Would rather bet on volatile returns rather than take a safe bet and overpay: Franklin Templeton

Even within the same sector, the impact can be different for various companies. So, it cannot be said that the new measures would uniformly impact all companies.

There is also another provision wherein companies coming up with new manufacturing facilities before 2023 will get additional tax benefits. This will invite new competition in various sectors. Because these new facilities will pay lower taxes, they would become more competitive.

Then, there is also the fine-print to consider. You cannot reduce your output from the existing plant; moving to a new facility should be genuinely for additional capacity because of increased demand; and you cannot transfer capacities to the new facility from the old one.

Some of the foreign companies that were desisting from investing because of high tax rates may now consider these options. For them, the tax rate moves down from 30 per cent to 15 percent.

The second point is there is a perception that, after these tax cuts, companies would go and invest the surplus money. This is a simplistic view.

Going by various analysis, the sectors that may benefit the most would be banks and consumer staples. And neither of these sectors is investment-heavy. In fact, if FMCG (fast moving consumer goods) companies make more profits, they will pay higher dividends and not set up new plants.

The clear correlation between higher profitability and the investment cycle is not well-established.

Third, not all incremental profits will be retained by the companies. There is a chance that some of the benefits will be passed on to consumers. Examples could be automobiles and select consumer staples. Even in banks, some products are weighed by competition, and higher profits due to lower taxes can be passed on in the form of lower lending rates.

The overall impact of all these three factors put together may not be substantial on the earnings of companies at the index level. But these cuts will arrest the earnings downgrades that companies in the listed space faced.

Of course, these moves do give investors the confidence that the government is willing to take fiscal measures to spur growth.

Q: With the tax cuts handed to corporates, there is the expectation that similar relief will be given to individual tax payers and that the direct tax code (DTC) recommendations would be implemented. What is your opinion, given that such a move is likely to improve demand significantly?

A: I don’t know if the government will offer relief to individuals, that too in the same year that the present move has been made, as there isn’t too much fiscal space. I would not attach a very high probability to such a move from the government.

Of course, there is will expectations around a more moderate personal taxation regime. In that sense, the implementation of the DTC – at least some recommendations of it – would ensure a fairer taxation system by offering parity between companies and individuals.

I believe that the government must give sector-specific stimulus than a generic one. For example, the government needs to offer specific stimulus to increase housing demand. They can give more housing-related benefits than they already have. These measures may not cost the government a lot, but will have a lasting impact on consumer demand and in turning around the economy.

Q: Would you say that the sharp market rallies for a couple of days following the announcement is just euphoria that will die down soon?

A: The announcement helped in a reversing the weak market sentiments. Post budget, Indian markets fell very meekly and underperformed global markets. The negativity was specific to India. There was fear and panic that demand was collapsing and that the government may not do anything about it.

So, these cuts have helped remove the extreme fear and negativity.

Soon investors will start watching the September quarter results and markets will start re-adjusting to earnings numbers and estimates. We will have to wait and watch if the market’s reaction matches with the reality of company earnings. My guess is it will be bit of a mixed bag.

Q: Is the present economic slowdown structural or is it cyclical?

A: It is a combination of both. Till now the economy was running only one one-and-a-half of the three legs – consumption, investment and exports. Consumption was doing all the heavy-lifting in keeping the economy afloat.

The country wasn’t investing, particularly in housing. The government, with its over enthusiasm to curb asset price inflation, has caused steep demand correction. Investment is pretty weak.

Of course, the government has invested in metros etc., but the impact of these investments come with a lot of lag and may not help jump-start the economy.

Only exports and consumption (partly) kept the economy going.

I am confident that the cyclical part – credit tightening, sentiment improvement, liquidity and corporate spending – will come back. But I am not sure about the structural part given the lack of targeted infrastructure spending from the government.

Q: For about three years now, earnings growth has been below expectations for most companies in the listed space. When is corporate earnings likely to revive to, say, 15 per cent?

A: The earnings growth in the listed space has been very narrow. There are many sectors that are not delivering earnings. Metals, capital goods, infrastructure, power, oil & gas and telecom aren’t delivering at all. In the automobiles segment, earnings growth is too volatile. Even consumer staples are delivering single-digit growth. It is a consequence of weak aggregate demand and economic activity. Only select private banks, insurance companies, some NBFCs, consumer staples and consumer durables and IT alone are delivering growth. These growing sectors account for 50 per cent of the index. The other 50 per cent isn’t delivering anything. If half the index constituents grow at even 15 per cent and the other half grows at zero per cent, then the overall index earnings growth would only be around 7.5 per cent mathematically. But every year, there is this expectation that we will get out of this slow earnings trajectory. But you will come out of the rut inly if the investment to GDP ratio goes up and demand improves.

This will happen if government steps of funding in infrastructure and companies find ways to take some exports market share away from China or if your imports fall. If all these happen, earnings growth will become broad-based. Else, it will remain narrow.

Otherwise, we will have to be reliant only on consumption.

I don’t see it changing anytime soon.

Q: Mid- and small-cap stocks have fallen heavily over the past year-and-a-half. Are they now attractive value buys or is there a value trap there?

A: As categories, mid- and small-caps got re-priced. There was a large influx of money to buy these stocks and these shares are illiquid. Even a small inflow in an illiquid small-cap will cause a large disproportionate movement in its share price. We call this impact cost. For a while, we mistook this impact cost for alpha. Liquidity coming into these counters in a concentrated manner and then moving out suddenly caused the heavy fall in the stocks. The underlying companies may or may not have had significant earnings challenges. It was bubble and later a blow down.

Small and mid-caps are now as attractive or unattractive as any other cap. I would not focus excessively on cap-based investing. There is as much uncertainty in large- or giant caps as well. But with this correction, mid-caps face relatively lower risks.

The performances of mid- and multi-cap funds have more or less converged.

The best way to play a rally now would be a multi-cap or a large & mid-cap fund. But if someone is keen on mid-caps, they are today probably less risky than they were, say, a couple of years back.

Q: Given that large-caps have struggled to match their benchmarks over even long terms of five years, is there a case for investors to consider index funds and ETFs, at least for this category?

A: These are phases. Globally, active fund managers have had long periods of underperformance. You can either go by periods or cycles. If an active fund manager underperforms across multiple cycles, then you should be worried. In a cycle framework, the last three years can be viewed as a single year. In a single year, markets and fund managers may have generated 30 per cent returns. You should measure active fund managers based on quantum of returns and cycles and not necessarily periods. Select banks and IT companies became bigger and bigger. Their stock valuations also became expensive. So, the entire index’s returns were delivered by fewer and fewer stocks. That is not what an active manager bets on. An active manager bets on some churn or rotation in sectors with growth moving from one segment to another. But that wasn’t happening.

Your choice to go passive should be based on the view of whether the trend of narrow growth – large stocks becoming larger and expensive, smaller stocks becoming smaller and cheap – would last for long.

But clearly, costs need to come down for active managers. Regulation is already working in that direction and companies are responding by trimming costs.

Q: Many of your equity funds across categories have underperformed. Even long-term SIP returns are have failed to beat benchmarks. Where do you think your bets went wrong?

A: There were a few wrong bets that we took. Our bets on the revival of auto and telecom sectors did not work. And generally, the hope that there would be broad-based economic revival did not happen. It is not that a few stock or sector bets did not work. The general expectation that earnings growth would be broad-based did not play off.  Even within our funds, those with concentrated portfolios have done better, like our focused equity fund did. The more diversified the portfolio, the more challenging the performance delivery.

If we bet only on consumption names and they go into hyper valuation zone, we wouldn’t want to be there. And these FMCG stocks have not corrected.

Active managers who are more conscious of what they pay for may not buy such stocks. We can forgo some short-term returns in search of long-term value. Certain consumer staple names have remained flat for nearly a decade, before rallying massively.

I would rather bet on volatile returns today rather than take a safe bet and overpay. This trade-off is tricky. It has affected our large-cap funds. But we also feel that at some point in time things will change. There is nothing inherently wrong with the stocks that we own.