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We are hearing early positive signals on the ground

Problems are well-understood and are being addressed by the administration with a sense of purpose and energy, says Lalit Nambiar, UTI Mutual Fund

Lalit Nambiar has recently taken over UTI Mid Cap Fund from Anoop Bhaskar. He shares his views on the current state of the markets, his strategy towards the Mid Cap Fund and the recovery in the economy.

We are hearing early positive signals on the ground

At the beginning of 2015, there was a lot of optimism that equities were now in a secular bull market. However, lately there are many reasons to revisit this notion. Now some are even saying that this year could be like 2008. What's your take on this?
If you break this expectation set into three parts, the first component was reforms from the government. The second was the economic cycle turning around. The third belief was that India is an attractive destination for international investors. Then there were lesser passive factors like monsoon and the budget, which were to be at worst benign.

Now if you see all these components individually, most seem to have failed. Government reforms were not fast enough. The turnaround in the economic cycle is incipient and gradual. In most business cycles, the stock market tends to run up a bit ahead of the real economy. In the present scenario, the market raced ahead perhaps a bit too much ahead of actual economic recovery. As to the third aspect, emerging markets are facing increased redemption from sovereign funds, especially those of oil-producing economies.

Monsoons failed for the second consecutive year, almost a black swan event, which impacted the rural growth story. Another important aspect is domestic liquidity. When HNIs and other investors realised that real estate and gold were not going anywhere, money started flowing into the stock market and equity mutual funds, helping the virtuous cycle of expectation and results. So, the mood has swung from perfect confluence of positives into a perfect storm. This may have been caused more due to high expectations and sentiment than due to ground reality.

At this juncture, the easy thing to say is that this is 2008 all over again. But at the global level, if you look at sentiment indicators such as VIX or gold, it does not look as bad as 2008. I would say that if in early 2015 we had overshot on expectations, we are now overshooting on pessimism. Closer home, we are hearing early positive signals on the ground from some companies as well as from within the government that serious structural reforms have been initiated and are being driven hard, but given the size of the country these will take time to show up in corporate numbers. It was unrealistic to assume that legislative bills would be passed quickly in the parliament. Action seems to have started in some areas such as road construction, but endemic problems in the power and the banking sectors are yet to be resolved. It is heartening to note that these problems are well-understood and are being addressed by the administration with a sense of purpose and energy, not often seen in these circles.

On China, do you think things are made out to be worse than they really are?
I am no expert, but it looks like the Chinese are in a far better position to manage their markets as they are a central-command economy. We understand that consensus view is that they will avoid a hard landing in their real economy. Their main problem is in the financial part of their economy, where a credit bubble has fuelled a lot of speculation which they have had trouble controlling. So there will be hiccups and volatility in their financial markets. This volatility will reverberate through the rest of the globe.

You will be taking over UTI Mid Cap Fund from Anoop Bhaskar. Are you going to stick to his philosophy of not concentrating the portfolio, owning a large number of stocks and so on?
Broadly the existing philosophy will continue and we will not have many stocks making up over 2 per cent in the fund. UTI Mid Cap Fund was Anoop's signature fund, so I have inherited a great responsibility. But many stock ideas have come from our eight-member research team, each of whom has done a fair bit of work in their sectors and have a good standing in the market. Anoop and I joined the organisation within months of each other and a large part of the transformation in the research process was implemented by me under his guidance. Over time, the factors we look for in mid caps have got embedded within the system, including management calibre, earnings quality, leverage levels, promoter ambition and equity dilution. The process of applying these filters on new ideas will be maintained and we will continue to own 80-90 stocks.

How do you see mid-cap valuations? A few funds that leaned towards small and micro stocks have shut due to a lack of opportunity.
The relative valuation of large caps versus mid caps is ultimately a comparison of averages, and the individuality of valuations tends to get suppressed. It is probably a good thumb rule for a financial planner allocating assets between large and mid caps. However, there may be stocks in the mid-cap space that can still be re-rated because there is a strong bottom-up story in them. When it comes to small and micro stocks, there will always be some capacity constraints for large fund schemes that want to run concentrated portfolios as liquidity and impact cost can become tricky.

How is the collapse in commodities affecting India Inc's earnings picture? Is it possible to quantify it?
Overall earnings should come through as India is largely domestically driven and a commodity importer. There are companies with a low ability to brand and they will have problems in a disinflationary environment. They will see their top lines compress but not necessarily their absolute margins. Also working-capital requirements will go down with some attendant savings in interest cost. The banking sector will see some impact in terms of business volumes, but as of now it looks like growth is not a big item on their agenda.

How will recovery pan out on the rural-consumption side?
There are two facets to the rural slowdown. First is the agri-commodity price compression and the MSP price rise which is linked to it. The second is the monsoon factor. On a structural basis, the sentiment should improve, as governance in states continues to improve, with competition for investment, increased spending on roads and other basic amenities. Part of what was rural is becoming semi-urban and part of semi-urban is becoming urban with better roads, and access to telecom and power and all this will also aid the recovery. Improvement in global commodity prices may take longer. Things will probably get better with a good monsoon. But a significant recovery will take time to come.

You also manage the banking fund. The financial sector has underperformed in the last one year. What is your view on that?
On PSBs, a somewhat similar situation occurred in the early 90s with respect to asset stress, albeit on a lower scale, when they lent to the steel industry. The main operational metric to see in PSU banks today is how much capital they need and, some need more capital than others. So, you may not want to own a lot of them, especially the ones who are really badly stuck on the asset-quality front. Private-sector banks have also lent to the same troubled entities as have PSBs. Some of them have already taken a write-down and they are looking attractive from a medium-term perspective. Overall, if we must differentiate between the baskets of banks, private banks do not need capital and so are in a better position. In NBFCs, we see reversion to mean in valuations and earnings and some of the more downbeat names catching up fast.

In the current market, some fund managers are betting on earnings visibility and they are willing to pay a high price for it. Others are betting on value, which can be unlocked with economic recovery. Where do you stand?
It may well be a classical case of 'let's do more of what is working' versus 'let's try to prepare for what will work in the future'. The current penchant for earnings visibility is a bit like a branch extending out of a tree trunk. You can keep moving out on that branch in search of fruit, but as you go farther, the strength of the branch is progressively getting weaker in terms of steep valuations. If you can run back to the tree trunk when you hear the first creak, you may have a rare skillset or some other unmentionable edge. But I do not think that is something which can be done consistently, much less developed as a skill-set. We do not try to play every twist and turn in the market. I think India continues to be a country where we can buy sensible companies which may be going through a transitional phase of weak earnings but where their past operational history has been above average. That said, there are a few companies which we hold where, though the multiples look high, there is a good long-term story building up and not necessarily because there is safety in immediate earnings growth.

This interview appeared in the March 2016 Issue of Mutual Fund Insight.