Vetri Subramaniam, Group President & Head of Equity, UTI AMC says that he is comfortable owning companies with growth challenges, but that he is not willing to take balance sheet risks. He says value picks from mid- and small-cap spaces would take time to play out. There is scope for passive and active investing to co-exist, he adds. Excerpts from his conversation with Moneycontrol’s Venkatasubramanian.
Have markets reacted too positively to the FM’s corporate tax cut announcements, given that consumer demand is still weak and tax tweaks may address supply rather than demand side of things?
The corporate tax cut during this period has perked up sentiment and it will have a long-term positive impact on profits accruing to shareholders. In the aftermath of the budget presented in July, there was a sense of drift and concern that the economy’s problems were not being addressed. The market is now taking comfort from the government’s continuous engagement with industry and markets to address their concerns. Also, keep in mind that India’s performance during the period August-October 2019 is only slightly ahead of the emerging markets indices and global markets have also performed well during this period.
Earnings growth has continued to disappoint, even in the recent quarter. For the past few years, earnings have been weak, though there have been constant expectations of a revival. Is there any scope for re-rating based on the possibility of improved margins as a result of lower taxes for companies?
Back-of-the-envelope calculations suggested that the Nifty 50 EPS (earnings per share) for FY20 could ceteris paribus (other conditions remaining the same) witness a mid-single-digit upgrade on the back of the corporate tax cut. However, the consensus EPS has not witnessed any earnings upgrade for the Nifty 50 post this event. It would appear that, in aggregate, the benefit accruing from the tax cut is being offset by the pressure from weak trends in economic growth. Top down on a P/E (price to earnings) basis, the market is not cheap, trading well above average and that limits the possibility of a re-rating. However when you disaggregate the data it tells a slightly different story. There is a wide divergence in valuations between sectors and stocks. There are some pockets which have re-rated to a significant premium to long term valuations and others which now trade at a significant discount to long term valuations. In other words there is potential at a micro level for re-rating higher but not so much at an aggregate level.
Even in the rally after the FM’s announcement, the rise has been narrowly led by a few stocks. How long will this concentrated rally persist?
This is impossible to know. Trends persist in the market for longer than can be justified and then reverse without any warning. In a way this concentrated rally going back to January of 2018 was preceded by an unusual period in the opposite direction. The mid and small cap indices outperformed the Large cap index by an abnormal margin based on history during the period 2013-2018. In our opinion trying to pick the point of inflection is virtually impossible. We prefer to address this by thinking about the risks posed by over extended valuations and trends and adjusting the risk in the portfolio accordingly.
The mid and small-cap pack has fallen heavily in the last couple of years and continue to appear weak. Is there scope for value buying now?
Valuations in the mid-cap space based on the Nifty Midcap 100 have moved to a discount to the Nifty 50. It is not in cheap territory on a headline basis, but it is a significant reversal, considering that it was at a significant premium to the Nifty 50 at the beginning of 2018. Bottom up as well we now see many attractively priced opportunities in this space. Buying such stocks cheap does not guarantee that they will start to perform immediately. These valuations could be a function of heightened risk perception and weak growth among other factors. As these factors normalise or witness mean reversion, there is an opportunity to benefit from both revival in their earnings and valuations. We are comfortable owning businesses that have profitability & growth challenges which are cyclical in nature but we are not comfortable taking balance sheet risk, i.e., companies with elevated debt and /or weak cash flows.
Increasingly, at least in the large-cap category, financial planners suggest investing through the ETF or index fund route. Would that be the way forward for retail investors?
Academic research suggests that as the institutionalization of markets increases, generating alpha becomes more challenging. The Indian data is consistent with that. I would only add that this pattern is visible across the board and is not limited to merely the large cap space. Further it is hard to argue that mid cap stocks are under researched or under-owned by institutional investors. The data may have supported this case 10 years ago but that is no longer the case. The reason to consider passive is because it ensures minimum deviation from benchmark return thanks to its nature and the low cost. Further it removes the risk of adverse fund selection. Active management can potentially add alpha to the benchmark return but that is not guaranteed. We believe there is room for passive and active to coexist in investor portfolios. It is a optimizing the path to their financial goals. Thinking about it as merely as an alternate within the large cap space is a misunderstanding of the nature of the product and the benefits it provides investors.
Even SIPs run over several years are reporting losses in the case of funds across AMCs. How should investors deal with this prolonged phase of underperformance?
Historical data indicates that rolling returns tend to stay positive once the holding period increases beyond 5-7 years. This applies to diversified indices, not necessarily to sector and thematic indices. Our generic guidance would be that investors should stay the course based on historical data. But monitoring at some frequency, which is different from action, is desirable. A good advisor could be very useful in this context. And for DIY (do-it-yourself) investors, there are research platforms and services that provide useful inputs.
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