With stock markets going through a difficult phase amid ongoing geopolitical tensions, rising crude oil prices and the 10-year US Treasury yield at multi-year highs, S Naren, executive director and chief investment officer of ICICI Prudential Asset Management Company, shares his market outlook, where he sees opportunities and why his fund house is launching a contrarian fund.
What is your outlook for Indian markets given high US interest rates, elevated oil prices, high US 10-year Treasury yields and geopolitical tensions?
Our view has been that near-term returns could happen if oil prices decline sharply. With oil at $107-108, coupled with high transportation costs, it remains a significant headwind for Indian markets in the near term. If oil prices decline, markets could recover.
Our broader view remains focused on asset allocation, unconstrained investing and moderate returns. This view is driven by several factors such as high US interest rates, geopolitical tensions and global equity market valuations remaining elevated.
Which sectors do you favour, and where are you concerned?
Anything connected to US AI, anywhere in the world, is not cheap and is priced for continuous growth. If those areas face challenges to their growth assumptions, there could be significant derating.
Following the recent sharp fall in insurance stocks, insurance is a sector worth considering. We have also been reasonably positive on banking, as it is one of the few sectors that remains relatively inexpensive and has a favourable near- to medium-term outlook. The only constraint with banking is that the investment industry already has significant exposure to the sector.
How are you viewing the Indian IT sector in light of AI?
Initially, we did not realise that the sector was even partially disrupted. We have now concluded that AI has indeed disrupted the sector to some extent. Valuations are cheap, so it may make sense to have some exposure, but it is difficult to take an aggressive position at this point. We are not significantly negative on the sector, but we are unsure whether to take a positive view and, if so, to what extent.
How is a contrarian strategy different from a value fund? Can it add differentiation for investors who already own a value fund?
In a value fund, we buy stocks where implied assumptions are very low. For example, even if quick commerce underperforms, we would not be able to buy the sector simply because it is a growth sector, not a value sector. Most new-age companies would not qualify as value stocks unless we find that their implied assumptions in their valuations are very low.
When it comes to contrarian investing, we look at stocks that have underperformed the market over the last three to five years, occasionally over one year, and research that addressable universe to identify investment ideas. So, there is a meaningful difference between value and contrarian investing.
Contrarian investing can include value, growth or quality stocks at different points in time. For example, quality underperformed over the last six years and therefore has become contrarian. But in 2020, quality would not have been bought in a contrarian fund.
So a contrarian strategy can also include growth sectors?
Absolutely. Power equipment, for example, would have been a contrarian investment five or six years ago, although valuations were not cheap even then. Today, it would not be contrarian because the sector has outperformed.
Small-cap stocks have done well in recent months. Are valuations stretched, or could the trend continue?
I think it is primarily a function of flows which has resulted in elevated valuations. Some companies in the small cap space have been growing well, but the current valuation differential is primarily due to the large flows into small and mid-cap mutual funds.
Are there still pockets of froth in small-caps? Should investors be cautious?
The advantage today is that there are small-cap stocks that have not gone anywhere over the last three to five years. There are also sectors that have performed extremely well. Therefore, even within small- and mid-caps, there are pockets where contrarian investing is possible because not every sector has gone up.
Does the larger size and improved liquidity of the small-cap universe offer more comfort than five or six years ago?
We assess comfort from the perspective of margin of safety and not market capitalisation. A high market cap does not matter as long as there is a margin of safety and we can buy the stock. Another important point is that liquidity is transient. Silver, for example, was one of the most liquid commodities at its peak in January. Therefore, liquidity and market-cap size do not particularly affect our contrarian strategy.
How should investors navigate a period of time correction and think about their portfolios?
Over the last three years, we have been advocating and telling investors to practice asset allocation rather than choose only equity funds. Investors should consider categories such as balanced advantage, multi-asset and aggressive hybrid funds. However, investors are generally more comfortable choosing equity because they believe equity will always deliver returns. That belief is flawed as equity is a riskier asset class that can deliver high returns at times and low returns at other times. Therefore, we continue to suggest that new mutual fund investors can consider asset allocation products rather than equity products because markets can be more volatile than investors expect.
What role can SIFs play in an investor's portfolio?
Basis the specialised investment funds we have, we are not running them as aggressive funds designed to deliver very high returns. Our objective is to manage them with a more moderate-risk mindset, particularly the active asset allocator offering.
Each asset management company has freedom in how it runs SIFs, and we are grateful to Sebi (Securities and Exchange Board of India) for creating this category. We are taking a moderate-risk approach because very high-risk products are harder to scale. We want products that can be scaled and accessed by a wider audience, so we are approaching them more conservatively.