An evergreen theme for these uncertain times
Head of Investments and Deputy CEO
Indian consumption story remains an eternal favorite for many fund houses, given their resilience to interest rate fluctuations and general market volatility. The new BNP Paribas India Consumption Fund will focus on this evergreen theme. Anand believes that alpha in this fund is possible from superior stock selection as empirical evidence strongly suggests that over market cycles B2C businesses (businesses selling goods and services to households) deliver superior earnings growth over benchmark. (Source: Bloomberg, Ace Equity, BNPPAM internal research)
WF: One of your principles in investing has been to pay a premium for a good business than buy an inferior business at cheap valuations. How do you view this in the current scenario where many companies are trading at higher valuations?
Anand: Our investment philosophy rests on the BMV theme (Business – Management – Valuation). While the general view is that any company that gives good earnings returns is considered a good investment, it may not necessarily be so. Apart from looking at superior earnings growth, we also consider sectors which are growing at a faster rate than the nominal GDP and also companies growing faster within such sectors. Further, we look at businesses possessing sustainable competitive advantage which could enable them to survive a downtrend and perform well during an uptrend. This essentially ensures the longevity of the business and in turn enables the fund to stay invested over a longer cycle. Returns are not made in a short cycle, since one may not be able to time it in many cases. We believe that the key to long term outperformance is identifying good businesses early and benefitting from superior earnings growth over many years.
When we talk of businesses being expensive, if a company is trading at 15% - 20% premium we look at the company’s compounded annual growth rate over a 5 year / 10 year horizon. If the same is 20% - 25%, then we may be willing to pay a premium. In such scenarios, in the worst case, the stock may correct 15% - 20% and achieve reasonable valuations or over a 1-year horizon it may not yield returns, here again the valuations become reasonable – in either case, it does present an opportunity to buy further in such strong businesses. If the same thing were to happen to inferior businesses, we may need to re-evaluate our thesis. Hence we believe that it is a less risky proposition to invest in good businesses even if they are at a premium, especially when investing for the long term.
WF: With the recent rate hike by RBI, there is likely to be some impact on multiple macro factors including interest rates and inflation – How do you think this will affect the equity markets over the next 6 – 12 months?
Anand: We had envisaged as early as end of CY 2017, that this year could see macro factors deteriorating vis-à-vis 2016 / 2017. In line with our view, inflation, current account and fiscal deficit, interest rates are weakening. However if we compare the same with macro data of 2013 India stands out amongst its emerging market peers. While 5% inflation rate may be about 100 bps above RBI’s expectations and 150 bps above that of 2017, it is still nowhere close to the numbers that we saw between 2011-2013. The current deterioration can be attributed to the oil prices going up, the aftermath of demonetisation and GST implementation curbed consumption. The Government spending towards initiatives such as farm loan waivers, rural spending and housing subsidy is expected to benefit consumption growth. This could be an indication of micro-economy picking up and could eventually reflect in the GDP print.
The macro factors don’t pose a threat to the equity markets at this stage. Even from the perspective of fixed income markets, lot of negatives have been priced in - the 10 year G-Sec bond yield which was at 6.40% almost a year ago are already hovering around 7.80% with inflation at 5%.
As we enter an election year, there may be further deterioration of macros, and hence being complacent in such a phase could be detrimental for the fund. In this scenario we would constantly look for high quality businesses, particularly those which are resilient to interest rate swings and are not significantly leveraged.
WF: BNP Paribas India Consumption fund proposes to invest in B2C businesses – generally, there is a perception of defensives attached to the sector (often, it is used to protect downside), how do you propose to deliver alpha with exposure in a sector with fairly muted volatility and stable performance?
Anand: First we need to understand which sectors fall under the so called ‘defensives’. These refer to businesses with earnings growth rate which are typically resilient to a general downtrend in the market. And thus depending on macro conditions, different sectors have been defensive sectors at different points in time. At some point even the pharma sector in the global generic phase used to be considered defensive, which is not the case today as the environment is no longer conducive. Similarly, during the consolidation phase of telecom sector when the industry was becoming more concentrated, this space was considered defensive. With new players entering, the scenario has changed considerably. At times cigarette business is considered defensive since the earnings are considered stable, which is not necessarily the case in reality. And at times, during difficult macro conditions in domestic economy and falling INR, information technology (IT) sector has behaved as defensive.
Currently, in the challenging global markets and rising inflation, you tend to look at businesses where the earnings are less volatile and the chances of growth prospects are higher. B2C businesses tend to be inherently resilient to the interest rate fluctuations or general downtrend in global markets.
Alpha for this fund is aimed to be generated by investing in companies with superior and sustainable earnings growth. In-house research suggests that over longer time periods, B2C businesses are capable of generating higher earnings growth rate compared to other companies which operate in B2B and B2G segments, even though they may be in the same sector. E.g. if we were to compare stocks within the banking universe, a bank which operates within the retail segment is more likely to deliver superior earnings growth rate than that of corporate lenders. While there may be a small phase when corporate lenders outperform retail lenders, the latter tend to deliver higher compounding returns vs. others over a cycle.
Similarly we have seen many consumer discretionary and consumer staples companies, over a long period of time, have grown faster than GDP due to rising penetration and rising per capita consumption.
Thus we aim to generate alpha with lower volatility by virtue of the superior and sustainable (less volatile) earnings growth rate. Another advantage of investing in B2C businesses could be to lower churn in the portfolio as they have more secular business opportunities and thus one is more comfortable to stay invested in them over long periods of times. On the contrary, there may be cyclical stocks which provide superior earnings growth in the short term; however, the volatility may be too severe which could prevent us from staying invested over long period of times.
WF: Within the consumption space, which sub-sectors offer the optimal valuations and which ones are you likely to stay away from given the current scenario?
Anand: Valuations will be more stock specific; however within the retail lending space (barring one or two) we believe the stocks are reasonably priced. Within NBFCs, housing finance companies or certain retail banks could be expensive. But given the compounding earnings growth rate potential that they reflect it may be worth especially over the long term. This specific space remains attractive.
Household savings is slowly moving towards equity markets; hence companies operating in the space of wealth management, asset management, insurance etc. remain attractive. At this point in time these are not available at cheap valuations, however, if we were to look at other emerging markets these types of companies are inherently expensive during initial growth phase of the industry / economy,
On the staples side, rural recovery has been supportive per quarterly results. However, the opportunity for Urban India lies in the consumer discretionary s space especially in auto, media and entertainment and leisure.
Sector disclaimer: The sector(s) mentioned in this document do not constitute any recommendation of the same and BNP Paribas Mutual Fund may or may not have any future position in these sector(s).
WF: What is the strategy / perspective on market cap mix (large, mid and small)? Where do you see the maximum opportunities for initial allocation?
Anand:. The Fund intends to participate across all market capitalization. The stocks in the consumption universe are biased towards the large caps since many of the B2C success stories have already panned out leaving less room for companies to make it large in this space. However we intend to scout for opportunities down the market cap curve in addition to the new forms of business getting listed under this theme.
WF: Given your BMV framework for stock picking, how do you propose to tackle macro situations where liquidity could be affected and B2C companies could be affected (example de-mon)?
Anand: Macro factors remain a key part of our investment framework; it helps to identify sectors that we would want to invest in and those which can be avoided. Given the current macro scenario, with increased Government spending, higher MSPs (Minimum Support Price) for farmers, ongoing pay commission recommendation being implemented across states and reviving urban consumption, we do want to invest in businesses exposed to household income. As far as tight liquidity situations are envisaged, the current situation is quite contrary to what happened around demonetization. Due to current tight liquidity conditions in the banking system, we expect the interest rates to remain elevated and that is a challenge for highly leveraged companies while there is no dearth of currency (as was the case during demonetization) for households to spend. While higher interest rates are on the marginally negative to large value consumption goods, however it had negligible impact on overall consumption as household debt to GDP remains quite low in India.
Product label & Riskometer
Risk Factors: The risks associated with investments in equities include fluctuations in prices, as stock markets can be volatile and decline in response to political, regulatory, economic, market and stock-specific development etc. The Scheme may pursue only a limited degree of diversification as it may invest in a limited number of equity and equity related securities or invest a greater proportion of assets in the securities of very few issuers (within the limits permitted by regulation) or be concentrated on a few market sectors as compared to a diversified scheme. The Scheme is also expected to have higher market liquidity risk on account of concentration. This could have implications on the performance of the Scheme. The scheme may be more sensitive to economic, business, political or other changes and this may lead to sizeable fluctuation in the Net Asset Value of the scheme.
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Please refer to Scheme Information Document available on our website (www.bnpparibasmf.in) for detailed Risk Factors, assets allocation, investment strategy etc.
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