Rich insights from a macro champion

Vetri Subramaniam

Group President & Head – Equity


  • Mean reversion in valuations requires a trigger – oil and dollar are perhaps the triggers that will get market valuations to revert to mean
  • Oil and dollar do impact our growth cycle – the offset has to be boost in exports led by enhanced competitiveness in the global market
  • Consensus earnings forecasts have been downgraded twice already – the NBFC issue needs to be watched closely as it has the potential – unless resolved quickly – to transmit to the broader economy in terms of higher costs of funding and impact on demand
  • Value opportunities increase when markets correct. Astute fund managers will look for value at both ends of the spectrum – those that can likely defy norms of cyclicality and mean reversion and those that are depressed due to various factors but have brighter prospects going forward.

WF: Are we witnessing a mean reverting correction that you have been anticipating or can this be something much deeper – perhaps the onset of a bear market?

Vetri: I wish I could answer that with certainty. There is scope for mean reversion in valuations and that remains my base case. But you can never know beforehand the exact moment of the onset of a bull market or a bear market. We know that markets oscillate in terms of valuations. Knowing that this happens can help us prepare for the oscillations but I don’t think we have the ability to forecast the exact turning point. In our equity funds we manage fully invested portfolios and do not take cash calls. We manage the risk only by the selection of securities. Knowing that there is valuation risk in the market we try to manage this by picking stocks where there is some valuation comfort or where we have conviction in the longer term growth prospects. That can hopefully allow us to navigate the volatility much better. The exception is our Multi Asset fund where do we adjust/manage the allocation to equities and this fund was at its lowest allowable exposure to equity in September.

WF: Some experts believe that oil price sustaining at or above $80 and rise in US rates leading to EM outflows are both structurally damaging for India and can be a strong reason to expect PE de-rating. Should we be that concerned about the structural story becoming weak?

Vetri: Our oil & dollar dependence accentuates our growth cycles. I don’t think we can argue against that. What we should actually be worried about is that we have not done enough to raise our competitiveness as a global producer. Our growth will require even more energy going ahead - the way to overcome this is to export goods and services that the world needs to meet our requirement of dollars for importing oil. No doubt a sustained high oil price will have a negative impact on the economy but as our own historical data tells us we are the biggest beneficiaries of remittances from Indians who work overseas. And more than 60% of our remittances come from Indian citizens working in Oil driven economies. So there is an offset but it is does not take away from the imperative that we raise our competitiveness as a global supplier of goods and services. I would also add that mean reversion in valuations will eventually be caused by something or the other. If not oil it would be something else.

WF: To what extent are corporate earnings taking a beating from higher interest rates, high oil prices and weak macros? Where do you see earnings downgrades happening and which sectors remain strong from an earnings momentum perspective?

Vetri: Consensus earnings estimates for the Nifty for FY19 have been cut by a little over 2% from June 2018 and about 4.5% from March 2018. The cost of money has been increasing for over a year. The recent outbreak of nervousness is causing an increase in the cost of money and the quantum of money available to NBFC's has reduced. If this persists it will likely transmit to the economy, have a negative impact on demand and increase interest cost thereby dampening aggregate earnings. The offset is that IT, Pharmaceuticals, Global commodity companies and companies with exports will receive a boost to their earnings from the fall in the value of the rupee. So while the aggregate earnings might not change as much, the composition will likely change significantly and the companies with larger dollar revenue exposure would benefit.

WF: What exactly ails the financial sector? How serious are the refinancing risks for NBFCs and their knock on effect on corporate borrowing programs? Is there something structurally changing in the BFSI space or is it just some valuation excesses that are getting corrected?

Vetri: THE NBFC sector has experienced significant growth in recent years-benefiting from easy liquidity in wholesale markets and reduced competition as banks vacated some markets. I think the IL&FS issue and the RBI comments on NBFC’s market access & ALM has raised the specter of refinancing risk for NBFCs This constitutes a significant change in the environment and is likely to cause a sharp change of trajectory in the growth of lending by NBFC's. The potential Asset Liability Maturity mismatch is now at the forefront. Our discussions with most NBFCs suggest that they are slowing down their growth as they look to handle the challenges of reduced funding and higher cost. If the RBI makes significant changes to the market access and ALM norms for the NBFC sector it will likely have ramifications on their growth. The focus of these companies would then shift to strengthening their liability side. There is a role for NBFCs in India and they will remain an important constituent of the financial system. But the current developments along with potential policy changes could be a reset - there will be winners and losers in this reset. This is filtering into the valuations of stocks in the sector.

WF: Is the IT sector only a tactical buy on weak currency or do you see better days ahead for this sector on a sustainable basis?

Vetri: IT as a sector was a very attractive valuation opportunity last year. They are among India's most competitive global companies. They were experiencing a growth challenge from changing business composition and pressure on margins from the currency. We think that the one leg of the re-rating process in the sector is now complete with currency aiding both growth and margins. Also a tailwind in their Digital practice is offsetting weakness in their legacy businesses. The US economy which is their biggest market is in a fine shape and the currency gives them an additional lever for growth & investment in the business. But from here on we need to see increased business momentum.

WF: UTI Opportunities Fund is now called UTI Value Opportunities Fund – what are the key strategic changes you have brought into the fund alongside the name change?

Vetri: The fund is managed with a value tilt. Our sector allocation is driven by valuations and while the fund also exhibits a degree of flexibility in its exposure to the mid & small cap segments of the market. This decision is also driven by valuations.

Undervalued businesses can be found at two ends of the spectrum. At one end the market may under appreciate sustainability of competitive advantages and/or the length of the growth runway for the company. These companies defy the norm of cyclicality and reversion to mean. At the other end of the spectrum there are companies that may be experiencing challenges due to cyclical factors, changes in the environment or their own past actions. But if the core business is healthy and a path to a better future (cash flows, return ratios) is visible then their depressed valuations offer an attractive entry point. The opportunity in both cases is buy something cheap relative to expectations.

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