WF: Equity markets have disappointed in 2015, with the Sensex now some 16% below its Jan 2015 high. While the structural story appears sound, some experts worry that the cyclical story may still take some time to pan out. What is your market prognosis for 2016 and beyond?
Nilesh: After a forgettable CY15, we expect CY16 to be a better year. The benefits of ongoing reforms will translate into a slow but steady economic recovery. Earnings expectations for FY16 have been significantly cut. However, it now does appear that the pace of earnings downgrades for the market is close to its peak and FY17E earnings growth should settle at around ~15-16% levels.
From here on in FY16, we expect a modest recovery driven by two factors:
A very low base effect in H2FY16
A recovery in margins as the complete pass through of lower input prices and interest rates is effected
In FY16, earnings growth when adjusted for one offs in pharma sector, banking sector NPA provisions and commodities would be around 9 %. Hence, after adjusting the one offs, the asking rate for earnings growth for FY17 does not appear very challenging.
With GDP growth expected to show an improvement in FY17, we are hopeful of a volume recovery as well and the current global construct is favourable for India macros. Low commodity and oil prices together with global liquidity would help keep India's balance of payments and fiscal deficit under check. Across all central banks globally, it does seem unlikely that there would be any aggressive tightening of rates anywhere and if at all in most cases (except the Federal Reserve) rates would continue to ease.
RBI has cut interest rates by 125bps in CY15 in an effort to boost the economy and kick start the investment cycle. As banks accelerate the process of monetary transmission and yields fall, we believe that India's cost of capital (COC) will also progressively reduce. The consequent expansion in the ROCE-COC spread could be one of the drivers of the next leg of re-rating in Indian equities.
Given these expectations of a recovery in earnings growth, we believe that the market is currently trading at valuations which appear fair at 15.5xFY17E EPS (Nifty on a free float basis).
However, we could see some downside risks from lower-than-expected commodity prices (metals, oil) and rise in credit cost in the banking sector. A reduction in corporate tax rate (1-2% possible), which is not factored in our estimates, may boost earnings.
WF: The specter of "policy paralysis" seems to be rearing its head again, with the Government's inability to get key economic legislations passed by the Parliament. Can the structural growth story sustain without key legislations like GST, land acquisition reforms and labour reforms?
Nilesh: We are far from that period to compare the current parliament imbroglio as 'policy paralysis'. The structural story of India is in her young and aspirational demography. Reforms like GST, land acquisition bill, labour bills etc are measures and mediums to help this demography realize their dreams more effectively, productively and swiftly. Absence/delay of these reforms may slow us down. But it does not stop us.
Having said that, the slashing of red tape, increased transparency in decision-making and efforts to improve 'ease of doing business' are all key policy developments that aid and assist growth. True, that the above mentioned reforms would boost growth further, but the point remains that Indian growth story exists.
Having said that many policy actions like subduing of inflation, transparency in tenders and contracts, professionalization of PSU banks, power sector reforms(UDAY), hike in rail and road capex, direct cash transfers all these indicate strong work is progress. To me it's more like creating a strong foundation, which, while not visible, will create a long lasting and a strong building for growth. As it is, Indian GDP is slated to grow by around 7.5-8% by FY17.
WF: A huge number of new investors have come into equity funds in 2015, and their initial experience has not been great. How should distributors handle conversations with new investors who came in with high expectations but are now getting jittery about this round of market volatility?
Nilesh: A sizeable number of these investors accessed equity market based on the word of mouth experiences from their neighbors, friends or relatives. A portion of these investors may have also invested in equities based on the investor awareness programmes. Now the last one year's volatility may have been discouraging to many such new investors. And if that is the case then it is because such investors still do not appreciate 'the what' and 'the why' of the equities.
We as finance professionals must drive home the point that equity investment is investment in the future of a business. That is - equity tends to give returns/dividends so rewarding over the long term that the portion/share of investor's current investment will rise up in value. The key is long term.
Thus, expecting a good return from a year old equity investment must be seen as equivalent of expecting a toddler to finish graduation. Or expecting even the best cricketer to score a century from the first inning, every inning till last inning. The point than that needs to be made is that even a great cricketer needs to be given time. There would be good years, there would be bad years, but when a sufficient time has passed an average run-score and strike rate will show how good a performer he/she/equity is.
We owe a lot to new investors. They have put more money in last 20 months into equity mutual funds than previous 10 years. We have failed to deliver their expected returns. We need to carefully engage with them to ensure that they remain invested and keep the faith on India Growth Story
WF: You have been very vocal about the benefits to the economy if we get our gold monetization program right. How do you see the current initiatives? What more needs to be done to get the desired results from this program?
Nilesh: We have spent far more money in imports of Gold, Silver and Diamonds in last 10 years than all the FII flows in debt and equity market combined. If we had not wasted that money in buying a commodity which does not grow, give dividend or create any economic value, we would have built many schools, colleges, Roads and Hospitals which would have grown our economy. India would have been 50 % more than what it is today if we were not obsessed with Gold.
The two gold schemes launched by the Government is an opportunity for us to pay for the sins of our forefathers. The gold monetization scheme is aimed at providing the benefit of any capital appreciation in gold to the investor, along with a regular interest income. So an investor rather than buying physical gold can invest in this scheme to gain similar benefits plus interest income.
The Gold deposit scheme allows investor to deposit existing gold hoard with the government and earn interest on the nominal value of deposit and take equal quantity of gold back at the time of redemption.
For the investors these schemes are better off than physical gold as they get interest income over and above the price movement of gold. But the issue is of the mindset and distribution network. The environment which can make people aware of the benefit of gold schemes as well as economic damage of physical gold purchase is missing. We have made buying of financial assets a tougher experience than buying of Gold. There is no KYC, paper work etc. in Gold Buying. There is no cap on commission income on distribution of gold like in Financial Products.
There is a need for an appropriate marketing campaign and a strong and incentivized distributorship to convert physical gold buyers into these schemes. Imposing significant wealth tax on physical Gold holding will be a powerful push to make this schemes successful.
WF: To what extent do you see global factors impacting the fixed income story in India? Can currency fluctuations derail the bond market? What is your prognosis for 2016 for the fixed income segment?
Nilesh: We believe that Global factors will keep the Indian FI market on toes and can potentially make the market volatile depending on the potency of the event but will not be able to change the direction of the yields. Currency fluctuation should be seen on Real Effective Exchange Rate (REER) basis and not on absolute basis and so far on REER basis INR has outperformed most of the Asian peers therefore the argument above holds true for this too. The H1 will be challenging and volatile but as the clarity emerges on Fiscal deficit and core liquidity eases the yields will find its way down again. If the govt. is able to push through reforms particularly GST it will have a meaningful impact on yields and INR for good. We have reasonable participation from FIIs in our debt market. Their continued interest is critical to keep interest rates under check as there is a large supply emerging from the Government side in FY 17 due to 7th pay commission revision.
WF: In what ways do you see distribution changing in 2016 - either in response to evolving regulations or market forces?
Nilesh: SEBI has carefully nurtured Mutual Fund Industry over many years. From a regulatory and compliance point of view we are at par with best in the world. Numbers of people who actively sell Mutual Funds are in thousands compared to millions who sell insurance policies, real estate, gold and chit funds. We can't hope to reach out to 99 % of population without many more agents and distributors. Share of AUM from Top 8 Cities shows the need for expansion of Distribution network beyond Metros. SEBI's initiative on B-15 towns has made a good beginning but a lot needs to be done to reach out to untapped areas and increase the Financial literacy of the populace.
We need to educate investors that SEBI has built MF Industry on a strong foundation which does not require gimmicks to sell. We have seen exit by so many players yet none of the investor had any cause of concern. Our growth can get accelerated if government gives us the push of compulsory at source deduction like 401 K plan or exclusive tax incentives.
People invest in Financial Products based on Trust. We are managers of investors trust more than their money. Trust is built on understanding and simplicity. We have more than 2100 schemes for two primary asset classes of debt and equity. We have too many products leading to confusion, misinterpretation and under-information to Investors. Many of us need to consolidate and simplify our products so that investors can understand them better. We need to make our products fewer and simpler. SEBI is pushing for consolidation of schemes to make life simple for Investors. Hopefully other Fund Houses in the coming year will rationalize their product portfolios like Kotak Mutual Fund.
WF: Kotak MF has had a good year in 2015. Looking back, what would you say are the key hits and misses of the year?
Nilesh: We had a good 2015. We were one of the fastest growing AMC in CY 15. More than AUM it is the client trust which matters a lot. One builds reputation over many years. We are glad that in CY 15 our reputation has grown as a trust worthy partner for investors as well as distributors. For us the biggest hit is the Investor and distributors Confidence and Trust. We cherish that and work towards to increase the same.
WF: What are your plans for 2016? What are the new initiatives on the product, sales and marketing fronts that are in the pipeline for 2016?
Nilesh: We are in this business to serve our clients which include distributor as well as investors. From a Product point of view we have to fight multiple battles. We have to launch product which makes sense for our clients. However at the same time we need to ensure that they are differentiated. Many of our products carry serious limitation from asset allocation point of view compared to peers which adversely impacts our performance. It is like running a hurdle race when others are running a normal race. We need to work with Regulators to either remove such selective limitations or enforce it on the Industry. We have adopted the philosophy that funds are like our kids. We will not have more funds that we can manage properly. There are many fund houses which have so many schemes that they can afford to play different strategy in each fund and hope that something will work out. This puts us at serious disadvantage in terms of performance evaluation. Other people are throwing multiple darts hoping that something will hit the bulls eye. I have to hit bulls eye with one dart. We have to work with Regulator and Distributor to ensure that there is consolidation of schemes and performance is evaluated in the form of client return rather than fund return. Our one point agenda for CY 2016 is to create value for our clients through better products, reasonable performance and helping them achieve their financial goals.
WF: What is your message to distributors as we enter 2016?
Nilesh: Financial intermediaries are the engine oil that makes the financial system roll smoothly. Theirs is an important economic role to perform. Distributors create time, place and information value for the Mutual Funds; and for the investors. Without the advisor, each investor/customer would have to develop financial expertise across the financial spectrum, analyzing the hundreds of investment choices, thousands of investment products to make a choice. On the other end, the Mutual Fund would need to be present and available at every nook and corner, raising the cost of the product. Point is distributors are indispensible to our industry.
But, the future success of distributors would be dependent on obtaining the long term involvement of the investors. This would imply advising the investor on the merit of the fund performance; rather than on the strength of the brand. The distributor would also have to become risk sensitive for their investors. Distributors would have to begin to measure whether the funds they are selling are assuming prudent risk necessary to generate performance for their investors. This is because; only a risk-justified return would enable a satisfied long term investor and a successful distributor.
As I see it, some of the challenges can be scaled were the distributor to actually become a wholesome provider of financial services under a single roof. This way the distributor can cater the investor across the entire spectrum of investment services, and not lose the opportunity to competitors from other financial sub-segment.
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