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WF: Markets have turned weak in recent days and the focal point of market worries for the moment seems to be the NBFC piece, where, as we know, mutual funds have a sizeable exposure. What’s causing this weakness in NBFCs and what is the likely road ahead for them?
Tushar: First, we need to understand why the NBFC space was attractive to the investor in the first place. NBFCs are often categorized under a single basket, however, each NBFC is quite different in its business model from the other. For example Gold finance companies are starkly different from the housing finance companies, life insurance companies; consumer lending companies etc. Under the mutual fund sector allocation mandate, all of them are categorized under financial services / banking. One needs to understand that we need not club these together, because they are diverse set of businesses. While, these companies have been trading at expensive multiples, the expensive valuations were being justified by the rapid growth that was seen in these companies. The fundamental reason to be excited about any stock is primarily the growth aspect. At a time when corporate exposure was coming down this sector seemed quite bright, where most of the business was being generated from private consumers or individual consumers. If one were to break – up the finance pie into two parts – Corporate finance and Personal finance; while it was evident that Corporate finance was being a laggard, Personal finance was taking off. Within the NBFCs, one can also make a demarcation of fund based NBFC and non-fund based NBFC like the wealth management companies, brokerage houses which grew in prominence during this time.
There was consistent quarter-on-quarter growth in the companies within this space. The growth was essentially on the backdrop of waning interest in the corporate lenders. NBFCs at the same point were expanding rapidly given the vast business opportunity available in their space.
The dip that we see in NBFC is primarily due to the fact that in line with the last monetary policy, interest rates have moved up. This was indicative of the fact that the funding cost of these NBFCs is clearly going to move up. For example, within the micro finance company where the spread was significantly huge, the increase in funding cost may not impact their margins significantly. However, for a housing finance company, where the spread is razor thin, the increase in funding cost (clubbed with complications on the asset side) could be detrimental on the profit booking. They are left with the option to either reduce their size of growth or continue to operate at the same pace with lower margins.
This phase is possibly temporary, where the NBFCs will re-adjust to the increased funding costs. As of now, there is not much of change we foresee in this space and feel that most NBFC will adjust their strategies to pace with the changed scenario (of increased interest rates and hence, increased funding costs).
WF: Should we be preparing for earnings downgrades due to worsening macros led by a falling rupee, rising interest rates and widening CAD? Is the market pricing in earnings challenges adequately?
Tushar: If you were to look at currency on trade weighted basis, there has not been much depreciation at all. If one were to look at the absolute number, there is a steep fall in the domestic currency valuations. Nobody expected / predicted this kind of a steep fall. However, currency strength is often viewed as a source of national pride, if one were look at it from this angle, then there is considerable damage.
A weaker rupee helps a large mass of Indian companies. The export competitiveness of these companies becomes better. The ones which are likely to hurt most are those who are using global services and imports. Unless one is importing, the global commodities / services margins are likely to improve for eg. Metals, ITES, Pharma etc., IT companies are clearly experiencing the tail wind of currency moving in their favor. The Oil and Gas companies are likely to be impacted which will reflect in the fiscal deficit eventually.
The only companies which will face downgrades are the ones who import. A large part of the Corporate world will remain unaffected. India is a domestic economy and not a very highly trade – oriented economy, hence, the impact is going to be minimal. An interest hike would impact the cost of capital and spending patterns which will have a notable economic impact. Many of the aspects we are seeing are a cyclical phenomenon, it depends on the response. The Government has continued to send out reassurances that these aspects do not seem to be affecting the economic prospects of the country. Some of the other countries such as Argentina, Turkey, South Africa have seen their currency depreciate even steeper and the Indian rupee has not seen such a steep fall in valuations. All the economies which have a current account deficit are being affected with the currency downgrade. This seems to be emerging markets phenomenon and not restricted to Asia alone.
WF: We seem to be one of the few emerging markets that has withstood the overall EM rout of 2018 which has seen the EM index fall by over 20% this calendar year. Have we broken away from the EM pack or should we brace ourselves for aligning with the overall EM situation?
Tushar: We cannot remain immune, given the fact that some of the global factors will affect us in some way or the other. There are 3 types of economies within the EM pack – economies with significant current account deficit (countries like South Africa, Turkey, Brazil, Argentina), economies with medium current account deficit (Indonesia, India) and economies with current account surpluses. The ones that are doing better among the pack are the ones with surplus. Globally, investors have taken money off the EMs, there has been no India specific inflow of funds over the past few years, there has been no India specific outflow as well. The entire EM basket is being impacted by the actions of fund allocation in European markets as a whole. Typically, India in most global portfolios used to have a significant weight (over-weight) compared to other EMs, at present, India would be market weight (equal weight). If there is any economic trigger, then there could be a chance of mean reversion happening and the Indian markets could correct significantly.
WF: Which are the sectors that you are bullish on given the current economic situation? Would you work with a defensive bias on your equity funds now or are you bullish on cyclicals?
Tushar: We are not inclined on defensives, since the valuations are expensive at this point of time. We have not been inclined previously as well, since we believe that there is an earnings recovery within this space which is likely to last for atleast 2 years. Given the earnings growth and valuations, the defensive does not seem to be very attractive at the moment. Cyclicals may appear risky at the moment; however, we are consciously taking interest in select cyclicals.
WF: Your fund house has an upcoming NFO in the aggressive hybrid category (HSBC Equity Hybrid Fund) – What is the relevance of this category? Why have you chosen to launch this fund now?
Tushar: We are now seeing significantly huge yields (higher than average) in the fixed income spectrum (8% - 8.15%). Equities are at an inflection point, where we are likely to see improving earnings growth. The fund proposes to exploit this situation, without making any extreme bets on either side (locking the high yields expecting a definite turnaround in the interest rates or expecting significant earnings growth on the equity side to pan out). Having a balanced approach makes sense given the dynamics of both the markets. Further, this was one of the gaps that we had identified within the product suite that we hold.
WF: While quality stocks remain expensive, some fund managers believe distortions and sharp polarization has created ample value buying opportunities. Is this a value pickers market or are the so called value plays more of value traps?
Tushar: The life time high of indices has been brought about by a narrow rally consisting of few stocks (5-6 stocks have contributed to about 80% increase in the indices). This indicates that there are over 70% of stocks within the index which have not participated in the run-up. There is definitely some value in a range of stocks within the index. There has been a 15% - 17% drop in valuations in stocks within the midcap and smallcap space. There are lot of stocks which are cheaper than what they were last year, these are stocks which are reasonably valued and will offer value buying opportunities. The headline (of markets being at all-time highs) is not giving the correct picture. This could keep investors away, but this does not necessarily mean that there are no opportunities in the space.
WF: What is the one advice you would want to share with the investor during turbulent times such as these?
Tushar: Markets are volatile in the short run, however, the long term prospects for the investor continues to look good. If one were to look at the rolling returns of 1 year, 5 year and 10 years within equities, the 1 year rolling returns would be the most volatile. Typically, investors look at either 1 year returns or more recent short term returns cycle, this could be a very dangerous scenario from the perspective of investment decision making. If one were to look at any 5 year rolling return in the equity market, the average would be in mid-teens. On a 1 year basis, the returns could range between -44% to +80%. Investors should look at this investment avenue only if they have a timeframe ranging over 5 years.
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