Union Mutual Fund, a unit of Union Bank, has an underweight position on financial services sector among its equity funds, says its Chief Investment Officer Vinay Paharia.
In a freewheeling chat with Moneycontrol, Paharia said that the companies in the financial services sector may suffer a double whammy due to the rise in the cost of capital.
The margins of financial services companies could be impacted due to rise in the cost of their primary raw material, i.e., money. Secondly, the cost of equity for such firms can rise disproportionately, as their betas - which represents riskiness of cash flows - are typically higher due to the leveraged nature of the business, he explains.
On the other hand, the fund house, which adopts a bottom-up approach for stock selection, likes defensive sectors like information technology and healthcare sectors for investments.
He rates performance in Q4 FY18 of corporate India as ‘good’ and expects improvement in performance of corporate earnings in the medium term.
Excerpts:
Q) How do you rate the performance of Corporate India in Q4?
Overall performance in Q4FY18 has been good for corporate India. Earnings growth for Nifty companies for FY18 was in high single digits, which is commendable, especially seen in the context of FY18 being a difficult period, due to Goods and Services Tax (GST) implementation. We expect a relative improvement in performance of Corporate India in the medium term.
Q) Twenty-one public sector banks have incurred losses totaling to Rs 25,775 crore due to banking frauds in FY18. Will it be a wise decision to catch this falling knife?
Current high losses in corporate lenders are due to the recognition of credit costs in legacy accounts. The same cannot be extrapolated into the future.
Q) Which are the sectors that you are bullish on and why?
We invest on a bottom-up basis within our investment universe, with a medium to long-term time horizon. We invest in companies which according to us offer optimum returns for the risk taken.
Hence, sector allocation is driven by stock selection. Currently, we are overweight consumer discretionary mainly automobiles, healthcare, and information technology (IT) sectors.
Q) Which are the sectors that you are underweight on or avoiding and why?
We are currently underweight on financial services sector. We expect companies in the sector to suffer a double whammy due to a rise in the cost of capital.
First, the margins could be impacted due to rise in the cost of their primary raw material, i.e., money. Secondly, the cost of equity for such firms can rise disproportionately, as their Betas (representing riskiness of cash flows) are typically higher due to leveraged nature of their business.
Q) Do you think global liquidity is a concern for Indian equities? Foreign Institutional Investors (FIIs) have been net sellers so far this month. How do you think FIIs are looking at India?
According to us, one of the biggest risks facing global asset markets is rise in inflation. Currently, the USA, which has a multi-year low unemployment rate, is not experiencing wage inflation. It is experiencing goldilocks scenario of low inflation and rising economic growth. Central Banks of Europe and Japan are yet to see a meaningful pickup in inflation.
Hence, European Central Bank and Bank of Japan continue to administer ultra-loose monetary policy. All of the above can change with rise in inflation. We can witness a fall in global liquidity, which can impact an emerging market like India.
Q) Mid and small cap stocks have taken a beating in the last 2-3 months. Both the BSE Small cap and Mid cap indices are down on a year-to-date basis. What should investors do with stocks that have seen double-digit corrections and is it impacting portfolio performance?
We need to put the current fall in small and mid-cap stocks in the right context. Both, BSE Mid Cap Index and BSE Small Cap Index, have outperformed BSE Sensex by about 5 percent over last 3 years and 11 percent over last 5 years, despite the fall. They have delivered a compounded 16 percent and 21 percent return over last 3 and 5 years respectively.
Thus, the current developments are a part of natural market fluctuations. The reason why returns in these categories of stocks is higher compared to Large Cap stocks is due to higher risks. Hence, an investor who has invested in Small and MidCap Funds should adhere to his financial plan.
Q) Do you think we will have a normal monsoon in 2018? What will be its impact on sectors?
We would go with India Meteorological Department’s forecasts that we should have normal monsoons this year. According to us, transient factors like monsoon or commodity prices which keep changing with regular frequency should not be used as a tool to make investment decisions.
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