We are in a Boom, but not yet in Bubble territory

By Morningstar Analysts |  17-01-18 | 
 

The 2017 Morningstar Investment Conference was held in Mumbai on October 10-11. At the conference, Kaustubh Belapurkar, Director Manager Research, Morningstar Investment Adviser India, chatted with Sankaran Naren, executive director and chief investment officer at ICICI Prudential Mutual Fund.

Give us your perspective on where we are right now in the market.

I divide the market into four cycles: Bust, Best, Boom, Bubble.

The bust happened in 2002, 2008, 2013, where if you managed to invest in small caps, you got returns which were unbelievable.

The best phase was 2003, 2004, 2005; you've seen 2014, 2015, 2016. So, those are best phases from an investor perspective.

Now, we are in the boom phase with Rs 20,000 crores of monthly inflows into mutual funds. Boom is the period where money can be collected in a big way. Investors will show 10% of their net worth to you in the bust phase; 20% in a best phase; 50% during the boom. In a bubble, they will show you 100% of their net worth.

After that comes the bubble phase. I would consider it the most irritating phase for all because it's where you have to cut risk and cutting risk is never pleasant. The last bubble phases – 1999 and 2007 were not easy. Even this time it would be difficult. During that phase one will have to cut equities and reduce the risk in the portfolio. On paper it looks extremely easy, because what you're doing is you're booking profit. But in practice, from my past experiences of watching 1992, 1994, 1999, 2007, it's very difficult to actually cut risk in a big boom.

Since you say we are in the boom phase and the next is bubble, what advice would you give?

In this phase, people have to respect asset allocation. People normally stop looking at asset allocation and invest in the theme of the day. In 2007, people invested in infrastructure; in 1999 it was IT.

It's very evident at this point of time that equities have delivered better returns than any other asset class, but equities is not a risk-free asset class and do have periods of time when they show volatility.

When I say respect asset allocation, I mean one has to invest in both debt and equity, or in products which have both. That's one clear learning from the past booms.

The mistake that people make is deciding to focus on just one sector. If you avoid themes, you actually ensure that you have not made a big mistake. Looking at past cycles, investing in pure large-caps and practicing asset allocation are two lessons well learned.

Why does pure large-cap work well? Because after a bubble comes the big fall. And in that period, mid and small caps have never done well, but large caps have. There are a lot of long-term investors, particularly in India; insurance being the biggest long-term investor. They tend to buy the large-caps in that fall and, therefore, large-caps tend to be defensive.

What is the dividing line between boom and bubble?

We try to look at what is common between the bubble.

One, you will find the top-line based valuation model. In Harshad Mehta's period, there was something called replacement cost theory of investing. In 1999, you had something called eyeball theory of investing. So, if you opened our website, that website got valuation. In 2007, if a real estate company got a landbank, the landbank got valued immediately, not profits on the landbank. In 2013-2014, you had gross merchandise value theory of valuing ecommerce companies.

Second, money normally starts pouring into a theme fund. I have seen that in every bubble there has been a theme which started to get money.

Third, in the IPO space, you will see unknown companies starting to raise big money. If you look at the cycle so far, all the big companies have raised money. And in the last phase, go back to the 1999 cycle, you had companies like Himachal Global, DSQ, Pentamedia. These all became stars of the market at that point of time. That has not yet happened.

These are some of the factors we are looking at. And normally, when you have to have a bubble, you have to have both FIAs and locals buying. Luckily, at this point of time, FIAs are selling and only locals are buying very aggressively. If you look at past cycles, you will see both locals and FIAs also turning together bullish. That would be the thing. Right now, we are in boom.

Where are you seeing the opportunities right now?

In 2015, it was Metal and Oil. In 2016, it was Telecom. In 2017, it is IT and Pharma. And given that these sectors are not trading at absolutely cheap valuations, as cheap as, let's say, Metals was two years back, I think one would have to invest with a 3-year view. The third would be corporate banks with a decent franchise. These look contrarian at this point of time.

We've seen increasing allocations in Financials. And if we look at where the industry is and where your allocations lie, it's clearly, that contrarian view that while you like certain pockets, but housing finance, for instance, you are very clear. What are your thoughts behind that?

What I have seen is that towards the end of the bull market, there are very high allocations to one sector. In 2007, almost all telecom, power and capital goods companies had entered the benchmark. When a sector becomes 40-50% of the benchmark, which is what it looks like at this point of time, in the ensuing when I take a cycle, it will be an aggressive sector.

Our best-performing fund is the banking fund; suitable only if you want high return, high risk.

If a sector becomes 40% or something like that, whenever there is a redemption, it's a sector where people will exit. We think corporate banks are clearly contrarian and cheap. But, having said that, any sector with 40%, I would say is a higher risk sector.

At this point of time, banking is a very strange sector. We have sectors where the valuations are really excessive and there are stocks where the valuations are really cheap. And there are some stocks which are in fact, at possibly 10-year low valuations. But herding is happening into the stocks which have done well and which are trading costly. And people are moving out of some of the strong corporate banks, primarily because they haven't done well. So, I don't think it's possible to take the entire sector as a whole.

I think the entire lesson that the world has learnt over the last 20 years is, whenever credit growth is very high in any sector, you have to be more careful. And we are actually more invested in the slow-growing parts of the financial market.

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