The 2017 Morningstar Investment Conference was held in Mumbai on October 10-11. At the conference, Nikunj Dalmia, Senior Editor at ET Now, chatted with Chirag Setalvad, senior fund manager of equities at HDFC Mutual Fund.
This year has turned out to be a dream year for the stock market. Is it only liquidity which has done the trick? Do you think the market is telling us a different messaging about which way the economic cycle is going to move?
A lot of it has to do with liquidity. In India liquidity doesn't operate in a vacuum. There is tremendous amount of liquidity in India, globally as well, which is why markets everywhere are at a peak. We look at the Indian market from an Indian perspective and think it's all about the Indian economy. We forget about the global impact. But emerging markets, global markets, across asset classes, everything is at a peak. So, I think, you have to be a little bit concerned that liquidity is very ample. I would be a little bit concerned on that.
Some say valuations are expensive. Some are waiting for earnings recovery. Some are waiting for a correction to kick in. How can you get both - earnings recovery and correction?
Look at it this way. The last few years we have seen the market do extremely well despite earnings growth not taking place. So, if that has happened, then certainly you could see the exact opposite. What have you seen in the last few years is earnings growth has disappointed but P/E multiples have gone up. What, I think, possibly could happen in the next few years is, you could see earnings recover, but you could actually see P/E multiples coming down. Neelesh Surana made a point about how interest rates have come down and there is now pressure on interest rates to move up, which should bring down P/E multiples.
So, I think both can happen. You can see a recovery in earnings, but you can see a market which doesn't necessarily move exactly in tandem with earnings. Hopefully, you'll see the next few years earnings growth will recover to 15-20%, but the market may lag that.
You can actually see returns of 15-16% or even a little less. So, I think, you're still in a reasonable environment from a medium-term perspective. My concern is mainly from a near-term standpoint, not from a medium to long-term standpoint.
So one must keep return expectations low. What's happened in the past may not get repeated.
Keep the basics in mind.
Asset allocation drives 80% of your returns. Getting that mix is the most important.
Invest systematically.
Invest regularly.
Keep a long-term perspective. You are getting into a market which is expensive. That means you are going to compromise your returns to some extent. The compromise in the short-term will be greater. As you extend the time horizon, the compromise becomes less and less and less. Take a 10-year perspective. Let's for a minute assume that the market is 20% too expensive; 20% over a 10-year period is a 1.5% lower return per annum CAGR. That's not a big sacrifice.
You may take a little bit of a hit in terms of short-term returns, but the long-term outlook is incredibly positive. Look at how the economy is growing. Look at the inherent growth. You can't but be optimistic from a 5 to 10-year perspective. But you have to be careful from a shorter-term perspective.
What's been your basic strategy in a market where you feel stocks are expensive? In your mid-cap portfolio, there is a bit of a pharma, a bit of an NBFC flavor and mid-cap IT.
Our focus remains on creating the portfolio on a bottom-up basis.
That's been something that we've been focused on for the last decade and that's going to be even more important going forward, because markets in general are looking expensive. We have to strive even harder to find individual opportunities. For any given sector, I can give you 3 companies that we like and 3 that we don't. So, being very stock specific helps.
Our focus remains on reasonable quality business, decent cash flows, decent ROEs, run by honest and competent managers and we try and hold them for 3, 5, 10-year type perspective. So, I think, in that sense, it doesn't change. We want to focus on cash flows; we want to focus on payouts; we want to focus on tax rates; we want to focus on working capital.
The conversation becomes meaningful when you look at it at a company-specific level, because within a pharma company, there are companies which are dependent on the U.S., which are dependent on India, within industrials and so on and so forth. Every company has a unique profile. Even more so in mid-caps, companies are very different from one another. So, I think, you have to get very stock-specific to add value to your portfolio.
What right now are the clear growth pockets which you can identify?
I think the opportunities are driven by growth on one hand and value on the other.
Look at neglected sectors. IT and pharma have relative neglect. Banks, particularly some of the public sector and corporate banks, have relative neglect. That's one set of opportunities.
The other set is where you see reasonable growth, and you see that growth delivering returns over a period of time to your stock. I think that is a lot more challenging today, because growth is getting very well-priced. So, you can find companies growing 20%, 25%, 30% but they are all available at multiples of 25, 30, 40, 50, 60 and so on. So, I think, the growth part of it is going to become even more challenging, but you have to look at sectors of neglect.
You don't get good news and good price together. What about sectors where news is good, and prices may not be good. NBFCs? Private banks?
If the news is good but the price is adequately or more than adequately reflecting it, personally I would prefer to avoid it because you will get long-term growth, but you will compromise on valuations. Eventually, it will normalize and become more reasonable. So, you will get a return as a result which is suboptimal. So, I prefer to be in sectors where there is relative apathy and neglect. There earnings will recover and normalize over a period of time and valuations give you an extra kicker. So, you have two avenues of growth as opposed to high fast-growing businesses which are extremely expensive.
Because the law of economics will always come into force.
So, if a sector is doing particularly well, more and more competition will come in. Unless you have a very, very strong moat which protects your business, it's only a matter of time before your returns become a little bit more normalized. So, you got to have a combination of both. So, I don't think any of our portfolios will be entirely growth or entirely value. We tilt depending on our personalities, upon our mandates and so on. And I feel, certainly, more inclined towards buying where there is relative neglect.
How would you approach financials? PSU banks, big yes and no right now. Corporate banks, it's a judgment call when the earnings recovery will actually happen. Private banks, crowded, expensive. NBFCs, valuations out of the whack.
If you put it into three broad categories: private sector banks, NBFCs and public sector banks, I think the public sector banks is a cyclical story. As the economy recovers, you'll see the NPA cycle improving and what is today anywhere from 0.3 to 1 times book, that valuation will move up over a period of time. So, there is money to be made in that segment of the market from a medium-term standpoint.
Between NBFCs and private sector, they are both very strong structural stories. They were long-term outlook, strong managements, good business models. But the private sector is much cheaper than NBFCs. And I think the private sector model, in my mind, is a more tried and tested model. So, between these three, I would prefer to be at the two opposite ends, which is owning the tough businesses, businesses which are going through a tough time and the high-quality private sector. The segment I would tend to be skeptical of would be NBFCs, which are high quality, but very, very expensive.
