Mumbai: There has been talk about how much money foreign institutional investors (FIIs) have brought in over the last few months—the number has touched $11.2 billion (Rs53,760 crore) for the year—and many FIIs have been fairly bullish about the current momentum in global equity markets. How do domestic mutual fund houses view the scenario? In an interview, Prashant Jain, executive director and chief investment officer at HDFC Mutual Fund, gave his take. Edited excerpts:
How are you feeling about this spectacular rally?
Fair valuations: HDFC Mutual Fund executive director and chief investment officer Prashant Jain
We have a fairly balanced view of the markets right now and the markets are trading at close to where the P-E (price-earnings) multiples are appearing to be fair... In my opinion, if we take a two- to three-year view, we should make returns which are in line with earnings growth rates—between 15% and 20% CAGR (compounded annual growth rate).
Do you think that the kind of bearish phase that we had is over and have we entered a firm uptrend or a bullish phase?
I think it is very challenging and we rarely take a view on the short-term direction on the markets, not because we don’t want to but we find that equities as an asset class are not reliable when you take a short-term view on the markets.
To put things in perspective, the 20,000 index (the Sensex) one year back and also the 8,000 index last year—they were aberrations and many people are concerned that the rally has been too sharp from 8,000 to 16,000.
The rally has been sharp, but to be fair, that rally came after an equally sharp fall, and I think the fall was wrong and this rally merely corrected what led to a severe undervaluation.
When we spoke earlier, the index was below 10,000 and I had discussed that the index appears to be quite cheap and though you can’t time it where it would go in one year, you could focus on valuations.
At 8,000–10,000, we said the long-term returns would be significantly ahead of earnings growth and today we are saying that long-term returns would be in line with earnings growth. But I don’t think there are any reliable indicators as to where the markets are going in three-six months from now.
What kind of (earnings) growth could you pencil down for fiscal year 2010 and more importantly fiscal year 2011?
It is not fair or easy to talk about the average because the average would comprise of companies like Reliance Industries, ONGC, Tisco (Tata Steel), Hindalco, where earnings could be vastly different from what you build in today, depending upon commodity price movements. But for a moment, we remove the global cyclicals like refining and metals, basically, if you look at consumer companies like media, banks, pharmaceuticals, automobiles, we think earnings growth should be north of 15% per annum.
So how do you play this? Do you say: ‘There is uncertainty in global commodities and I don’t want to be in that basket’ and so take a very big underweight call and avoid those stocks and focus on India-specific stories?
That is how we have positioned our portfolio because we believe that at a very broad, at a very macro level, the global excesses have been so large and for so long that it is unlikely to correct in a few years’ time and therefore the Western economy should continue to grow, if at all, at very low growth rates.
We don’t have a definitive view on which way commodities are going and in any case, most commodities are prevailing at prices which are significantly ahead of the marginal cost of production. Some people are still positive because they believe the dollar will collapse, we don’t know. So basically, we are underweight the global cyclicals.
There is one other area of concern when you are trying to map earnings for the next couple of years and trying to discount the fact of interest rates, where increasingly we are hearing from more and more bankers that over the next three-four months, they would start climbing once again. Would that interfere with your (earnings) assumptions?
I don’t think so because if you look at the Sensex composition, the corporate leverage is actually very low and I don’t think companies would get hurt in any meaningful way because of the interest rate movements. On the contrary, banks are a very large component of the indices and I believe that higher interest rates should actually help banks maintain or even improve margins.
Is that the reason why your top sectoral holding is banking and that includes the largest public sector and the largest private sector banks?
Yes, we think that credit growth in India should continue to be ahead of the GDP (gross domestic product) growth rates because, one, banking is a very ingrained way to save—bank deposits are a very popular way for people to save money and we are focusing on banks which have a good deposit franchise and different interest rate regimes, whether low or high or medium interest rates, that banks in India have more or less maintained.
In general, do you expect a significant rise in interest rates throughout 2010?
I would not say anything with any high degree of certainty, but I don’t think interest rates should go materially higher because there is clearly excess liquidity and credit offtake is not happening, and because of what happened last year, the capex plans have been postponed or scaled down; companies are now focusing a lot more on cash generation or reducing working capital. So as and when credit growth picks up, by that time hopefully the government borrowing would also not grow because the current year should be a peak year for fiscal deficit and, next year onwards, one should expect a significant easing in fiscal deficit and that should compensate for higher borrowing...and that’s why we don’t think by and large that interest rates should go meaningfully higher.
What’s been your general approach towards the primary markets over the last six months, particularly the last three months? We have had some really big-sized issues such as NHPC Ltd, Adani Power Ltd being floated—not all of them have done very well after debuting—but at HDFC Mutual Fund. How have you approached them?
Exactly the way we approach secondary markets, and we will invest in the issue if it’s sensibly priced and if there is a reasonable return in it for us and if it’s a good quality company, and if it is not one, we will avoid it.
So have you had reason to avoid big issues over the last few months?
Yes, we have avoided some of them.
What’s your general take on the infrastructure space? L&T (Larsen and Toubro) is one of your top 5 holdings, you purchased some Punj Lloyd (shares) in August as well. Do valuations make you comfortable there or would you say they are on the expensive side?
Infrastructure is a very broad term, it would include cement, steel refining, power, power equipment, engineering. So I don’t think it is fair to comment on this whole world in one stretch, but by and large we think there will be a reasonable growth in the engineering and construction space and L&T is clearly one of the most—there is a big gap between L&T and the No. 2 player—so it will get good premium. It is not cheap but we think it offers quality and growth.
The same question for frontline IT (information technology firms). Infosys is one of your top 5 holdings, and the sector has outperformed significantly over the last six-odd months. Where do you see that whole IT story heading from here?
IT broadly, in my opinion, is quite fairly valued now again as the markets are and I don’t think there is any material upside to the P-E multiples as we see them, and we think it’s a very high-quality sector... However, there are risks to the sector as well, and if all continues to remain where it is or if it heads lower, and as and when we get more capital inflows, currency could start appreciating, which is again not good for this sector.