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Purchase Timing Makes Fund Contrarian

Bhupinder Sethi, co-head, equities, Tata AMC, explains why Tata Contra has underperformed…

With bad news — political tensions in the MENA region and multiple disasters in Japan —buffeting the Indian and global markets, we decided to speak to a contra fund manager for ideas on how to negotiate the current turbulent markets. Over the one- and two-year horizons, Tata Contra Fund has outperformed all other contra funds. Explaining the fund’s strategy, Bhupinder Sethi, co-head of equities, Tata Asset Management and fund manager of Tata Contra Fund, says that while both value and growth stocks could be part of his fund’s portfolio, what is important is when these stocks are purchased — usually when there is a lot of negative sentiment around them. Excerpts from an interview with Sanjay Kumar Singh.

What are some of the major headwinds that the Indian markets are facing currently?
The major headwinds for the Indian equity markets are related to high inflation, surging oil price, and the spurt in interest rates in the economy. In addition, India’s consolidated fiscal deficit is still at an elevated level compared to the levels to which it had dipped a few years back. The surge in India’s current account deficit in recent years is a concern. Also, the slowdown in the buildup of infrastructure in the country is a cause for concern as it will hurt our long-term growth prospects.
In general, an environment where interest rates and commodity prices are this high is not favourable for equities. Both commodities and equities across the world rallied from September 2010 onwards, when the US Fed announced its plans for QE2. However, from November 2010 onwards, when QE2 was actually rolled out by the US Fed, commodities rallied further, but emerging markets in general, and India in particular, caved in. Clearly, only up to a certain level of commodity prices can equities be directly correlated with commodities. Beyond that, as higher commodity prices start seeping through into inflation numbers and higher interest rates, they start hurting corporates, consumers and equities.
However, given that India has good long-term growth prospects, periods like these, where macro concerns dominate, are good times for accumulating equities gradually through systematic investment plans for medium- to long-term gains.

What do you see as the likely impact of the political turmoil in the MENA region? Will the price of crude oil rise and stay high for a prolonged period, thereby creating a plethora of problems for the Indian economy and markets? Or is this likely to be a temporary problem?
Based on the demand and production data available, there is enough spare crude oil production capacity available currently. Yet the price of crude oil has been on the boil after QE2 was unveiled and also because of the political turmoil in the MENA region. So far, the countries that have been at the centre of the political turmoil are Tunisia, Egypt and Libya. Whatever disruptions in crude oil production have happened there, the slack has been picked up by Saudi Arabia which has a reasonable amount of spare capacity. With the attack on Libya by the Western allied forces and uncertainty regarding the crisis spilling over to some other parts of the MENA region, a certain political risk premium has got built into the price of crude oil. It has also become much more difficult to predict how some of these political events will unfold. The key thing to watch out for would be if political tensions cascade into a few more countries within the MENA region, and especially if they escalate in Saudi Arabia. Barring an increase in tensions in Saudi Arabia, things should hopefully sort themselves out.
An oil price shock will in the short term definitely hurt the Indian economy and spook the Indian stock market, given our high degree of dependence on oil imports. However, even if the worst case scenario doesn’t pan out as far crude oil is concerned, soaring energy prices is a challenge that the Indian economy has to contend with over the next decade or so. Since we are dependent on imports to meet a large share of our energy requirements, it is extremely important that our country takes steps to improve the energy efficiency of the economy, explore alternative energy solutions more vigorously, rev up its own exploration and production efforts, move much more swiftly to increase mining and production of our own coal reserves, and finally, give a very strong impetus to exports of goods and services to be able to pay for our energy requirements. Only steps like these will provide a long-lasting solution to our energy-related needs.

What impact will the natural disasters in Japan have on Indian corporates and markets?
Japan is not one of India’s major trading partners, so there should not be much impact on the trade side. There might be some temporary dislocation in industries like automobile and metal-products as some Indian units source some of their components and parts from Japan. For IT services companies in India as well, Japan is a small part of their overall business.
Data available on Indian funds accessible to Japanese investors and other guesstimates point to Japanese investments in Indian equities being around $15-16 billion. We have checked with some of the leading FII broking outfits: so far we haven’t seen much redemptions from Japan. In the aftermath of the Kobe earthquake, Japanese banks and households had repatriated around 7-10 per cent of their overseas assets. All in all, there should not be any major impact on the Indian markets in the short term. In any case, Japan is a very resilient country, so I am confident it will bounce back from this unfortunate event strongly.
In India, since we were looking to diversify away from our dependence on thermal power, and were looking at the nuclear power option in a bigger way, the events in Japan could mean greater scrutiny of our nuclear power projects. This could delay the rollout of nuclear power further and make it costlier. With nuclear power generation coming under a cloud, we have to brace ourselves for higher prices of oil, coal, LNG, etc. over the next few years.

A lot of FIIs have been engaging in the “sell India, buy US” trade? Do you think that the recovery in the US economy is sustainable or will it fizzle out when the impact of fiscal stimulus wears out?
While it is possible that US economic growth may moderate in the next couple of quarters because of high crude prices, it does seem that the risk of double dip recession and deflation may be over in the US. The US economy has now seen seven consecutive quarters of economic growth, corporates have begun hiring again, and unemployment rate has come off slightly, though it is still high at around 9 per cent.
From November 2010 to now, in this five month-odd period, Indian equity markets have underperformed US equity markets by around 20-odd per cent. We have again started to see FII inflows into India. FIIs have invested around $300 million in March 2011 so far. Over the longer term, we believe that emerging markets, including India, should have a differentially higher growth rate vis-à-vis the developed markets, including US. Also, a host of pension and endowment funds in developed countries are still underweight emerging markets. So, while the Sell EM, Buy DM trade may have been the play in the last couple of months, we see flows returning back to EMs, including India, strongly in the medium to long term.

Read the second part of this interview on May 10, 2011