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The Believer

Mr. Agrawal, fund manager of India Opportunities Fund, believes that the infrastructure theme hasn't run its course

When the India Opportunities Fund opened, Agrawal had a tough task on his hands. Though the fund house expected to garner around Rs 1,000 crore, they had to make do with just above Rs 100 crore. Moreover, it was in March 2008 when the bears had totally taken charge of the market. A year later, the fund has managed to do quite well as compared to its peers. Here Agrawal talks about his investment style and his views on the market.

Do you think infrastructure, as a theme, has run its course?
No. I don't think so. Our view is that without infrastructure spending, India will find it difficult to grow. The infrastructure in this country needs significant improvement. We need a minimum of $20-25 billion of investment in this space to maintain even the GDP growth rate of 6 per cent plus. Without infrastructure spend, it would be difficult to maintain this growth rate.

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.

Do you think it is the right time to buy?
Currently, the capital goods sector is linked with economic growth and activity. Faced with the credit crisis across the globe and the way the financial market collapsed, there are two issues. One is how future growth will pan out and the other is funding of long term projects. Taking these two factors into account, we have seen multiples correct in this sector.

For a money manager or investor constructing a portfolio over the mid- to long-term, this is the ideal time to look at such companies. But the companies that should be picked must have a very good cash flow and the project should also be able to generate cash.

We are very positive on the power sector. With the restructuring of electricity boards and the privatisation of some distribution circles, collections have improved significantly. So the cash flow has improved. Thus on the power sector as a whole, we are very positive. If one is looking at the capital goods segment, we are positive on companies in the power space.

Roads would be less preferred as compared to power - be it generation, transmission or distribution.

Besides the above, which other sectors are you looking at right now?
We are comfortable with the oil and gas sector. Because of the global credit crisis and recession, we have seen crude correct from $147/barrel to $32/barrel. This is a deep correction. If we take into account the future discovery of oil and the production costs, they would be in the range of $40-45/barrel.

As the world economy revives, the prices will move from here. So there is opportunity. In the next few months we also see gas being produced in India.

But you have tilted your portfolios towards defensives like FMCG and pharma stocks. So you favour such stocks too.

We are comfortable with FMCG stocks due to domestic consumption. It is a cash and carry business. So there is no cash constraint. We are also positive on pharma stocks. It is overall a cash generating business. In India we are one of the lowest cost producers in the world. Across the globe there is a demand for lower cost of medicine. So India does stand to benefit. In addition, rupee depreciation should also benefit this sector.

What about interest rate sensitives?
We are selectively positive on the banking sector after the correction. We are also positive on the auto sector. We are in a falling interest rate environment. Statistically, inflation is virtually zero. The interest rate will moderate over a period of time. Also the domestic consumption story is very strong. Rural India is almost insulated from this global downturn. So we are actually seeing strong auto numbers. With commodity prices cooling down, margins are likely to be better.

Did the current rally catch you by surprise?
No. Not at all. I was honestly looking at an upside when the market touched around 8,200. When everyone was bearish on it, I was expecting it to start moving upwards. But I was looking at a 15 per cent return and not expecting it to go above 9,500.

Do you think the rally is sustainable?
My perception has been that at 8,000 levels, the Indian market is very, very attractive from an investor point of view. We have carried out our own EPS estimate. In the worst case scenario, the EPS is around 812-815. We are at the bottom of the earnings cycle and a falling interest rate scenario, so India should not trade below 10PE. So we have touched the bottom. If the market falls below 8,000, it would be due to huge redemptions in emerging market funds.

What happened in the past one year or so, because of the structured products launched globally, we actually shorted the volatility. When Lehman Brothers and Bear Stearns collapsed and AIG needed to be bailed out, the credit market virtually shut down. And the spread in the CDS market was incongruous. So what would a fund manager do in the face of redemption? The bond market was virtually stopped. Since the equity market was open, sales took place there. So everyone was selling equity.

When the market went from 17,000 to 20,000, it was overshooting. In the fall, it is undershooting. I do think 8,000 is the bottom of the Indian market. The risk reward for an investor at 8,000 is very favourable. This is not the time for investors to go into a shell and say that the market may come down to 5,000 levels so let's wait.

But there is the general election in India so we may not rally much. But even if the U.S. market does not recover, the way the government has pumped money into the system - around US$2.7 trillion, my sense is that the emerging markets will outperform for sure. There should be liquidity in the banking system and trade should flow. Trade had virtually stopped in October 2008 due to the collapse of Lehman Brothers. The BRIC markets will come back even if the U.S. does not, assuming that nothing goes wrong with the Russian currency.

How bad will these quarterly results be?
In my view, it will be bad but definitely better than the street estimates. The rupee depreciation is going to benefit most corporates in majority of the sectors. If they have not implemented AS 11 then their reported earnings would be significantly higher.

Do you see the forex losses of corporates being curtailed going foward?
Beyond Rs 52 to a dollar, the Indian rupee should not depreciate. With commodity prices falling, what I am seeing is that we may end up with a current account surplus. The rupee is falling because of huge redemptions. There is also a fear that remittances from overseas will come down significantly. These are the reasons why the rupee is depreciating. If we have a stable government at the Centre, the Indian rupee may appreciate.

After a number of years corporate India witnessed a decline in PAT growth. What are the factors that really led to this decline?
If you look at the index constituents, around 45 per cent is directly in commodities. We have seen commodity prices correct around 60 per cent from the peak. That is a big contribution to the reduction in PAT growth. We saw a 200 basis point increase in the interest rate in the short term. This too had an impact.

In the last quarter, IT did very well and auto companies too reported good numbers. It was pharma that really disappointed because of marked-to-market losses. FMCG was alright but metals did badly. Any sector related to commodities did not do well.

Where do you see commodity prices heading?
If you look at the CRB index over the long term, you will see that the bottom of the commodities cycle is around 180, inflation adjusted. We touched 202 so I now believe we are nearing the bottom. If there is any growth to come, the commodity prices will shoot up from here.

There is a coherent step taken by all producers to cut production. The OPEC countries have decided to cut production by 4.2 million barrels. In steel we have seen production cut by 25 per cent across the globe. Similar moves have been made in copper and aluminium production. Except for iron ore and coal where the cost of production is lower and the prices are higher, in all other commodities we are nearing the bottom. So prices can go up from here on.

Mirae Asset India Opportunities Fund seems to be doing quite well. What has been the reason?
Our performance is a combination of taking the right sector calls, stock picking and active trading. Most on the street were significantly overweight on the banking sector. We took a call that the credit crisis will not only have an impact on the entire company but the banking sector will surely be impacted by it. So we remained underweight on this sector and stayed overweight on pharma and FMCG.

You said you go for bottom-up stock picking. So what affects your sell decisions? When we do our fundamental research, we set a price target. But as circumstances change, we may change our price target. We find it better to book profits when our price target has been reached.

How does the commodity fund function?
In Mirae Asset Global Commodities Stocks Fund, 35 per cent is to be invested in Indian equity, equity related securities and money market instruments while 65 per cent in Brazil, Australia, S. Korea, Hong Kong, China, Indonesia, Thailand and other Asia Pacific countries and emerging markets. The fund management of the scheme lies with the India AMC while we receive non-binding advisory services from Mirae Asset Global Investments (Hong Kong) Ltd.

How big is your team here?
We are three fund managers (including the overseas fund manager), four fundamental research analysts, one quantum analyst and one dealer.

In this entire downturn, what was your biggest learning?
That back to basics always helps. In the euphoria we were all carried away by the India growth story and FII inflows. So the market was actually chasing liquidity. I find that value investing really works. It may be painful in the short term, but it stands when investing for the long term.