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Rural sector and government employees will not be immune to this meltdown

Apoorva Shah, Executive Vice President & Fund Manager - Equities , DSP BlackRock Investment Managers.
Apoorva Shah joined DSP BlackRock Investment Managers in April 2006 and currently manages three equity funds, and the equity component of the balanced fund and Monthly Income Plan (MIP). He previously worked in the Global Private Client and Institutional Equity Sales divisions of DSP Merrill Lynch. A commerce graduate, he has a post graduate diploma in management from the Indian Institute of Management (IIM), Ahmedabad, with 22 years of experience in the finance industry

GDP growth in the third quarter slipped to 5.3 per cent due to the decline in the agricultural sector. This is a sector that was to get the minimal impact of the global turmoil. How serious is this?
I don’t know why the data showed up negative for this quarter. The one sector that is relatively immune is the rural sector. There has been a consistent rise in the Minimum Support Price over the past few years. Then we have the farm loan waiver and the rural employment guarantee scheme. So this sector is protected.

Rural folks do not have exposure to stocks and are typically not involved in the financial markets. So I think this segment is holding up quite well. The other segment which is immune is that of the central government employees which make up 10 per cent of India’s households.

So you are saying that this GDP figure is just an aberration.
It could be. We need to see more. When you look at the ground realities and talk to the people involved, there is not much concern on the agricultural front. We are going to have a good crop even this year.

The capital goods sector is going through a rough patch. The PE multiple for the sector has fallen substantially even from January and the RoEs are under tremendous pressure. Where do you see this sector heading?
This sector is facing a lot of challenges. There are project delays. Banks may be eager to fund but there is the lack of equity capital that the promoter brings. There is also uncertainty with respect to demand as promoters are changing their assumptions with respect to growth. So now it is the promoter who is unsure of whether or not he should go ahead with the project. What’s more, these projects were slated to give a particular potential IRR when the assumptions were rosy.

Now he is not so sure and neither is he certain of getting the money. So there are genuine problems.

Of course there are different segments contributing. One is oil and gas and the global demand for oil and gas projects. For instance, the oil prices have come down. So those players who were generating huge cash flows and going ahead with oil and gas projects in the Middle East and other places have slowed down. The private sector generally has slowed down, even in the power sector.

The public sector and the infrastructure projects are moving forward but these are not as remunerative as private led capex. And they also require more capital. So working capital needs have gone up and the mix of projects has shifted to the relatively unprofitable.

So has the infrastructure theme run out of steam?
For the time being, it is definitely on the back burner. It could revive but will need substantial efforts from the government as the private sector does not have the resources. So if the government steps up its efforts to revive infrastructure, this theme could take off.

Globally there is an effort towards this. China has been spending on infrastructure for many years and have had a 40 per cent CAGR over the last five years in infrastructure spend. All that went into the export sector which was directed to the U.S. and Europe. Now these countries are facing a problem taking on more consumption. So if China was producing for the West, that growth is not replicable and will definitely slow down. But since China’s predominant mandate is to keep its people employed and factories running, they could turn into exporters at lower prices. That could have a negative impact on the sector.

You said the infrastructure sector could take off if the government steps up its efforts. Do you think the government can with such a fiscal deficit?
In India there is not sufficient room on the fiscal front. So the government is not going to spend as much as what is required to substitute the private sector capex spending. And whatever they spend on, there is a doubt on the efficacy. Do they have the ability to implement what they said they want to? Money may be allocated but is it spent? Efficacy of execution is in doubt. And of course, the very ability to fund is also in doubt with such a fiscal deficit. So it does lead to the conclusion that this sector is facing big problems.

So which are the sectors you are favouring right now?
Consumer non-durables because that is based on our assumption that the rural sector is doing fairly well. This sector too may see a slowdown but at the end of the day, they are basic consumption items and are not cyclical. There is a natural tendency for people to move from high end to low end to cut costs. But if a company is present in all the segments, it won’t be hit too hard.

Domestic pharma is another sector. Utilities are relatively alright. They have a fixed revenue so you can be sure of the returns they are going to generate.

Any contrarian bets?
None right now.

The recent IIFL survey stated that no single fund manager with a position on India is long. And just 3.3 per cent of them are overweight on India. What’s keeping the FIIs away — the fiscal issue, the elections?
If they have to allocate money globally, India stands out because it’s a domestic led growth economy. So the global markets do not pose as strong headwinds as they do for other economies. And our banking system has not been that badly affected by the global crisis. So on paper, India is a relatively safe place to invest in.

The fiscal problem is a global one. Every country is pump priming. It will have an implication whether or not money will go to equity. But if money available for equity shrinks, then every market will suffer, which is what we are seeing.

The elections are a big concern. If you have a large fiscal deficit you want to be sure that you have a responsible government at the helm so that resources are productively spent and projects are implemented. You need confidence in the ability of the government to control expenditure and direct it in the right places. If they cannot deliver on this front then this deficit may turn into a structural deficit in the coming years.

Looking at the news flow, there is a potential for negative surprises. We need a government which can handle the fiscal situation because that in turn will impact the interest rates. Finally, if interest rates shoot up because of the deficit and lack of flows from abroad, then economic recovery will not be possible.

After a number of years corporate India witnessed a decline in PAT growth. What are the factors that really led to this decline?
In the October-December quarter, there were huge inventory losses. The world virtually came to a halt and companies were stuck with inventories. There was a crisis and no money was available so they had to dispose their inventory at a loss to fund their working capital.

Companies also got into raw material contracts at high prices. Now these prices have come down. Margins got squeezed last year when raw material prices went through the roof. But now that margins have improved, top line is slowing down because of the decline in demand.

It is a combination of slowdown in sales and flat margins. As a result, net profitability has fallen.

Last year, a lot of ‘other income’ was generated. Now that too has fallen substantially. There is no surplus money anymore.

Do you see the forex losses of corporates being curtailed going foward?
The fall in currency value is continuing even in this quarter. So there may be fresh losses.

What is your strategy to ensure that your funds are top quartile performers? What’s the reason behind the good performance?
We got our sector calls right. From the top of the market we under-rated the risky sectors like the capital intensive ones. For example, capital goods, metals and real estate. These were the sectors that did very well in the last bull market. We overweighted the defensive sectors which had visibility of demand and decent profits. They also offered dividend yields.

Do you resort to high cash allocations?
We do from time to time. When we are not convinced about good ideas, we do raise our cash levels.

What are the parameters that influence your sell decisions?
If we find that the assumptions on which we made our purchase have changed then we consider selling. Or if the way the market perceives it has changed and in the current circumstances the stock is considered expensive, then we sell. In such situations we do not give the stock too much of benefit of doubt. But we do not have a target profit in mind.

How do you resort to statements from your critics that state you lack the conviction to ride your bets and that is why your portfolios are cluttered with stocks?
DSPBR Equity is so designed that we take two portfolios and combine them into one. So the fund is a combination of DSPBR Top 100 Equity and DSPBR Small & Mid Cap. In DSPBR Equity, which is a blend of all market caps, we pick the large caps from the DSPBR Top 100 Equity fund and the smaller stocks from the Small and Mid Cap fund. That is how we end up with around 70-80 stocks. However, the DSPBR Top 100 Equity fund has half the number of stocks.

But even in the Top 100 fund, you do not think that 40 large caps is a large number?
40 stocks are needed for good diversification and risk reduction.

If there was a unique investment philosophy that you apply to all your equity funds, what would that be?
We focus on return and risk but do not allow one to dominate the other. Our focus is not solely on risk or on return. So that’s how we have been able to do well in good and bad times. We are very flexible in our approach. So in good times when the market rewards risk, we do not shy away from it. When we find that the market’s risk aversion is high, we do not take certain risky bets.

Techonology.com was a fund that did really well earlier. Recently it has fallen harder than its peers. Why?
It is a technology, media and telecom sector fund. So it does not make a fair comparison with its peers which may be pure technology funds.

The entire downturn, the collapse of major banks, the global crisis —have these events brought about a change in your investment strategy?
It has not changed but reinforced our belief that history does not repeat itself. Each market theme is unique. In each market you have to be alert to changing trends and cannot afford to be dogmatic about a particular way of investing.

Where do you see the market in 2009?
The market may continue to be bad. We have the fiscal deficit which is looming. The election is a major uncertainty. This recession seems to be quite deep and we have not yet reached the end of it. And it is only in hindsight that we shall know when the bottom was made.

The global policy needs to work in such a way that they find a solution to the global banking crisis. Unemployment is high in the U.S. Europe seems to be in a bigger mess than the U.S. India has a lot of exposure to the European banks. We have a lot of debt from these banks and there will be a problem of rolling over the debt. So companies exposed to debt will have a problem because they may not find refinancing.

If governments keep printing, then people will lose confidence in currencies. This could lead to hyper inflation which is always bad for the equity market.