In Conversation with Prashant Jain

By Morningstar Analysts |  20-12-17 | 
 

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 Prashant Jain, executive director and chief investment officer at HDFC Mutual Fund.

You've been an investor for many years and always a believer in early identification of a cycle. Share some insights.

I have learned two basic lessons over the last two-and-a-half decades in this market.

1. India is a secular growth economy despite the changing news flow. Look back over the past two, three or four decades. The headlines are seldom positive, but the growth seldom disappoints.

Right now we are seeing a bit of a slowdown. We are disappointed with 6% growth and it is a sign of what expectations we have. But I think even this will pass and very soon we should see higher growth going forward.

Indian equity represents a tremendous opportunity and the best investors are the ones who have very high levels of patience. The Sensex was 100 in 1979 today is at 30,000; 300x. The Sensex has compounded at 15% p.a. There are many funds whose NAVs are more than 500 now. This means money has become 50x or more. The funds have been able to compound at slightly higher growth rates. Equity is a really powerful asset class in India. To benefit from that, get your asset allocation right and have a lot of patience.

2. Markets can be imperfect in short to medium periods and the majority opinion can also be wrong on a few occasions. But over long periods, markets are driven by logic, are rational, and quite perfect.

In 1999, there was a general consensus that technology is a great sector and no one wanted to invest in old technology stocks. See what happened in the following years. Technology was a big underperformer and Metals, Banks, Capital Goods went up 5x to 30x. This was one clear illustration that markets are not shy of disagreeing with the majority.

In 2007, virtually everyone said that Infrastructure is the next best theme. Money poured into it. FMCG and Pharmaceuticals were not the preferred sectors. Look at what has happened in the last 7 to 8 years. Infra has been a big drag and companies in FMCG and Pharmaceuticals have done extremely well. The majority opinion can be wrong.

Probably the next 3 to 5 years will be quite different from the past few. We are sitting at the cusp of an acceleration in GDP growth rates. The macroeconomic fundamentals of India are extremely sound. Profit growth - which has been weak driven by sectors which are passing through a cyclical downturn, namely Metals, Capital Goods and Corporate Banks, is set to change. Over the next few years, the sectors which will do best will surprise us and they should be quite different from what we have experienced over the last 3 to 5 years.

You've been an early-cycle investor. So your investments might take some time to play out for the market to recognize that. How do you deal with that?

You said I invest early in a cycle; maybe I personally have a value bias. And value is available only when a sector is passing through some pain. And if you believe that that pain will go away, and performance will improve, over time, it turns out to be a good investment.

If you were early in the cycle, the rewards come a bit late but are fabulous. If you bought Capital Goods, Banks and Metals in 2000, they went up 20-30x. If you bought Oil Companies when they were burdened with the subsidies, they've gone up 5-10x and someone who has bought them in last few years would have made little money. So, the real returns come if you buy a business when it is trading much below its intrinsic values and that typically happens only when there are some challenges either in the environment or in the business. We have faced some challenges and things are likely to improve going forward. 

What are some of the risks that you see which could probably derail your thesis at this point of time?

The economy is well-placed. I’m not trying to be overly bullish, but I genuinely am unable to place too many risks to the local economy. The geopolitical situation can cause a market correction, and we have seen the Indian market have a high correlation to events outside India. But as far as the economy is concerned and profit growth, I am quite optimistic.

In the last 10 years, the CAGR of the index has been only 5-6%. There is this notion that the market is expensive. If in an economy where nominal GDP has grown 12-16% and the index only 6% over a decade, India's market cap to GDP is at very attractive levels.

Why is the market cap to GDP low?

Simply because few sectors have very low levels of profitability - Corporate Banks, Metals and Capital Goods. As these profits come back, the stocks will do well. The market respects profits. Whichever sector has delivered sustained and good profit growth, stock prices have followed. Stocks are slaves of earnings. People said they would never buy Oil companies, but when profit grew 5x, those stocks are went up 5-10x. Earnings in India have been weak for the last few years. That is set to change, maybe from the current year itself.

Technology is one area where you have been increasing exposure. Why?

It is a globally competitive sector. It's a very sustainable business. That is the first thing you look for when you are buying into a business. The attractiveness of the business is extremely good. Incremental return on capital (ROC) is very high in this business because actually it does not need any incremental capital. The payout ratios of these businesses are extremely high. The challenge is that the growth rates are low. And that is why the multiples in this sector are low. So I feel that this sector offers reasonable risk/reward.

The way we look at tech is –dividend yields are good and it is globally competitive. If growth rates improve, you can make reasonable amounts of money. If they don't improve, you can still make a little amount of money because in a relative sense these stocks are quite cheap. If currency were to appreciate, it would be a risk for this sector. But net-net, I feel the risk/reward is somewhat attractive. That is why we have a kind of neutral exposure to this sector in our funds. 

Money is moving from fixed income to equities. What is your take on this in terms of flows? Does that worry you?

Rs 20,000 crores a month is coming into mutual funds is $3 billion a month; $36 billion a year. India is a $2 trillion economy. The pool of household savings is $500 billion a year. So, this flow of money into equity and balance mutual funds is totally about 6-7% of household savings. That’s still a conservative asset allocation.

Investors are moving in the right direction. There could always be some corrections here or there, but by and large, I find the understanding of equities as a long-term asset class that is risky in the short-term is quite common knowledge nowadays. So I'm not unduly worried with what is going on right now.

If you had a 10-15 year perspective, which sectors would you wholeheartedly bet on?

Difficult to answer because the pace of change is so fast. There is disruption in Banking and Automobiles. Currency plays a role in Software and Pharmaceuticals. I would say that a diversified portfolio biased towards large caps would be my preference. The reason I say this is because the market is not expensive. I find lots of value in many, many sectors.

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