Daily Voice | Now valuations reasonable, India has more upside risk than downside, says this smallcase manager

Abhishek Banerjee of Lotusdew

“After the recent banking crisis, I am particularly worried about the UK where inflation is very high,” says Abhishek Banerjee, smallcase manager & Founder, and CEO of Lotusdew in an interview with Moneycontrol.

Many of the UK pension funds run liability-driven investment plans to pay pensioners, so he expects that the next bank trouble can be in the UK if this were to spread even more.

He says valuations are reasonable and there is more upside risk than downside risk for India.

With over a decade of experience with asset allocation, portfolio construction and quantitative investments, Banerjee is bullish about the Indian banking system as few large and conservative banks make the bulk of deposits.

The general theme is an asset-liability mismatch. This is not uncommon in banking and this is the reason banks can borrow from central banks to cover the asset-liability mismatch that might arise in a day. For example, a bank might take in more deposits than it lent out - this creates excess liability for banks as they need to pay interest on deposits.

Similarly, a bank that has a liquidity shortfall can borrow to maintain its liquidity. However, in the case of US banking turmoil, this mismatch wasn’t cured in time and kept on expanding as was the case of SVB. This is primarily due to sticker-than-expected inflation, which kept eroding prices for US government bonds they held in their balancesheet while they didn’t find liquidity to pay depositors.

In India, we have seen this last with Global Trust Bank, which was taken over by DWS and some cooperative banks where due to an asset-liability mismatch depositors were unable to withdraw money.

In general, banks are based on an assumption that all depositors will not need money at the same time and all borrowers will not return money at the same time. Whenever one of the two goes out of balance, it’s called a bank run which is precisely what SVB faced.

As trust is fragile and banking is an opaque business, any trigger that causes depositors to doubt their ability to get their money back is always the trigger for a bank failure. You will be surprised to know that before RBI was instituted, there was on average one bank failure every month. So while greater regulation has stabilised the system, it also means things happen suddenly when least expected.

The Federal Reserve has a dual mandate of price stability and full employment. The labour market in the US is still very tight so the Federal Reserve is mainly concerned about price stability for now. Their inflation target is 2 percent and the Federal Reserve has no choice but to raise rates given their mandate and law.

Failure of a few banks will not materially change employment numbers but they need to backstop the lack of trust. Hence, I think rates will continue to rise in the US while markets decide, which banks are better users of capital.

European banks have generally been under pressure. Credit Suisse has seen changes in top management and also the fact that they are aggressive can make them appear riskier. That said, I think India is more resilient from bank runs as the deposit base is distributed and there is more friction in larger transactions.

What is worrying is that institutions built over decades are brought to a grinding halt due to certain actions by their management. Hence, the moral hazard of being backstopped by central banks can create distorted incentives.

I am particularly worried about the UK where inflation is very high. Having worked in the pension industry, I know many of the UK pension funds run liability-driven investment plans to pay pensioners. I expect that the next bank trouble can be in the UK if this were to spread even more.

I think it depends a lot in the near term on monsoon predictions by IMD. If poor crop yield is expected, it will directly feed into food and core inflation. The Indian demand for credit is strong but depositors are not impressed by the interest income of banks. This can lead to a further mismatch of assets and liabilities, which can lead to banks having to borrow at higher costs in the overnight market.

That said, I am bullish about the Indian banking system as few large and conservative banks make the bulk of deposits. Hence, I am confident, around an election year, there is very little we need to worry about the banking systemic risk.

Generally, companies that are insulated from macro are likely to do well as the western countries head towards a slowdown. This includes IT services and automotive part exporters. Also, as people lose trust in new-age assets like cryptocurrency - they might go back towards the traditional store of value like gold, real estate etc. That said, smaller companies have a typical advantage. They are insulated from macro as well as serve specific needs, and have concentrated cashflows from a few geographies.

We think smallcaps, which are micro monopolies will beat the odds of macro issues. Our listed venture capital focuses on such micro companies that have a dominant position in niche markets. Another smallcase Golden Opportunities invests in an asset allocation of gold and gold-related equity. This is also expected to do well.

No, I don't think so. There is always room for good companies to raise money. Given so much, Indian markets have held on and are not too far from all-time highs. This resilience with more financialisation of savings bodes well for IPO aspirants.

Yes, I think they are reasonable and there is more upside risk than downside risk for India. Given the current environment, a selected concentrated basket of equity in long-term portfolio should be a good way to increase risk allocation in the portfolio.

Looking at history, inflation levels of around 6 percent have been good years for Indian markets.