Nilesh Shah on why the right time to invest is now

Dec 28, 2015

Nilesh Shah, Managing Director of Kotak Mahindra AMC, shared his views during a panel discussion at the Morningstar Investment Conference held in Bengaluru.

At this point of time, how should an equity investor be playing it?

We should all be overweight equity as much as possible. Right now, 25% of Indian equity is owned by foreigners, the FIIs, and about 10% odd is owned by the foreign direct investor, such as Unilever owning Hindustan Lever. That accounts for 35% while 50-55% is owned by the promoters. Effectively, what is left for the rest of us?

Today the stars are aligning in favour of the equity market. Domestic flow of capital into equities is increasing. There are 86 lakh Indians who do SIPs every month. To benefit, they should continue and not stop in between like they had done before. But 86 lakh Indians doing SIPs gives Rs 30,000 crore to us every year. The domestic flow of capital from real estate and gold coming into equity can really change the dynamics of demand and supply. In 10 years we have imported $221 billion of gold, silver and diamonds. All the FIIs put together - in the debt and equity markets - have only given us $190 billion. Imagine this $221 billion not going out and staying in India. Imagine what will happen to prices.

From a flow point of view, our markets were running only on one wheel of foreign institutional money. Now, it will run on foreign as well as domestic investors' money. That's going to make a big change.

About 10 years ago, the Ministry of Finance approved pension funds, provident funds to invest in equity, but the Ministry of Labour did not ratify it. Now this government has ensured that Ministry of Labour also ratifies it and provident funds are putting money in the equity market. This year they will put between Rs 5,000-10,000 crores. But over the next 5 years they will bring Rs 10 lakh crore. In most parts of the world, provident funds are the largest owner of equity.

Then there are the fundamentals of economy. We believe the government is actually working for the country. The way things are happening is changing and we are seeing it in the unlisted segment where your clients will be getting $1 million and $1 billion valuations in no time. If that kind of bullishness, which is there in unlisted segment, comes to listed segment, what will happen?

So spread the cult of SIP. There will be short-term volatility; markets will go up and down. But if you give time to your investment, things will really grow manifold.

Our GDP is now, let's say, about $2 trillion. Over the next 7-15 years, it will become $4 trillion. So, in this $2 trillion GDP we created Infosys, Axis Bank, Kotak Bank, Reliance Industries Limited and so on and so forth. Over the next 7 to 15 years you are going to see a similar kind of wealth creation. It's your job to capture it as much as possible. Don't let go of this opportunity. No generation before or after us is going to get this kind of opportunity.

But is it right time to invest? The India story sounds good but what about valuations? Should we wait to see how the economy is impacting corporates?

The Indian equity market is like the Indian Railway. When you sit in the train, it makes lot of noise. It gives lot jerks. But it is important to sit in the train rather than stand on the platform. What you're recommending is that try to stand on the platform until the trains improve. In that case you will keep standing.

Look at the HDFC stock. How many times it would have looked expensive in the last 25 years? How many times would it have corrected in one year from top to bottom? Average is 45%. If HDFC was quoting at Rs 100 every year, it has come down to Rs 55 every year. The gap between high and low of the HDFC stock is 45%. Can you get in at the bottom? If you have that ability, great! If not, do an SIP every month. After 10 years you will recognize what you have got.

It's like bungee jumping. Half the people return after paying money but refuse to jump. Don't think too much, just jump in.

Looking at equity investing in this perspective, is there a rationale for allocating some amount to global funds?

From an asset allocation point of view you do need to look overseas, but let's not forget what we have created.

Take HDFC. They only give housing loans. The customer loyalty is such that if someone is walking to the HDFC branch to get a loan and at the door they are told, SBI is giving a quarter percent cheaper, the customer will move out.

Take Apple, the Amitabh Bachchan of the stock market. Its market cap is No. 1 to No. 10 and then the second company comes. The brand loyalty of Apple is tremendously strong. People pay a premium to buy that product. My daughter only wants an iPhone and if I do not buy her the latest versions, as they come out, she will probably divorce me. Such is the brand loyalty of Apple.

Apple is sold all over the world; from Azerbaijan to Zambia. HDFC is probably only available in some parts of India. It has barely scratched the surface India.

Apple's market cap is 23 times bigger than HDFC.

Yet, in dollar terms, like-to-like, apple-to-apple, orange-to-orange, HDFC has delivered 3 times more return than Apple.

All of us knew HDFC was a great company. I can bet that in this audience there will be no one who has 10,000 shares of HDFC, but most of them will have Apple's iPhone and iPod and iPad. So, do go overseas but do ensure that we retain ownership of HDFC in India.

On how the government has performed over the past 18 months and the reason for subdued corporate growth..

FIIs are movers of the markets. Is there going to be a time when domestic institutional investors are on par with FIIs?

It's been close to about a year-and-a-half since the government came into power. What are some of the positives that you've drawn out from the initiatives they have taken? How do you see that as an investor?

What we have seen from the government is that at least in certain segments they are doing good work. So, for example, in FY15 India's coal production went up by more than 34 million tons which was more than incremental coal produced between FY11 to FY14. So, in one year we have produced more coal than what we produced in previous four years. All the coal trucks which come out of coal mines now have a GPS. Straightway, it plucks the leakages, it improves the efficiency.

On the road sector we have started building 18 kilometers of road a day. We were previously about 7 kilometers of road a day. Today tender happens on an electronic platform. Your settlement of tender happens on an electronic basis. And you get letter of commencement within 3 hours of closure of tender which previously used to take a lot of time.

So, there are sectors like road, railway, defense, mining where the government has brought e-governance, removed the discretionary power to a great extent, not eliminated but to a great extent removed, and is trying to encourage a mechanism where whether you knew someone or whether you have ability to do business in a noncommercial manner, it does not matter anymore.

This is all changing the way India is doing business and it's going to have an impact on some of the sectors. By taking such steps the government is improving the country and eventually it will be reflected in an improved corporate sector.

But it's been a year-and-a-half and we haven't really seen corporate growth come back the way people initially expected it to.

Our economy has many sectors which are linked to global markets. If steel prices go down, steel companies in India will lose money or make less money. The government cannot do anything to improve their profitability. This is the price we pay for global linkages. Commodity prices have corrected globally and lot of Indian companies which were exposed to the commodity sector have been hit, hence profitability is lower.

In the case of public sector banks, profitability is depressed. This is the year where they have started recognising their NPAs in a slightly more aggressive manner. These NPAs were not created this year; they were created long before but they are being accounted for today. Now just because it is accounting today we say “after Modi government profitability is not coming back”. You have to look at cycles.

In last 18 months, corporate profitability growth has been a bit depressed, a bit subdued, and it is proving all of us wrong for the last nine months. There are many reasons.

One, the commodity cycle has been on the wrong side, on the lower side, and it's impacting profitability.

Second, we have started recognizing some of the issues in the banking system a bit late. So, it's not the result of last year but it's a result of many years before that.

Third, our corporate sector is paying one of the highest interest rate. In real terms if I calculate on a wholesale price basis, we have very high real interest rates running into double-digits. If I ignore WPI and just look at CPI, real interest rate is very, very high. Our real interest rate is more than the nominal interest rates of most of the countries. On top of it, in FY15 our currency appreciated against the yen, euro and GBP. So, I'm making my entrepreneur, who is already paying high interest rate, noncompetitive in currency terms.

All these factors put together has resulted in subdued corporate profitability. Today corporate profit as a percentage of GDP is at 4.3% of GDP. Historically, it has been averaging about 6% to 6.5%, so we are about 33% lower than our historical average in terms of making money, making profit, making margins.

FIIs are movers of the markets. Is there going to be a time when domestic institutional investors are on par with FIIs?

If you know that someone is a seller of a stock at Rs 100, what will be your price for bidding? My guess is Rs 96 or 97, but not 100. And certainly not 101. So, if I know that sovereign funds have to sell, why will I give them an exit?

But do FIIs dominate the Indian market? In August and September, FIIs sold more than what they sold in October and November 2008. In those days you see how much percentage markets corrected and vis-à-vis see how much percentage markets have corrected. By absorbing more selling there is a much smaller correction in the market. It just shows the ability of domestic investors. The market is a congruence of factors where the domestic and FII investors are one and the same. If prices go up, both benefit. If prices go down, both lose. When the Satyam mis-governance issue erupted, the domestic investor was on no different terms than the foreign investor.

As long as these 86 lakh Indians, which I mentioned earlier, keep doing their SIP and it increases, our ability to take on foreigners also increases. But that doesn't mean that they will get a cheap exit. If they are selling something which is worth Rs 100 at Rs 10, I will probably bid Rs 9 rather than Rs 11. So, that's why the markets will be volatile, but we need not be unduly worried about foreigners. Their interests and our interests are aligned and as long as you bring more SIP into equity mutual funds, our ability to fight them keeps increasing.

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