand in jobs and that is probably one or two years as a process to actually play out. It also assumes that you will see improved governance because while we did implement bold moves in terms of GST and demonetisation, one of the things that is also displayed is a lack of consistent implementation which is a function of weak administrative capacity at the centre, the state and municipalities for that matter.

I think it has just brought into very harsh light once again what the real priority for this country is that until we actually focus single-mindedly on strengthening governance capacity, we will always fall short in terms of expectation. And it is probably too much to expect of any government or Prime Minister to be able to lead such a process on their own. So in terms of prioritisation, I would hope that the building up of administrative capacity will be the leading priority for this government, if not in this term then certainly by the next or whoever wins the next election because without that, we are really at risk of failing to sustain momentum. But earnings will recover, but they will recover in a year or two. I do not expect to see any recovery in the course of this fiscal or indeed the first part of the next. It is a slow process at this point.

Q: Do you think the domestic investor interest will hold or do you think this postponement of earnings growth quarter after quarter can disappoint and disturb this trend?

A: There is room for correction. Some corrections will be healthy, some of them will be sector specific. There are some sectors which have run away partly due to supply scarcity which is an issue in our markets. That is another reason I welcome primary market development. We need primary market development because otherwise we are all being forced to buy the same stocks. So, there will be some healthy correction.

I think investors are also willing to wait because what they perceive are lack of alternatives and partly because they do believe in the underlying story and partly also because they have invested through mechanisms which are longer term. So, the stickiness of a SIP investor is designed to allow them to ride through 6-12 months of lower returns and corrections on the basis that they may end up over a cycle with let us say 11 or 12 percent in yields which is typically what our market delivers over long cycles. So, people will hold on. I don't see any need to panic at this point but euphoria also needs to evaporate a little bit in that problem.

Q: Is privatisation an option? Privatising any one or two public sector banks, would that be a good idea at any cost because that will mean at least shares go up, immediately there will be a positive vibe.

A: From an economic point of view or economist point of view, it is undoubtedly a good idea. From a political point of view, who knows? If you were to privatise, you have to prepare a bank for privatisation as well. You cannot just privatise any bank that exists now because that has some immediate second order risks in terms of deposit light and so on. But assuming that you were series and you had an agenda for privatisation, this has happened in other countries and you prepared banks for privatisation, as is being talked about Air India at the moment actually. There is a process going on to prepare Air India for privatisation which I think is a very welcome sign and I am keeping my fingers crossed if that happens. It will be a positive example for the rest of the industry. Then it actually does make sense. So yes, I think there is no taboo about privatisation. I think we should have a public debate about it. I think the government should be stepping back from non-strategic investments across the economy, is one of the reasons this government was voted in and it is bold enough to do demonetisation and GST, surely the privatisation can happen quickly.

Q: If you have one advice to give the government on public sector banks, what would that be?

A: I would actually immediately think of a recapitalisation plan in the context of a revival strategy, in the context of a business plan, business plan accompanies by recapitalisation is now inevitable.

Q: Forget what youir fund and fund managers and your research team thinks. At the moment if you were to put your own money, would it be in public sector banks? Do you think they are just bottoming out?

A: It is very hard to make an investment case for public sector banks. From a systemic point of view, I hope they revive. It is important that they revive or that the problem is dealt with in one way or the other. But the investment case remains fairly weak.