How are you reading the markets?
Markets are as usual. Many times over the last few years the markets have been as volatile as now. They are no different in that sense. It is markets as usual. There are certain events over the next six months which only comes once in five years and markets are focussed on those.
From an investor standpoint, has 2018 been disappointing? Could one look at 2019 more optimistically for next year?
Over a 30-year window, equity markets in India have returned about 14% to 15% and that has not come in a straight line. In certain years, we have been down 40-50% and in certain years we have been up as much as 100%. That is the nature of the market and this year has been flattish, though there has been excitement in the mid and smallcap space. They have been down a lot and the largecaps have held up flattish. It is one of those years where one has not done too poorly.
We are just a month away from the year ending, and looking forward to what 2019 could throw at us. The Nifty is back at 10,900. Crude has slumped to a one-year low. The rupee has strengthened to a nine-month high. With so many events lined up, can one say how long the market is going to sustain here?
The events like G-20 and OPEC meet, all continue in the backdrop all the time. What is most pertinent for India is the corporate earnings growth which is picking up momentum over the last few quarters are there are clear signs of the long awaited earnings growth picking up from single digits to at least in the teens.
The next six months with general elections in May and a the results of the assembly elections coming out in a couple of weeks could see a little more volatility.
How does one go about stock picking in such a scenario? Where is the risk- adjusted reward opportunity present in the market?
Stock picking is not much affected by these events. It depends on your style of investing as well but you continue to look for good businesses or great businesses which are attractively valued. And those businesses occur in every environment. Volatile environments may give even more opportunities. But since environment is always volatile, you have those opportunities all the time. I do not think that from a stock picking perspective, you can change anything event to event. There are better ways of generating higher returns. Otherwise you just generate a lot of turnover without generating much return.
Are you buying in midcaps?
Yes as always, we are buying across the market cap segments, large, mid, small across various sectors. The team has a certain investment philosophy and process that leads to certain sectors presenting larger number of opportunities and yet other sectors presenting fewer opportunities and it is more structural in nature and not dependent on specific events.
Since you are market cap agnostic, where do you find those alpha opportunities?
The alpha opportunities are found across the spectrum around the world, not just in India.
But let us start with India first.
In developed or emerging markets, there are greater inefficiencies in midcaps and smallcaps. There are certainly opportunities you find in largecaps as well but just the sheer numbers in mid and small caps are much larger and they are by definition under-researched. There are a greater number of inefficiently priced attractive businesses in the mid and smallcap range. We do find a lot of opportunities in mid and smallcap and also opportunities in largecaps but as I said, they are fewer.
So, you take chunkier positions in largecaps and the liquidity and the market cap also allows for chunkier positions. In mid and smallcaps, there are large number of opportunities and you do not need to take chunkier positions but you can take larger number of positions.
In terms of sectors, it is easier to highlight sectors where we have historically or structurally tended to have greater difficulty in finding great opportunities because our philosophy is focused on superior returns on invested capital, scalability and well managed companies both in terms of execution and governance.
We have historically struggled to find opportunities in the energy sector, telecom and utilities. At this time are not able to find opportunities in real estate or in metals. Generally, we do not have much investments in government owned equities and that is the case right now as well.
With banks too?
We have hardly ever invested in government owned banks be it in India or abroad when I was managing global emerging markets. I think of government owned entities as a bit of a separate asset class just like you have fixed income commodities, private equity, and public equities. There are privately owned public equities and there are government owned public equities and they are quite different. I have usually struggled to find attractive opportunities in government owned entities.
So you have told us what are staying away from. But that leaves two large pools which I guess you would be keen on — financials and consumption. Where are you taking concentred bets in these sectors?
There are several sectors. Consumption and financials too, but also technology, also healthcare and industrials more broadly. All these sectors are well represented in the portfolio.
Among financials, we have historically always found a lot of opportunities in well-run private banks. The asset quality is of highest focus for us while investing in financials because when you look at three times price to book versus one time price to book, it is a very misleading comparison because the debt is a given. You have to pay back the debt and these banks are leveraged 10 times to equity. When you look at a high quality asset bank which is trading at three times book, you can also see it is trading at 1.3 times assets compared to a bank which may be trading at 1 time or 1.1 time assets.
So are you staying with the compounders?
Certainly, if you are positioned this way, if you position this way 1.3 times for these well run banks is a lot cheaper. They are very attractively valued than for some of these corporate lenders where you do not know what is in the asset side.
I know that HDFC Bank, Kotak Bank, IndusInd Bank have done well. But it is not just about what the compounders do in terms of giving you consistency in returns, it is also how much of outperformance can be generated on the alpha. What about leadership transition? Would you attribute a change in their business model and leadership as a positive to seek value in those businesses?
A lot of the managements which are in transition, offer a lot of opportunities. There are certain sectors like banking and IT which are very execution led businesses. There are certain businesses which are brand dependent and a good management or a bad management can do only so much additional good or harm to them.
But businesses like banking and IT are very execution dependent. PSU banks have execution driven or execution shortfall problems. Sooner or later, India would have the largest bank by market capitalisation and those are banks which have created value through sheer execution.
Management changes are happening particularly in banks which were not well managed in the past. That does present an opportunity and we have used some of these opportunities offered by the recent NBFC related market falloff.
We have added to those financials where we believe the new managements would execute well and so their future would look very different from their past.
One of my fund manager friends has said that never let a crisis go to waste. Are you sizing up opportunities within NBFCs and saying that some of the high quality names did not deserve to fall as much as they have? Should we on a selective basis look at those opportunities?
Financials are heavily levered and the price-to-book multiples mean ultimately less. So a three time going to two times is not as attractive as it may sound. Typically, in financials, given the leverage element we have always been focussed on superior asset quality. Many of those also came under pressure both in NBFCs, particularly in the NBFC space and the team has used that opportunity to build to those positions.
Just a little bit on the crisis, call it a mini crisis. What has happened is very interesting since Lehman Brothers, is something you only see once in a lifetime in my view. It is a species of flower that only blooms once in 50 to 100-year timeframe.
My whole issue with a lot of these global managers saying 2019 is going to be disastrous is that nobody before 2007-2008 ever saw the magnitude of the problems. So, the very fact that they are calling for it, reduces the chances of it happening?
Absolutely true. The fact is that since 2008, everybody is running pillar to post looking for the next Lehman. The odds of sighting the next Lehman have gone down quite dramatically. But what it does do is even when there is a small problem, it can blow it a little bit out of proportion.
Do you think that was the case with IL&FS? Was it blown out of proportion?
Not particularly, I would not say any particular name necessarily but yes the scare of Lehman comes back to everyone when there is one skipped payment. But the scare and crisis of confidence or lack of confidence can be magnified, maybe rightly because you have learnt something from Lehman fiasco. I did say 50 to 100 years but you can never rule out the odds of the next Lehman in our lifetime.
What about consumption? Where are the opportunities?
Again opportunities are across the board. When we talk about consumption, we typically think of consumer staples and all but consumption is a very broad category including automobile and what is called consumer durables, We are finding more opportunities in travel and tourism related, entertainment related and also staples related space. We are finding opportunities across the board.
Consumption as a theme has never failed investors looking at India. The Indian consumers have always given returns. Shouldnt a price to earnings of 50 times or even 60 times as a multiple seem heady?
In my experience, PE multiples are the most useless and most abused. We have a very deep rooted disregard for PE multiples as a means of valuation. I do not think my team members know or remember PE multiples for current year or next year of any of the stocks in the portfolio.
PE multiples are not just useless but they are harmful because you attach meaning to something that is meaningless. So ours is a lot more cash-flow focussed approach and when you look at cash-flow based valuation, some of these names are very attractively valued.
I am not suggesting that high PE means attractively valued but that is not a metric you can rely on. An often asked question is why is China trading at more attractive multiples than India? China often trades at half the PE multiple compared to even Russia or EM in general. But that is comparing apples to not oranges but lemons at times. You have to look at the underlying constituents, cash flow generation capability, the governance structure and composition of the index. Government ownership of Indian index is one of the lowest in emerging markets and one of the highest is in China and Russia.
As I said earlier, they are two different asset classes. If you separate the government owned or sovereign owned equities and privately owned equities and then compare the respective valuations, they would be a lot more similar. But mix two different asset classes into one index and then compare the composite, which is true for individual companies as well.
Russia is 50% plus commodities, you cannot compare an Exxon multiple to a Pepsi or a Google multiple which is what you will end up effectively doing if you compare Russia, leave aside the governance issues.