We sat with Nitin Rakesh, CEO of Motilal Oswal Asset Management Company, in a freewheeling discussion on why the firm's strategy, stock markets, the economy and why investors must focus on earnings amid the prevailing global uncertainty.
Here is the full conversation.
You've not been a career Indian market person, having run State Street-Syntel and before that Syntel's BPO unit. With that experience, what were the challenges and advantages of heading a firm like Motilal Oswal AMC?
I have been associated with financial markets for 17 years. But in a way, my stint helped as it gave me an outside perspective coming back in. That's probably the reason why we were a little innovative with our funds. We didn't follow the routine of launching liquid funds, then a diversified equity fund, and then a dynamic bond fund. It gave us an outside perspective and we could differentiate ourselves looking at what we think would be the longer-term trends in the marketplace.
Equity and mutual-fund ownership in India is low compared to developed markets. But the industry is evolving rapidly. Where do you see it five years from now?
Obviously penetration is low but keep in mind that only a small number of people [in the country] has bank accounts. But clearly as we increase the scope of people in the middle class and those who have investable incomes--and I do not mean savings --there is only way for this to go: to keep growing.
So even though we a 30% savings rate, a lot of it doesn't trickle back into the investment market. I don't know what it will be in next five years, but over the next 20 years, it will definitely be 10-20 times its current size.
What will be the major investment vehicles and products in the market then?
It's probably going to continue to be fixed income [as a major investment asset class]--like it stands today at about 75:25 between fixed income and equities. Maybe only slightly different from what the mix currently is.
Only because it takes a certain bit of awareness and literacy level to understand what equities and equity products are. It takes a certain level of advisory capability. All of that is not easy to create overnight. Even in the U.S., it [affinity towards equities] didn't happen till the '80s.
It will be an evolutionary process. It will be faster than what it took in many other parts of the world because of the information revolution but it will take its time because you can't create experts and advisors overnight.
Coming to your products, MOSt Shares M50 was not off to a good start with the quant-based strategy.
It underperformed in the first year of inception but it hasn't lagged in the past one year. This year has been a good year for the ETF. It is too small a timeframe to measure a fund because we have not seen a full market of ups and down, it's been a sideways market.
In an environment where people get risk-averse, expensive gets more expensive and cheap gets cheaper because of flight to safety, any model or strategy that looks at valuation as a parameter may tend to underperform. So we need to look at a full market cycle to be able to judge its performance.
Our view is the model [where capital is passively allocated to a fundamentally-weighted basket of Nifty 50 stocks using a four-factor valuation methodology] has a very sound premise and with the short time frame since its launch, the jury is still out on its performance.
The Nasdaq ETF has done very well in the past one year, gaining over 40%.
It's a simple tracker fund providing Indian investors access to the Nasdaq index. Most of the big stocks in the index have performed great recently—be it Apple, Google or Microsoft. So it's been an across-the-board performance for stocks in the index.
The falling rupee also helped.
Yes. Half the performance came from the currency movement and half from the index's gains. In hindsight, when we launched it in 2011, it was perfect timing--we launched it before the rupee crashed and before the Nasdaq rallied!
But more importantly, it demonstrates the power of strategic asset allocation and diversification which benefits in an environment like this. If you had a 25% allocation to the Nasdaq 100 in the past one year, you would not have had lost money in equities.
What are the other products we will see you roll out ahead? Would you stick to your strategy of focusing on ETFs?
ETFs for us are just one form of a distribution channel. They are just a way for us to distribute a product and make it available to investors in a convenient way. People tend to confuse us as an ETF house.
We are basically looking to simply create access to asset classes that did not exist before. That doesn't mean it will always be ETFs. We have nothing against active, discretionary products even if we have stayed away from them. We are looking to give investors tools to build their portfolios.
You have a view on largecaps, on midcaps, on the Nasdaq, or even on the 10-year government bond, we'll give you a product, and the last one is not an ETF. It's now one of the largest gilt funds in the market.
So for us, the idea is to create a toolkit for investors and advisors and provide them with the building blocks to create a portfolio.
We are launching a short-term fund right now on the fixed-income side and a liquid fund next month—again it will have a value proposition to it, you'll see when it comes out.
We probably will have a few more international funds when the time is right.
What about the Indian markets? Every time the world starts attaching a premium to valuations here, things come back to the ground. It happened in 2008, again in 2011.
Clearly, the global macro news flow is driving markets right now. Of course, we haven't made any great moves ourselves by shooting ourselves in the foot by creating confusions over things like the general anti-avoidance rules (GAAR) and not even doing simple reforms like, say, on pension, where it won't hurt anyone.
There's a very high degree of frustration in corporate India. It's not a very conducive environment for growth. So there are a lot of things we could have done right domestically, which we haven't.
The economy grew at 5.3% in the last quarter. Can it then grow its way out of despair, despite the government?
It has been and I think it will. At some point, when your back is up against the wall, you have to do something. You can't sit in hubris all your life. The only thing the government really has to do is to change the sentiment. It could also be doing the simple things: picking the low-hanging fruit kind of things, doing the non-controversial stuff.
The economic story will carry on because it's about consumption and aspirations and the expansion of the middle class. Let's not forget we're in the only country with the kind of demographics that we have and the scale with it. Though that is a double-edged sword as well, the demographics can backfire if we don't create the opportunities.
The market at about 16,500 Sensex is not cheap or expensive on historical valuation basis.
Clearly the market has support on the downside. If it goes down another 10%, we will start seeing buying.
But uncertainty remains very high, which is usually a feature of phases where everything has sold off which we haven't.
The uncertainty has more to do with investor confidence and the global macros. Remember, we haven't had an earnings breakdown. We saw an EPS growth of about 10% this year and are projecting double-digit growth for the next two years, so that's not a problem. The issue is more based on the sentiment and the environment, as risk aversion won't help equities and it can continue for a very long time.
The market is not expensive and it's not downright cheap but it's slightly cheaper compared to the historical averages on a valuation basis. So there is valuation comfort, there is monetary-easing [expectation] comfort but risk appetite is just not there.
What does an investor do in such an environment where we've seen two themes running since the 2008 bottom, with the consumption-focused sectors continuing to be valued at a premium while the leveraged sectors are shunned?
Consumption has held up well but if you analyse any market, wherever there is earnings visibility, it will not be decimated. Leverage obviously is a bad word, cost of borrowing remains high, price inflation was high. So I don't think anything is going to change in the immediate term.
We are not recommending that if it is cheap, you go and buy the stock but at the same time, the focus should be on earnings visibility and the valuations attached to the stock.
Even if you want to play the interest rate cycle, the best way to do it would be to stick to the banks and the two- and four wheelers rather than the construction and real-estate plays.
On the global economy, what is the one thing that, if it happens, would make you think: now that would be really bad?
There are a lot of things that continue to be bad right now. The Eurozone crisis continues to hog the headlines. These are perilous times with countries after countries facing bankruptcies. Until that goes away from the horizon or till the can gets kicked down the road…
Till how long does the can get kicked down the road?
That's very hard to call. My sense is, at some point in the next 12 months, they [European authorities] will have to find a resolution. Either it will have to be an exit plan from the Eurozone for a few countries and to do that, they need time because I don't think anybody had thought this through when the euro was created.
So they need to find out an exit plan without causing systemic risk or without making the financial system collapse. That's why they need to kick the can down the road a couple of more times till they figure out how to do it. That, to me, is the only resolution or they'll keep throwing good money after bad…
So they won't take the right choice till that's the only choice left.
Everybody knows what the right choice is but it's hard to make it right now because they're not ready for it. We don't know what the repercussions can be. Banks haven't planned how to exit government debt, how much haircut they'll take in the event of Greece leaving the euro and going back to the drachma, where it will have to hyperinflate and devalue its way out of the debt.
And that's not an environment for which the markets are ready yet. So I don't think the European problem is going to go away in the next month or two. And Greece isn't the only problem, there's Spain and Italy and others.
So we have to stay focused on earnings and figure out a way to make money because who knows how long this will go on?