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“The way to manage or create alpha in a market like today which might remain range bound for some time is to be in slightly more value conscious sectors or stocks and also to be in the cyclical sectors because we are seeing a cyclical recovery in some of these sectors,” says Rahul Singh, CIO-Equities, Tata Mutual Fund.

This issue of elevated commodity prices, particularly oil and its ramifications on corporate India, has been around for a few weeks now. Have you made any early estimate about how damaging it could be, eating into the margins of corporate India in the coming quarters? Could it last two or three quarters more?
Well, it could. It is obviously dependent on the geopolitical situation but looking at the way things are, it could very well last for the next few quarters. From an impact point of view, we have to look at certain sectors which are able to pass on the price increases wherever demand-supply or the capacity utilisation allows. But there are certain sectors which do not have the pricing power given that the demand is also weak.

Overall, it is going to be a negative hit on the earnings. If one looks at the FY23 Nifty earnings estimates, it shows roughly about 17-18% growth. Now in the current situation, where rural demand has not picked up and at the same time, commodity pressure is coming up, we expect the 17-18% number to come down. We need to watch how much of that it will come down.

Will it come down to 10% or 12% or 5%? It is difficult to say at this point of time because there are also counter balancing factors in terms of commodities helping certain profit estimates. So on the net basis, it is still a bit of a negative but we have to see what exactly is the quantum of impact and whether that 17-18% growth can come down to 10-12% or it can be more.

For FY23, on absolute earnings per share basis, if you track Nifty or Sensex, how much downward pressure do you see? How do you see valuation in the renewed light of margin pressure? Does the market look expensive?
That is a different discussion altogether because the valuations are also simultaneously adjusting to the fact that the interest rate environment in which we have lived for the last ten years, is changing too and that is resulting in a downward pressure on the market PE ratios and valuations.

We need to keep watching how much of that has been done and how much is still left and where the US 10-year bond yield trajectory goes. That will really decide it. But just to give a perspective, if one looks at the Nifty average valuation one year forward for the last 10 years, it has been about 18 times or 18.5 times and we are pretty much there right now. So we have come down to about 18 times or 18.5 times PE ratio on a one year forward basis as compared to 22 times which we had started trading at last year in November.

From there, we have seen a bit of a downward correction which is also because of the time correction and from here on, there is little bit of a support and it is again contingent on 10-year bond yields in the US not going up to 3% or beyond. If it does that, then we will keep adjusting the valuation. That is how one should be looking at the market.

In such inflationary times, how can one shield the portfolio? What kind of sector bets or themes are you overweight on in your portfolio which maybe relatively shielded?
More than the portfolio, one has to look at the investment philosophy first. The investment philosophy at Tata Mutual Fund has always been growth at a reasonable price. We have not been present in the more expensive segments. While we do like growth, we do not chase growth at any valuations. So to that extent, when interest rates go up, the segment of the market which gets impacted the most is the high growth, high PE, high quality segment and to that extent, the way to shield is to reduce one’s exposure to those categories of stocks or sectors.

Also, cyclical recovery is taking place in the economy and sectors which had not done well in the last 10 years have started doing well. Commodities, real estate, capital goods and industrials are seeing a big revival. High commodity prices are sometimes positive for the industrial capital goods cycle or industrial capex cycle we say. To that extent, the way to manage or create alpha in a market like today which might remain range bound for some time is to be in slightly more value conscious sectors or stocks and also to be in the cyclical sectors because we are seeing a cyclical recovery in some of these sectors which I mentioned. That is the mix we need to go towards in our portfolios to try and create alpha in a market like the present one

One of the global brokerage report cite data that equities as a part of family incomes in India has shot up to all time high of almost 4.8% of portfolio while real estate forms 49% of their savings, FD and gold 15% each. But at 4.8%, equities share is rising. Do you see this continue to rise in the next couple of years?
I think so. Till the time we have returns from the debt side not exceeding 6.5%, we will continue to see it rise. Also remember that if you take a long period history and get the CAGR returns from equity, they have been well in excess of the debt returns. So everything has to be adjusted for risk and maybe in the near term, the risk return from equities are not looking great. The way to manage the risk in the intervening period and which is what we have been saying is to go more towards the hybrid categories, towards the balanced advantage fund categories.

But if one looks at the changes happening in the economy and the kind of capex cycle revival which we are beginning to see, the cyclical recovery means that over a slightly longer period – three years or five years out – the return potential from equities has not got down irrespective of the fact that the interest rates are going up and which might go downwards a little bit. But even if one adjusts for all of that, maybe in a period of a few quarters or maybe one or one and a half years, one might not see the index doing too much but below the index level, we are seeing opportunities in various sectors.

Banks are underperforming, especially large corporate banks despite the fact that their actual performance on ground – be it on asset quality, credit growth, fee income – is improving. But the stock market performance continues to languish. Any thoughts on why this kind of divergent phenomena is taking place?
I think part of it is technical and we all know about the over ownership and all that so I am not going to talk much about that. I think there are a lot of other issues which have been concerns on banks, which we think are unjustified. But over a period of time, those concerns will go away. One concern is over credit growth which has started coming back though it is early days yet. But high commodity prices also support credit growth, more from working capital but also from the investment cycle perspective.

The second concern is the issue of net interest margins where obviously the repo rates have not gone up but the cost of funding might be going up in the system as a whole. Since some of the loans on the lending side are linked to it, therefore this would put pressure on the net interest margins on the banks. That is an additional risk factor which we need to worry about especially given the inflationary scenario we are in.

Large corporate banks are still looking in that front but it is the issue of credit growth which is something which is currently concerning the market. It will go over a period of time. It is not something which will change overnight and result in significant outperformance by the sector but the valuations at which the sector is in today and given that the NPL cycle is behind us, the capex cycle is in front of us is looking very well placed over a three-year period.


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