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BW Businessworld

'European Downgrades Not To Impact Indian Economy'

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The new RBI guideline — not allowing banks to invest more than 10 per cent of its networth in liquid and liquid plus funds — has been  worrying Rajan Krishnan, managing director of Baroda Pioneer Mutual Fund, who feels the bread and butter business (liquid and liquid plus) will put further pressure on the mutual funds that continue to reel under pressure of stringent regulatory norms and the overall weak market condition. In a freewheeling chat with Businessworld he discussed a gamut of subjects from business strategy to lack of decision making by the government to European crisis and its impact on the equity market.

Though he doesn't see the Reserve Bank of India (RBI) cutting rates next week,  he feels it could be a welcome move if the governor cuts cash reserve ratio (CRR). Holding on to its equity investments through mutual funds he is bullish on sectors like auto, IT and pharmaceutical, while bearish on FMCG. Overall he feels this could be an appropriate time for investors to build a good equity portfolio for a long-run and would advice investors to come through systematic investment plan (SIP) to avoid volatility.
Excerpts from the conversation:

What impact do you see on the overall P&L of the mutual fund with the RBI norm of restricting banks to investing not more than 10 per cent of its networth in liquid funds coming into effect?
The new ruling of a 10 per cent cap by the investments of bank in liquid will see the Assets Under Management (AUM) in liquid funds come down substantially for the industry from the peak levels seen a year or so back. Maybe by 50 per cent or more.  While Liquid Funds are low margin products, the big reduction in AUM could see a very significant drop in revenues for a number of fund houses, without any commensurate drop in expense levels.

What would be the strategy of Baroda Pioneer to grow its AUM and investor base? How much are you investing in the business?
We are very committed to both – increasing AUMs as well as our investor base. However, we have taken a call that we will pursue growth at a meaningful cost rather than growth at any rate.  We have been investing in strengthening staff, improving systems, widening distribution, internal communication &training etc.  For the moment, we have not been spending much on creating visibility through external communication.

The AUM growth is likely to come from growth in corpus of our fixed income product range. Here the key approach from Baroda Pioneer is to pursue and convert as many large clients as possible. And from the converted one pursue higher allocation. While doing that, we have kept our focus on the smaller companies who can benefit from the opportunities provided by our various schemes.  Over the last couple of quarters, our average AUM has gone up from around Rs 3,395.58 crore to Rs 4,581.67 crore currently.

On the retail side of the business where growing the investor base is key, Baroda Pioneer's focus to a large extent has been in working closely with Bank to Baroda to extend our coverage to as many branches and locations as possible. We believe that the branch network of Bank of Baroda is a very effective platform to reach out to investors in even the smaller towns. We hope to be active in all 3,500 plus Bank of Baroda branches, including rural ones, by mid-2013. These efforts have yielded some success and we have increased our investor base from 57,000 at the end of 2011 to more than 116,000 currently.

What is your view on the overall financial market? Do you think the downgrades in Europe will have a major impact on the Indian markets?
Currently there are huge challenges facing the financial markets. At a global level as well as at country specific level. Even as one set of issues seem to find a solution others are cropping up. Even though I am optimistic that we will see improved conditions in the coming quarters, I expect that financial markets will keep us on our toes for the next 12 to 18 months.

Overall, financial markets are driven by news flow from Europe, global economic data and domestic macros. While conditions in the US are improving slowly and Asia presents a mixed bag, Europe continues to be under pressure. Undeniably, major problems in Europe have and will move global financial markets. Global financial markets are beginning to price in the possibility of a break-up of the Euro, which would have catastrophic consequences not only for Euro but for the global financial system because of the interconnectedness.

The European crisis or downgrades in Europe may not affect our economy that much but it will have an impact on the Indian markets. However, spill-over effects from European defaults (or sovereign departures from the Euro) to the banking system and economy to other countries would be manageable. Ever since long-term refinancing operations (LTROs) were issued on 21 December 2011, the tail-risk situation seems to have been averted and liquidity has improved for EU banks. Last week, Spain and Italy could sell more bonds than its planned target. The IMF now says they have $500 billion to lend to Europe's bailout fund. The funding crisis there is over for time being which is a big a positive for European market and equity markets elsewhere.

Till when do you see such a drag market condition and why? What is your take on the Indian equity market and why?
I am more worried about domestic issues. The growth rate has been retreating. Investment climate has worsened. On the political front, worsening political gridlock and revelation of a slew of scams left the government unable to deliver on any structural reforms. We do not see that quick a recovery in growth. Improvement in fiscal situation too will take some time. The European crisis will continue to weigh heavily on global markets. Things are not looking great but then most negatives have been factored in. We see 2012 to continue to be a challenging year. We expect to see some relief on the inflation and interest rate fronts. Downside from the current level is probably capped at 8-10 per cent. The market is trading below long term averages and this is a good time for long- term investors.

In your view what will be the next trigger for the Indian equity market? And why? And when do you see it coming?
Decline in inflation and interest rates: The sharp slowdown in economic growth and a decline in food inflation have led us to advance our policy easing call. We believe the RBI will begin easing monetary policy in 1Q12, probably starting with a CRR cut and following it up with a series of cuts in benchmark interest rates.

Industrial growth, particularly led by an upturn in manufacturing and infrastructure construction, should revive in 2H12.

Potential downgrades in earnings estimates, particularly for FY13. However, we believe the January- March quarter should mark the end of the earnings downgrade cycle, particularly for the rate-sensitive sectors.

On the political front, observers hope for a second lease of life to reforms after the conclusion of the key state elections in February-March 2012. We expect the policy environment to remain unsupportive in 1H12 due to the election season.

What is your take on next week's RBI policy? Will it set the tone for a rally in the market?
In Tuesday's RBI policy, we expect the central bank to be dovish showing concern on slowing growth. With inflationary expectations changing for the better and growth decelerating, RBI will initiate easing monetary policy. But inflation is still not in the comfort zone for RBI which may force RBI to refrain from cutting policy rates just yet. RBI may indicate easing measures from next policy in March if inflation slips below 7 per cent. We feel market is factoring in the above as 10-year government yields has rallied recently.  Whether as a signal of policy or not, a CRR cut would be very welcome given the very tight liquidity conditions in the country currently.

What is your view on the overall corporate performance of Indian Inc? Have the December-ended quarterly results that have been declared so far been in line with your expectation? Which are the sectors that you are bullish and bearish?
December quarter results are likely to reflect the challenging environment being faced by India Inc. There could be several one-time hits due to forex losses. Till date major results from IT, banks, financials and metals are in line with expectations. However, the commentary about future from the IT sector has disappointed the market. We are positive on pharma and IT companies which will benefit from rupee devaluation. We are positive on auto manufacture, which are trading at reasonable valuations. We are bearish on the FMCG sectors due to its stretched valuation.

In current market condition where will you advice investors to invest? Currently where are you investing your own money? And why?
Given India's long-term growth story, equity investments would continue to offer good returns. I would advise retail investors to invest in equities through the SIP route, as it is a time-tested strategy to even out the effects of volatile markets like what we are going through. I continue to hold my equity investments, mainly through mutual funds.

As a fund manager what call will you take on the overall portfolio of the mutual fund? What will be your short-term strategy in the current market condition?
We are not trying to ride on momentum. At present, it is better to spread out and balance our portfolio across sectors rather than sticking to defensives or going too aggressive.

What is your take on the 10-year G-Sec yields and why?
We maintain our stance that 10-year-yield could soften to 8 per cent level in next 3 to 6 months due to weak global economy, slowdown in growth, decrease in inflation and open market operation (OMO) purchase by RBI. But the key risks are deterioration in the government fiscal position, supply of government securities and higher crude and commodity prices.

Fixed income, particularly FDs and bonds have become a flavour among investors, even equity fund managers. In your view is fixed income still a cushion for equity investors?
We believe fixed income is a cushion during a bear phase in equity markets. Currently the equity market is volatile and may continue to remain so for some more time. Therefore, we have seen asset allocation shift towards fixed income/cash by investors as well as equity fund managers.

What is your take on the 1 year, 2 years, 3 years, 5 years and 10-years yields in corporate bonds? Will you be a buyer in corporate bonds and what would be the tenure?
We expect the 1-year CD rate could come down by 75 to 100 bps in next 6 months. Similarly 2- and 3-year bond yield can potentially come down by 40 to 60 bps. The 5- and 10-year ones can come down by 20-30 bps to 8.75 per cent in next 6 months but the risk is higher in the long end of curve due to deterioration in the government fiscal position and supply of government securities. In this scenario, the short to medium term bonds offer better risk adjusted return.

What is your view on gold? Should it take maximum share of one's portfolio as the world economy is still not showing signs of revival?
Gold is another important asset class. An asset class that Indians have been extremely familiar with, has not been taken that seriously as a pure investment option. Its only more recently that Gold ETFs have become popular as an investment opportunity. Gold has run up quite a bit in the last few quarters with uncertainty levels high. As the global economic conditions stablise there is every possibility that we will see a correction in gold prices. Hence, it may not be prudent to have a disproportionate part of your portfolio in gold.