S Naren, CIO at ICICI Prudential AMC, says at this point in time, a lot of cheap sectors/ stocks have near-term outlook constraints. Citing upstream oil companies as an example, he says they have very low margins today, but going ahead they will do very well.
The investing culture has changed more towards equities, though there was a time when people were putting their money into real estate and gold, says S Naren, CIO at ICICI Prudential AMC. He sees the scope for financial assets going up.
He is waiting for a cyclical recovery because then a lot of stocks will look very cheap. According to him, at this point in time, a lot of cheap sectors/ stocks have near-term outlook constraints. Citing upstream oil companies as an example, he says they have very low margins today, but going ahead it will do very well.
Sector-wise, Naren is cautious on the banking sector and says interest rates have to come down, while adding that the non-performing loans problem will take time to resolve. He is cautious on public sector banks. He is also negative on downstream oil companies despite the fall in crude oil prices. Pharma companies on trailing PEs are not cheap either, he adds.
Below is the verbatim transcript of S Naren's interview with Latha Venkatesh & Sonia Shenoy on CNBC-TV18.
Latha: Chennai was always seen as a fixed deposit (FD) market. People play safe, don't dabble in stocks. Has the culture changed?
A: The culture kept changing. When I was studying engineering at that time I would agree with you and after that between 1989 and 1994 I did work in both investment banking and project finance and between 1994 and 2000 I was in broking and I had clearly seen even at that point of time the culture had changed much more towards equities.
The fact is that Chennai had the first private sector mutual fund and if you see the non-banking financial companies (NBFCs) movement also, I would say Chennai was at the vanguard of the NBFC movement, even the microfinance institutions (MFIs) movement, I think it was south driven. However, I do agree the equity cult started from both Gujarat and the West but otherwise in other areas, Chennai is certainly been involved particularly south has been involved.
Latha: At this point in time you see a lot of converts into SIPs? As a fund manager I think you guys are now wondering where to put the money isn’t it?
A: You had a situation where people were putting so much of money into property and gold between 2007 and 2012 and after 2012 both these markets haven’t done well. Clearly there is huge scope for financial assets to go up. I believe mutual funds with the kind of regulatory framework and ease of investing I guess there is huge scope for all of us.
Latha: What are the numbers you are looking at, in the last one year there has been a rush of money, it is about a trillion rupees that you have got just in the last few months. What kind of money are you looking at in the next two and a half years?
A: As a firm my CEO Nimesh says you manage the money well, don’t worry how much money you will get.
Latha: But it becomes important isn’t it when you have this kind of a rush for money, liquidity kind of sets the price. Markets refuse to go down so do you think that domestic liquidity is going to provide that kind of support which pushes the bottom of the market up?
A: What we as an asset management company do is also sell what we call our defensive equity products like our Balanced Advantage Fund or Dynamic Plan which have a fair amount of cash in their portfolios as you can see from their monthly disclosures. So, I would say that one of the objectives we think that equities is a very attractive asset but not all the money should come only aggressively, it should come defensively and we have spent a lot of time and energy in marketing our defensive products. So, I would say that with these defensive products we use market volatility to buy and that is what we are hoping can ensure that the investor experience can continue to be good.
Sonia: I was just going through your sectoral allocation in your funds. You have been fairly cautious on the banking sector. In fact n your dynamic plan you have reduced your banking allocation to just about 18 percent versus more than 30 percent that it was a couple of years back. What makes you circumspect on banking and how would you approach both these pockets PSU’s versus private?
A: These are question we have answered; basically what we can clearly see is interest rates have to come down. At the same time people believe that non-performing loans (NPLs) problems can get resolved very quickly. So, what we thought was why not look at par utilities which are bond proxies as a good way of playing for the interest rate fall which we have been expecting for the past quite some time. We think that may be that is good way to actually invest in banking in a defensive way is to look at bond proxies so that is one model we are looking at.
If you look at the NPL issue, particularly there are sectors like steel and power where the problems can’t be resolved overnight. There are complex problems to be resolved and I believe that it can take some time. So, our portfolio has been defensively positioned given these problems. However, in lieu of that I would say we look at bond proxies like par utilities which have regulated returns which we think can fulfill what we want, lower risk but reasonable returns.
Sonia: If not banking then which is the others sector that could perhaps take leadership in the next leg of this market up move? Do you think technology could play its part?
A: Clearly technology could play its part. It did play its part for a brief period and periodically you are going to get corrections in that sector because absolute market caps are not that low. What we are waiting is for a cyclical recovery then you have an entire set of stocks which look really cheap because think about it today you have a very low growth in cement. You have very low growth in power demand. You have very poor margins in sectors like metals so you know that upstream oil companies have very low margins today.
So, there is a whole set of sectors who’s margins can go up significantly from where we are if you take a three year period. Can it happen in one quarter I am not too sure but clearly there are wide areas of the market which are very cheap today on price to book. Actually today we are in a strange situation where the aggregate market caps are reasonable but there are costly sectors and cheap sectors. The cheap sector seems to have a bad outlook at this point of time. However, you can’t leave without those cheap sectors also going up.
Latha: How did the midcap earnings look to you, it is very difficult to look for sectoral themes over there because by its very nature it is bottom up but the market has only seen as Anuj was just telling us midcaps index has reached an all time high and the Sensex and the Nifty are still a distance away, probably 6-7 percent away from their all time highs. How do you negotiate this place? If you can give us within the constraints of your compliance stocks that you will look at?
A: Our view has been that midcaps are fully valued at this point of time and both smallcaps and largecaps present much better opportunities. In particular if you look at largecaps, what has happened is, in the March to July phase, fair amount of deleveraging has happened by the selling in stock futures. Consequent to that many of these largecaps have corrected including quality names. Then smallcaps you can go bottom up across sectors.
However, if you see today, midcaps, there are number of midcaps which trade at 40-50 times trailing. You can look at the cheaper ones there but the cheaper ones there do have constraints on I would say near-term outlook. So, as such if you ask me we have bet on largecaps and smallcaps not that it has worked; midcaps have been doing well but I don’t think midcaps today are – there are that many attractive opportunities at this point of time.
Latha: Would you dare buy the public sector banks?
A: We believe that NPL issues are something which will take time to resolve. We believe that there has to be a gradual process of accumulation given that the NPL problems can't get resolved so quickly. So we have been cautious in that sector. We do have a few of them and we don't think they are thumping the table buys at this point of time because of the issues involved.
Latha: What about the traditional defensives, technology and pharma stocks? Pharma stocks have not always been defensive as we learnt; suddenly they can give you a very nasty jar.
A: We are grappling with pharma at this point of time because one or two companies, the large cap companies have shown pretty bad numbers and actually if you look at their valuation on trailing price-earnings ratio (PE), you will find that they are not cheap at all.
On the other hand you have lot of these small cap pharma and midcap pharma which all have some attractive product opportunities which gives you lot of opportunities for growth. Technology on the other hand is a reasonable return sector with reasonable risk. Neither is a sector expensive neither is outlook extremely positive because growths are not increasing substantially. So, technology gives us a good investment from a garbed framework, it is a growth at reasonable price etc, so it fits into our investment philosophy.
Sonia: I wanted to ask you about the oil and gas space because that too has relatively high holding in your portfolio in your top 100 fund, about 10.3 percent and as we speak, many of these oil marketing companies are hitting fresh highs. Can you break it up for us, what are you bullish on? Is it the upstream or downstream and what do you see as the triggers from here?
A: From a value point of view, upstream oil is very cheap. On the other hand downstream oil believes that any drop in oil leads to increase in margins. That is not our view because we believe that a downstream oil company has to pass the lower price to the customer and we have been of that belief but the market seems to believe that as prices go down, their margins will increase whereas that is not our view. So, we are actually negative on the downstream oil companies because the market seems to think of them as anti-oil proxies whereas we see them as more regulated return kind of sector at this point of time, so we are not positive on the downstream oil companies.
So, clearly the rest of the oil pack is value-will it work in one quarter? No because I don’t think people expected such a drastic fall in oil in the last one month and therefore today clearly you have to look at that sector with a three-year view and I believe some of the upstream companies cannot be given subsidy when oil is crashing below USD 50.
So, it has to be adjusted somewhere else, so that is why we think that the upstream oil companies neither got the benefit of oil when oil went up, so when oil comes down also if they are going to be hurt, then it means that the sector becomes uninvestable. So, I believe that can’t happen because some of these companies are very important from a national point of view and they will have to be given adequate resources to invest when oil is down, otherwise you will never create oil security in a country like India.
So, this is our view, we could go wrong because finally these are sectors where what policy government decides, decides what happens to the margins and profits in this sector.
Sonia: One of you top holdings in your dynamic plan is Tata Motors. Although I don’t want you to comment on Tata Motors as a stock, just wanted to understand your philosophy on how to approach quality companies that go through adverse times and get de-rated significantly, do you keep the faith and increase allocation there or do you at some time – say after a 10 percent or a 20 percent loss decide to book out?
A: With a value contrarian framework, these we see as opportunities and not worries. So, what we think is when we are managing large sums of public money, for us a setback in a stock or a sector which is temporary actually gives us an opportunity rather than we worry about it.
So, with that framework, we actually as a house are given the large public money that we manage, we look for opportunities in many of the sectors as and when there are corrections and actually look at them for long-term investments, may not be all our strategies are focused on that, we have a few strategies which have a value-contra kind of model, in those funds clearly we look for such opportunities and we have seen that over the long term, buying cheap in a sector in trouble works very well and with that strategy we look around and booking, doing a stop loss in stock which we think has very good long-term potential is not our framework unless the company is exceptionally leveraged and has a risk of bankruptcy which certainly most of the stocks don’t have.
Latha: You have been talking about the kind of flows the mutual fund industry is getting and even in a global scenario while a lot of emerging market equities are getting bashed up because they are commodity producers. India even if the emerging markets (EM) basket isn’t doing well, is slated to be an outperformer, give us an idea of what kind of yearly returns you can reasonably expect at an index level? One year, two years, three year?
A: Three months back people said that China is attractive, let’s take out money. Today money comes to India because Brazil, Russia, Indonesia, China, Turkey and South Africa are unattractive. Then money comes to equity because gold and property is unattractive, money doesn’t come into bonds because rates have not come down, so I believe it is very difficult to make these assumptions. Clearly Indian markets are not cheap, Indian markets on the aggregate are not expensive, so our view has been to expect for moderate returns but if people are going to invest in India not because of India but because of Brazil has a problem, then it is very difficult to predict the upside of the market because upside of the market is not being determined by India, is determined by the downside in Brazil or Indonesia or Turkey.Get access to India's fastest growing financial subscriptions service Moneycontrol Pro for as little as Rs 599 for first year. Use the code "GETPRO". Moneycontrol Pro offers you all the information you need for wealth creation including actionable investment ideas, independent research and insights & analysis For more information, check out the Moneycontrol website or mobile app.