Sankaran Naren: Why Debt is an outstanding asset class

Oct 18, 2022
Investment Specialist Larissa Fernand on the views shared at the Morningstar Investment Conference held in September 2022.

SANKARAN NAREN is one of India's most recognisable value investors. He has never been afraid of going against the tide, and his convictions have been deeply tested when he has done so. Over the years, he has proved his mettle and has been a voice of sanity in extreme markets.

The Executive Director & Chief Investment Officer at ICICI Prudential Asset Management Company once again stands out with his contrarian stance. This time he tells investors to look at debt.

  • Equity will be a volatile asset class going ahead.

Indian macro has been well managed. There has been less tampering of the monetary framework as compared to other central banks. So, India has a good chance of outperforming the Western markets. India may be a structural outperformer relative to the world, but that doesn't mean it will be a smooth ride. We live in world that is very interconnected. And if the world is going to have a rocky ride, we can’t expect a smooth one.

Equity will remain a volatile asset class till the day Jerome Powell declares that he is over and done with tightening. That would be the turning point. When that is done, equities will become a great asset class everywhere in the world.

When will that happen? Tonight? Six months from now? A year from now? I don't think anyone really knows. Until then, we are going to have a period where volatility will remain.

  • Equity could be risky because of valuations.

India is the costliest market in the world today. It has also been the best-performing market. Given my value contrarian hat, I recognize that when you are in the costliest and best-performing market in the world, the risks are slightly higher.

Just like last year, the NASDAQ was the costliest and best-performing market in the world for a decade, and the risk suddenly played out. Hence one has to be a bit more cautious with it comes to equity.

The Reserve Bank of India, the Indian government, and even Indian corporates, have handled the situation brilliantly. Despite that, we must be conscious of the risk. One year back if you had gone and looked at U.S. corporates, even they were in good shape. But the risk did play out because valuations were too high. It's that kind of a risk that we have to worry about.

  • Debt will be an outstanding asset class.

From 2008 onwards, central bankers took over the role of fund managers. They controlled the equity markets beautifully for 13 years and ensured that they don’t fall. That role of being the biggest fund managers was over in November 2021.

Today, both the U.S. and Europe are raising rates. Japan, not yet.

From the point of view of wealth managers, this signifies big opportunity in debt. Debt has become an outstanding asset class for a long period to come. It has been an ignored asset class because of the central banks' tampering over the past decade.

  • There is more to debt than meets the eye.

If I look at a period from March to May 2020, there were so many investors who were 95% in equity and 5% in debt. They never got the opportunity to invest. So, the role of debt is not just to yield return. Equity can be the highest-yielding asset class over the next 10 years. But that doesn't mean that debt doesn't give you the chance to make more money in equity.

From 2017 to 2019, we tried our best to explain to people that debt was an important asset class. And people who had invested in debt got the opportunity to shift in 2020. That is something people realized in 2020.

In a rising interest rate environment, we told investors that a floating rate fund was a great product. But it was very difficult to convince the entire community that it's the only product to actually benefit from rising rates. The floating rate bond would actually give the highest G-Sec yield, something no one could have ever believed six months back, but that's what has happened.

That is the real problem at this point of time. Warren Buffett says that he has cash; from a wealth manager point of view, it is a debt fund.

  • Contrarian: Being disbelieved is normal.

When you take a contrarian view, it is perfectly normal for others to disbelieve you. Investors disbelieve me when I say that debt is a great asset class. Having said that, you should not end up buying junk under the guise of being a contrarian.

In 2020, before investing in Metals, we analysed the WFH – work from home – setup. People were buying dishwashers, air conditioners, vacuum cleaners, and refrigerators. Every one of these goods required metals. So we looked at metal companies. Have they delivered negative returns over the past 10 years? Yes. Are they affiliated to prominent industrial groups? Yes. Can they go bankrupt? No.

We were very clear that we were buying companies which belong to India's best groups. So, there was no risk. Buy junk – be it an NBFC or real estate company or debt, then it will go to zero.

We never said we are going to buy junk debt. As Seth Klarman says, be contrarian with a calculator. You need both. The calculator is to prevent junk.

  • Profitless companies: Why it’s good that some failed.

Profitless companies are a big challenge. And luckily, the first few with irrational numbers failed in the marketplace. Due to that, the ones following have been forced to tone down their expectations.

We were very, very worried about them succeeding because if they did, we would have had a problem like what happened in U.S. In the U.S., the first few succeeded and the following few also succeeded. Then everyone started coming at irrational and absurd prices. Luckily, for us, after the failures, sanity has set in and they are forced to think more rationally.

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Sandeep Gandhi
Oct 20 2022 08:41 PM
Excellent narration. Keep it up!!
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