The 2017 Morningstar Investment Conference was held in Mumbai on October 10-11. At the conference, Nikunj Dalmia, Senior Editor at ET Now, chatted with Neelesh Surana, CIO of Equity at Mirae Mutual Fund.
What is your understanding of valuation versus risk plus return?
I think the market is reasonable, maybe driven by flows, one can say, midpoint or so. But there are two things to be kept in mind when the perception is that the historic P/E multiple is at 23x or 29x for midcaps. When you look at the P/E multiple of midcaps, 29x become 16x in FY19 and 23x becomes 27x.
While macros have improved in the India, earnings are yet to revert to normalcy. Many sectors are below 10-year average in terms of their potential earnings. Return on asset on corporate banking is much lower. In terms of infrastructure – many things are missing in terms of trajectory of the economy while the macros have improved. So, it's always better to buy a high P/E provided E is compressed, some element of that, that's why it is reasonable.
P/E multiple is also a function of where we are in the interest rate cycle. Today, interest rates have come down by about 200bps. P/E is a function of that. That said, plus the flows, I think, it's reasonable. There are enough opportunities to hunt and construct a portfolio. So, if the expectation is reasonable, which is, let's say, around 15% sort of returns, and if the timeframe is 3-5 years, I think the market offers enough opportunities, particularly many of the larger pieces of the industrial sectors are cheap, in fact. Some pockets can be frothy and some expensive.
Why is the market is going up? There is lot of liquidity. Is that as simple as it sounds?
Domestic liquidity has improved since 2014. Liquidity could be a factor which could temporarily impact. But we have to look at where the valuations are, which is driven by earnings growth.
The money coming into the domestic market should be seen in a broader context. In a $2.3 trillion economy and the high savings rate, the total amount invested in equity mutual funds is about $100 billion, including all the appreciations of so many years. It's too small. Indians are underinvested.
So is the market at a peak or just the start of it? Only time will tell. But it appears, given the alternatives and that domestic liquidity is here to stay, it could sort of remain supportive. We don't believe that solely based on the premise of liquidity, one should take an investment call.
The general positioning for mutual funds is to bet on the economic recovery and sectors which will aid economic recovery. What are your thoughts? Do you think you would like to marry sectors like corporate banks, infrastructure, some companies – cement, roads which essentially would be a big and direct beneficiary of economic growth?
Our portfolios do not reflect too many names in infrastructure or construction because the template we utilize has some predetermined filters in terms of RoI growth, cash flow, good management and valuations. So, some of these businesses, while on a top-down will grow, do not feature in our portfolios.
The construct of the portfolio is fairly balanced, except for one name which you mentioned, corporate banking, where we see there will be one-time mean reversion just like we saw mean reversion in oil marketing companies four years back or commodities over the last 18 months. Corporate banking would see a mean reversion and that presents a very good sort of value, sort of opportunity to identify. Otherwise, the portfolio is more driven by individual merit of the business based on the certain filters.
On a top-down basis, our portfolios are slightly more focused on the consumption theme rather than investment, subject to the valuation filter. Because these days you have pockets where everything is good in terms of consumption, management, good RoI growth, but valuations do not fit. So, subject to valuation, in the top-down, we like the consumption theme for obvious reasons; the youngest population with a median age of 27, very good dependency ratio, cultural factors like more women in workforce, and urbanization. So, that theme clearly looks good. But a stock comes in the portfolio only subject to whether the valuation is making sense or not.
Let me talk about NBFCs and private banks. You can see the growth for coming quarters. What is your positioning?
We favour private banks because for similar growth and RoE over the longer term, it’s much cheaper. Some of the NBFCs are quite expensive at 5.5 to 6x book value. You would get closer to 20% RoE in some of the very strong-managed private sector banks. That's why our portfolio is more loaded to towards private banks purely on account of valuation.
