Return potential of AA-rated papers may be better than that of AAA ones
Today, there is reasonably high margin of safety in categories such as moderate duration and credit risk
PremiumSankaran Naren, chief investment officer of ICICI Prudential Asset Management Co. Ltd, talks about his calls on credit risk, market valuation and the relative attractiveness of the US markets compared with India. Edited excerpts:
In January this year, you gave a call on small- and mid-cap stocks. Do you continue with these calls?
Over the past three months, Indian equities across market capitalization have rallied. The rally in mid- and small-cap comes after years of underperformance, which started in 2018. This broad-based rally was primarily due to the steep cut in interest rates in India and, globally, coupled with the US Federal Reserve pumping trillions of dollars to improve liquidity. But we are not sure how long the liquidity will sustain, when the vaccine comes and when economic activity will normalize globally.
Going forward, owing to the recent rally, investments should be done in a staggered manner with at least a five-year horizon. From a three-five years’ perspective, small- and mid-caps are well-placed. In the event of a domestic market correction (owing to any correction in US equities), in the interim, investors can consider stepping up their investment in this space.
On the debt side, how do you see credit risk now?
We have always been disciplined with the credit process. This has ensured that in our 22-year history, we received the investment principal and interest on debt investments without any delays. We believe that from the investor experience point of view, the return potential of investing in AA-rated papers at this point is likely to be better than investing in AAA-rated papers.
When compared to the low return in overnight funds, there is scope for much higher returns in categories like moderate duration and credit risk, which will tend to have considerable exposure to AA papers. Today there is reasonably high margin of safety in these categories.
In 2017, investors were eager to take on risk, a phase when we chose to adopt a cautious stance compared to the street. As a result, the YTM (yield-to-maturity) on our debt funds was much lower than the peer group.
The moratorium will end in August. There is a restructuring scheme on the cards. How does that change the scenario for companies that have some level of credit stress?
There is no moratorium involved in any of the debt papers that we are invested in. The issuers have been prompt in their payments in the past five months. Moreover, moratorium is available to bank customers. Most of the top banks in the country have raised capital on the equity side over the last 45 days. So, they are well capitalized to tide over any potential uncertainty over the next six months.
Turning now to duration, in the recent outlook, you have asked investors to add duration and earn carry. Can you elaborate on this?
Currently, there is only one major borrower in the country—the government of India and everyone else is a saver. This has led to massive surplus with the Reserve Bank of India (RBI), because of the excess saving of both individuals and corporates. We believe this trend will reverse over time as the government has to reduce its borrowing rate. The CPI has been higher mainly because of categories such as recreation even though not many are stepping out of their homes. Housing is another sector where we don’t see prices going up. At the same time, WPI is in the negative. So, we believe that monetary policy should be looked at considering both WPI and CPI.
Nifty is trading at 31 times earnings on a trailing basis. What’s your view on valuations and future corporate earnings?
We think the current year’s earnings is not a justification of how one looks at earnings. Currently, the most expensive market, globally, is the US. As the economy improves over the next three years, valuation is likely to be more reasonable.
Even today, if we consider the sector valuation of, say, power utilities, which we are positive on, there are stocks which are trading at six or seven times earnings. So there are pockets of value which are very cheap even though market valuation in general has turned expensive.
Your fund house is among the biggest believers in the asset allocation or hybrid category of funds. Some of the AMCs, including yours, have increased credit exposure? How’ll this play out in terms of risk and reward?
Over the past one year, returns generated by the balanced advantage category (which sells equity as market rallies and vice-versa) outshone other equity categories, delivering exceptional investment experience even during turbulent times. Even over the next three to five years, we believe this category will perform well amid volatility, especially in a market which is largely propped up by the global central banks. For the bulk of Indian investors, asset allocation is the way to invest for a decade or two.
There are concerns on the credit quality of the papers on the debt side of such funds.
Over the last 22 years of our existence, we have never faced a single day’s delay in payment on our debt investments, on account of robust risk management and superior credit selection process. That said the future is not equal to past.
The excess returns that debt investors enjoyed over risk-free rate has been remarkable on one- and three-year basis. Compare this to a single month like March, where equity fell 20%.
How do Indian markets match up against global markets like the S&P 500? Funds tracking US markets have outperformed domestic equity funds in the past decade. Will this continue?
The US market has seen continuous rally from 2012 to 2020. It’s currently more overvalued than almost any other global market. We have been very cautious on US equities. In fact, we’ve created a global advantage fund of fund, which invests across global markets and not just the US markets.
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