Remain cautious on smaller PSUs; positive on retail-centric private banks: Kotak MF

Below is the verbatim transcript of the interview.

Sonia: I wanted to start by asking you about the big story of the week which was the government notifying the banking regulation ordinance. Do you think the government has the capacity to solve the malice in the banking sector or are you circumspect?

A: It clearly shows the urgency and the focus that the government has in terms of resolving bad assets problem in the banking sector but at the same time, we cannot expect everything to get resolved in a very swift manner. I think it is going to take time.

What is different this time around compared to some of the committees or some of the guidelines that have come out over the last two-three years is the fact that the first time you have Reserve Bank of India (RBI) as one of the participants in the entire process, which means that the details as we go ahead but seems like RBI can direct banks to resolve some of these outstanding issues in a time bound manner which is definitely a welcome move.

That is where even if there was some hiccup because of commercial reasons or because of the fear of possible investigations into some of the older issues. All of those can be set aside now since regulator is also going to be directing the banks in terms of how to go about the entire process. So that is definitely a positive but without seeing too many of the details, it is very difficult to comment how successful this will be at this point of time but definitely a good step in the right direction I would say.

At the same time, we need to be worried about capital adequacy of some of the smaller public sector banks because as you try to resolve some of these issues, the provisions will increase, the haircuts will increase. At this point of time, they are already undercapitalised. So to that extent, capital will become even more scarce for some of these smaller public sector banks. So that is the worry at this point of time.

Anuj: The other point is how much of this is now in the price? We have seen public sector undertaking (PSU) banks for example double from the recent lows and some of the corporate facing banks have also started to rally. Do you move some money to some of these stocks because they still remain under-owned or do you still stay invested with the outperforming lot or the erstwhile outperforming lot of the retail banks and well managed banks?

A: We do have some positions in corporate lenders and some of the bigger PSU banks. We haven’t cut that position, so we continue to have that position but our tilt has remained towards retail centric private sector banks and financials. That continues.

We will wait and see how this new step that has been taken by the government will affect the non-performing assets (NPA) side of the story. As we go along, maybe we will get more clarity and will be able to take better call in terms of how successful this game will be and how it is going to impact some of the banks that we hold in the portfolio or some of those which we do not at this point of time hold in the portfolio.

Our initial reaction would be some of the smaller public sector banks will find it difficult because once the resolution process starts, there will be provisioning, there will be haircuts and that is where their capital will get eroded much faster. So we will remain cautious on the smaller public sector banks but other than that the current position continues in our funds.

Sonia: What is the recommendation to retail investors now? I know as a CIO of a mutual fund, you would recommend to put in money at all times but do you reckon that a 30,000 on the Sensex is better to keep your powder dry, raise your cash levels and wait for better times to invest?

A: While index is at the same level as what it was in the earlier peak, the earnings in the interim have gone up. They have not gone up very significantly but still there has been some growth in earnings over the last few years. So to that extent, the valuations are not same. Even though we are at 30,000 today, the valuations are not same as it was when it hit 30,000 first.

So to that extent, one should be focusing on valuations rather than just the index levels. Also, there is no need to chase this momentum and we have been advising the same to our retail investors as well.

This is not a market where you should keep chasing your levels and keep investing at all levels. It is better to go on a discipline staggered way. Valuations have just moved above that fair range of valuations I would say. Slightly above fair range of valuations today. So to that extent one needs to remain cautious and make those regular and discipline investments. So that the story of economic recovery over the next few years will give you wealth creation opportunities. If anybody is betting on equities for the next few months or quarters, I think that is not the right way to play the market.

Anuj: Some of the midcap funds, yours included, have done remarkably well. The index itself is up and I would expect a good fund managers to beat index. So what does the fund manager do now in midcaps? Do you raise some cash levels, do you churn your portfolio, are there enough stocks still available in the midcap basket where I am assuming with so much money still pouring in, you would have to deploy so what is the strategy here?

A: You have to be stock specific in midcaps at this point of time and it is becoming a challenge by the day as markets are moving up. I would say 25-30 percent of the midcap basket today is at very high valuations maybe 30-35 times one year forward kind of valuations. So that becomes a risky part of the entire midcap basket.

As far as our strategy is concerned, we continue to focus on bottom-up stories where we believe that the valuations are reasonable and the growth numbers are also in terms of visibility, so that is where we bet on visible growth stories, which are available at reasonable valuations.

In terms of the cash levels, while it has increased little bit in our funds, it is not very significant. Currently, we are holding about 6-7 percent cash in our midcap strategy, which is not a very high number in our opinion but that is what we have maintained at this point in time.

Sonia: What are the sectors that you would be recommending now because we have seen quite a bit of sectors play out beautifully whether you look at the falling crude theme, aviation, tyre, in the midcap space particularly, what would you be bullish on?

A: In the midcaps we have been looking at some of the stories from next two-five year kind of horizon. We are betting currently on some of the rural stories, it could be in rural dependent consumer stocks, it could be fertiliser, it could be in agriculture related, irrigation related. So that is the basket that we like.

The second basket that we like at this point of time is on the midcap capital goods side where at this point of time in terms of visibility, there is not much of visibility but we believe with economic recovery gaining ground, you will start seeing some of these midcap capital goods companies seeing good growth in terms of both topline as well as profitability going forward. I think that is another story which investors can look at.