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 Sohini Andani, fund manager at SBI Mutual Fund.
Where would you define that we are in this bull market? Where are we in terms of your understanding of valuation versus market cycles?
Difficult to say what stage of the market we are in. I think given that the growth is taking much longer to come in vis-à-vis what we all have been expecting and the market continues to run I think we moved well ahead on that path.
I would say that we've not yet reached the extreme toppish kind of a market level. But I would be concerned with where valuations are. So, today, it's more a question mark of how soon you see the growth coming. And I think the wait has been much longer than all of us has been expecting. So, there is no clear picture, because we are trading on an economy side a very different growth path than what it has been. So, the correct answer we will come to know only depending upon how growth pans out going forward.
There is the view that the market has run up in anticipation of earnings and when the real earnings does happen, the market would say that we knew this was to happen. So prices may not respond in proportion with earnings. Your view?
Yes. If we look at it from the earnings perspective, last three years, we have not gone anywhere, but the market has moved up. The market discounts earnings faster than what the investors anticipate. And if there is a lot of liquidity then the process is much faster than investors in general expect it to happen. So, what is expected to happen in three years, happens in one year or less than that period. But over a period of time, it averages out.
Once earnings start to pick up, P/Es will get more normalized, and that again will be a factor of what is the growth that you are expecting in future. So, if one expects the high growth period to sustain for a longer period, then the multiples can sustain, but which is not a given thing.
Economies have always seen a cycle, and as globally the liquidity tightens, it will also have an impact not only on markets, but on the economy and growth itself.
So, a lot of economic growth also globally has been driven by a lot of liquidity. As this liquidity gets pulled back, there will be some impact on growth as well. So, it's a question of whether you are expanding or lowering your growth expectations. And the multiples, whether they will correct or no, will be a factor of where you are going in that direction.
So, how should one approach, invest in this market? Wait for a correction? Wait for earnings recovery? Keep expectations low? Investor expectations are spoiled because of double-digit returns. Your funds have given that kind of return over the last couple of years.
The investor comes into the market for a couple of reasons. One reason is how the market has delivered over the past 3 years. The last 3-years return has had a lot of impact on the investors' mind. And this return has now become an expectation with which a lot of investors come in. So if the last 3-years' return looks very nice, they come in. And we've certainly seen above 20% kind of a return happening on the mid-caps and on the large-caps, at least, 14-15% kind of a CAGR.
That is a very decent return vis-à-vis any other asset class. Today people are finding it more challenging to invest into other asset classes, especially real estate where earlier the bigger chunk of money was going. So, when the other asset classes become less attractive, and the return on equity looks very decent over the past 3-5 years, people believe that this is the best asset class and they want to come in at this level.
Those who come in at these levels need to answer the question of whether they will be satisfied with returns which will be lower than those of the recent years. If the earnings have not moved up, but the market has, the market is already factoring in a future growth. So, it has to average out as we go forward. Return expectations have to come down meaningfully.
I believe that whatever we've done in last three years or five years, even in next two years, if we do half of that, that will be very good. And if people think that they are okay to have lower returns, and there is no other avenue to park, they can come in. But you have to remember, especially on the equities that it's a risk asset and the returns can be negative also in the short term. Long-term compounding may be quite attractive, but people should be ready to sit on it.
We always tend to ask fund managers what they are buying. Let's talk about what you are not buying. Where do you think valuations are not comfortable?
One of the most important things in terms of creating long-term value in a portfolio is what you don't buy. It has as big an impact as what you do buy.
In today's environment, where the market is running very high, I am clearly happy to buy where the growth expectations are lower rather than where the growth expectations are very high. For example, if there is an NBFC or a private sector bank where the AUM growth is expected to be 30-40% CAGR over the next 5 years and credit cost to be very low, you can justify a high valuation. But I believe clearly the risks are more. Whereas if the growth expectations are much lower, say 15-20% - sustaining that sort of a growth itself is very challenging and very few companies are able to grow.
Wherever growth expectations are low, and the valuations are factoring in the growth at a lower rate, your chances of success are pretty high. Because if the company has delivered in the past but is facing a cyclical issue, once the latter is resolved, it will again come back to that normal growth path.
Say an auto company’s volumes are growing at 20-25% CAGR, whereas on the 2-wheeler side, companies are expected to grow at 6-8% volume growth, then I'm more comfortable thinking that the latter is a better possibility than continuing to do 20-25% irrespective of how good the management and business are. Because that's there in the price and you are already paying for that sort of a growth.
So, where I have to pay for lower growth, I'm more happy, because the chances of success are much higher. Of course, it’s a given I am talking about companies where the management is good and they are able to deliver; not all companies which grow at a lower rate are good. But everything else being equal, I would put it that way.
What’s your view on Infra and Pharma?
The wait for growth recovery has been very, very long and we are still not seeing the growth coming back in a meaningful manner. Within infra I think it depends upon what subsegments you're looking at, where the growth would be, and the companies which benefit from when the capacity utilization moves up and in general. I think it will be pockets within infra which will do well and pockets, which will not do well. But I'm clearly not seeing the big bang capex cycle coming back very soon.
Though pharma has corrected meaningfully and valuations have come down, one has to also understand that the growth expectations there have also materially come down. The environment into which the companies are trading, doing their business, are undergoing a lot of challenges. Not all companies will be successful in coming out of this phase. The last 10 years have been a very good growth phase for pharma companies. Going forward, in general, their RoC are going to be lower in next 10 years vis-à-vis how they have been in last 10. So, while stock prices have come down meaningfully and there is value there, return expectations have to be kept lower.
