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BW Businessworld

The Cautious Optimist

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Equity has been a key component of Bhupinder Sethi's investment and he continues to invest through the systematic investment plan (SIP) in his own managed funds. Talking to Businessworld, the head of equities at Tata Mutual Fund feels the markets can always correct a little bit post a sharp run-up, but he would be a buyer on every correction though on a more stock specific basis. He feels the current rise is a good opportunity for investors to reduce holdings in companies with deteriorating economic fundamentals, poor business models and questionable governance practices.

His short-term strategy in the current market condition would be to go down the cap-curve into buying some better managed mid-caps across sectors as mid-caps tend to outperform large caps in an uptrending market. At the core of the portfolio, he remains biased towards sectors with secular growth prospects and superior return ratios like consumer staples and discretionary, software, pharmaceuticals, private sector banks and upstream oil and gas. However, he feels for the index to cross the 18,000 levels, the triggers would be fiscal consolidation in the upcoming Budget in March 2012, the government shedding policy paralysis and moving ahead with infrastructure and investment thrust.

Excerpts from the conversation:

Do you think the recent rally in the equity market will continue and why? What is your take on the Indian equity market and why? Will you be a buyer in this market and why?

Over the last four years, while our nominal GDP has grown by around 80 per cent, BSE Sensex at 18,000 is down by 14-15 per cent from the peak level of 21,000 it touched in January 2008, which gives a sense of the value that has crept into stock prices as businesses have scaled up over this period of time on back of overall economic growth. The BSE Sensex is up by around 20 per cent in the first one and half month in the current calendar year and at 18,000 it quotes at 14 times 1 year forward earnings. Post the run-up. The extent of undervaluation has definitely reduced but the market is still quoting below the long-term averages by around 10-12 per cent. The markets can always correct a little bit post a sharp run up and while I would be a buyer on every correction but now on an even more stock specific basis.

What is your view on the overall financial market? Do you think crisis in Europe is behind us and why?
Since the global financial markets have increasingly become inter-linked, the overall financial market's health would continue to be dictated by what happens in Europe. ECB's lending to European Banks three-year money at low cost has helped bring down the yields on Euro-zone sovereign bonds. Now there is an expectation of a second round of lending by the ECB. In the immediate near
term, the biggest issue is the Greece debt rollover in March 2012. Our view is that given the improving situation thanks to ECB's flooding of the market with money, every attempt would be made to avoid a disorderly default by Greece even though there would be hard bargaining and tough negotiations till the very end. So while the ECB's recent actions have averted the European crisis in the near term, the longer term structural problems remain in Europe and would need to be addressed.

What is your view on the overall corporate performance of India Inc? Have the December-ended quarterly results that have been declared so far been in line with your expectations? Which are the sectors that you are bullish and bearish about?

The sales growth for corporate India continues to be very robust at over 20 per cent even in the last quarter of calendar 2011,  amidst a slowing economy. The slowdown in the economy has become more broad-based with it spreading from investment related sectors to some of the consumer discretionary sectors as well.

The earnings for the quarter ended December 2011, have been largely in line with the beaten down expectations with a marginal positive surprise. The operating margins showed signs of stabilization on a sequential basis, though they were down on a year-on-year basis. Profit growth continued to lag the sales growth by a big margin because of continuing high interest costs.

Consumer staples, information technology, private sector banks and some industrials surprised positively. The disappointments were mainly from sectors like utilities and telecom.  The key takeaway of the earnings season is that the earnings downgrade cycle seems to be bottoming out, whereas in previous three quarters, the downgrades were prominent.

At the core of the portfolio our bias remains towards sectors with secular growth prospects and superior return ratios like consumer staples/discretionary, software and pharmaceuticals as also private sector banks and upstream oil and gas. On a complete cycle basis, these sectors can be expected to deliver good returns. Incrementally though, given the improving macro economic conditions and possibility of rate easing cycle, we are also looking at stock specific opportunities in interest rate sensitive sectors which have been underperformers over the last year. The actual recovery in business may take time for some of these sectors, but the fact that the stock market is a discounting mechanism; the stock prices are moving up ahead of the event.

From the valuation perspective, some of the consumer stocks are richly valued. Given the high quality of capital efficiency,  prospects of robust, structural growth over long periods of time, the sector lends itself to a bullish view from a medium to long term perspective. However, in the near term, the sector may underperform given the high valuation divergence with the rest of the market. The sector would still be part of our core portfolio, though tactically we have reduced our weightage.

Why is the market neglecting the fact we are in a slowdown?
The tops in the market are made very often amidst bullish news and the markets bottom out typically when the news flow suggests all gloom and doom. Also, at times, the equity markets can move up if the valuations become very compelling, even though the economy may be undergoing a near term slowdown.

The valuations had definitely become very attractive and significantly below long term averages in December 2011 and a "risk on" trade globally was all that was required to spur the market.

What are your concerns for the equity market?
The biggest concern is that the government fails to live up to the now raised expectations on either of fiscal consolidation or push for investments. Also, while inflation is coming down, we believe that some of the structural issues around our economy having a tendency to have high inflation haven't been addressed. So, even if the Reserve Bank of India (RBI) does start the rate cutting cycle, the market may be disappointed with the quantum of rate cuts.

While currently the Euro-zone situation seems to be in control, any deterioration or any disorderly sovereign default by a Euro-zone member country or a further flare up of oil prices because of escalation of geopolitical tension would be a major dampener for the equity market.

In current market condition, where will you advice investors to invest? Currently where are you investing your own money? And why?
To exploit the power of compounding, my advice to investors is that they make equities a core part of their overall asset allocation plan, since equities have delivered excellent long-term returns. At the current juncture too, investors should continue to invest systematically in equities in line with their long term asset allocation plan. Systematic investment in good quality companies and investing though mutual fund schemes with good long term performance track record is what should help create long term wealth.

Another advice to investors would be that generally an uptrend is always a good time to reduce holdings in companies with deteriorating economic fundamentals, poor business models and questionable governance practices. That's what the volatility in the market should be used for, to buy strong businesses on dips during market turmoil, and to treat up-trending markets as
cleansing opportunities.

I personally am sticking to my asset allocation plan, in which equities are a key component. I continue to invest in the equity funds I manage through systematic investment plans (SIPs).

I like equities as an investment avenue because equity shares of well managed companies, with good growth prospects and who do not dilute equity often and therefore are not easily replicable, should over the long term hold and advance in value vis-à-vis currencies which are easily replicated in the printing machines of the central banks.

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?
Short-term strategy in the current market condition would be to go down the cap-curve, into buying some better managed mid cap companies across sectors, as midcaps tend to outperform large caps in an up-trending market.

In your view, what will be the next trigger for the Indian equity market? And why? And when do you see it coming such that we break the 18K levels?
The triggers for the Indian equity market would be fiscal consolidation in the upcoming Budget in March 2012, government shedding policy paralysis and moving ahead with infrastructure and investment thrust, resolution to some of the problems facing the power sector both on the fuel supply side and the distribution side and start of the rate cutting cycle by the RBI. Also, globally, the
current "risk on" trade has been triggered by ECB's lending to European Banks three-year money at low cost. A second round of lending by the ECB would keep the animal spirits alive. Smooth passage of the Greece debt rollover in March 2012 should also be favorable for the equity market.