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‘Utilities will be a better bet than consumption stocks post covid-19’

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Global markets, including India, have seen a meaningful correction. What should investors do now?

The current situation is indeed unprecedented and the world is still in the process of figuring out the medium- and long-term impacts. For India, while the impact on economic growth, incomes and fiscal deficit is significant, the external side is likely to improve given the sharp fall in oil prices.

From an investor’s perspective, it is best not to focus on the current year’s profits for two reasons: first, financial year (FY) 2020-21 is clearly an outlier and this year’s profits are not representative of the future; and second, the impact on the intrinsic value of businesses due to lower current year profits will be marginal.

After the sharp correction, market capitalisation to GDP (based on FY22 GDP estimates) is below 60%, a level last seen during the global financial crisis in 2008-09. Historically, market returns from such levels were strong over the next three years. Indian markets recover much faster than the global markets because of strong domestic growth and low to moderate impact of global developments. This suggests that markets hold good promise over the medium to long term.

This event also highlights the risks in equities and importance of right asset allocation in investment decisions. In view of the attractive valuations and the inherent strengths of Indian economy, if their risk appetite permits, investors should use this deep correction to their advantage by increasing exposure to equity funds in phases over the next few months.

Which sectors are witnessing deep value post the recent market correction? what will be your investment strategy going forward?

These are sharply polarized markets. This is evident from the fact that about 80% of the NIFTY 50 returns in calendar year 2019 were contributed by five stocks. Assessment of value, however, varies from individual to individual. In my judgement, currently, both discretionary and non-discretionary consumption (excluding tobacco) are at one extreme while utilities, corporate banks, certain oil and gas companies, etc. are at the other. Sectors like information technology and pharmaceuticals fall in the middle.

The key overweights in the funds which I manage are utilities, corporate banks, tobacco, etc., and the key underweights are in discretionary consumption, consumer staples and retail banks. It is interesting to note that 10- 12 years ago, the market’s perception of these sectors and our positioning of funds was exactly the opposite of today.

This role reversal is not a first – there are several illustrations of how once fancied sectors fell out of favour over time and vice versa. In my experience markets can misprice a business for a while, but over time, just like water finds its own level, so do valuations.

Select funds have underperformed their respective benchmarks. What is the reason for this underperformance?

This is true that performance has been weak for the funds managed by me. The primary reason for this is the overweight position in utilities, tobacco and select engineering, procurement and construction (EPC) companies along with underweight position in consumption companies and retail banks vis-à-vis the benchmark. The impact of corporate banks has been partially offset by similar or higher fall in some non banking financial companies and small banks.

Two things make me optimistic about the future: first, the businesses that have caused the underperformance are some of the strongest companies, not just of the respective sectors but of the country and they continue to grow. Second, I have experienced similar situations of deeply polarized markets on several occasions, and each time, while the markets have tested my patience but eventually the excesses reversed.

In my view, the post covid-19 environment is particularly supportive for the utility sector as the impact on earnings for this sector is likely to be minimal. The impact on incomes of large section of population, on the other hand, should have an adverse impact on consumption for the foreseeable future.

Much of the government’s 20 lakh crore package is for providing easier loans to businesses rather than large cash transfers or infrastructure spending. Will this be enough to revive the economy?

Over the past few years, the government has reduced the tax rates through reduction in GST rates , cut in corporate tax rates, etc. This was done despite India’s tax to GDP ratio being relatively low. These changes along with expected loss in revenue due to covid-19 and the necessity of supporting the vulnerable sections of society has constrained the ability of the government to provide direct fiscal stimulus.

The ideal stimulus for reviving the economy should be increasing infrastructure spending. This can be done through various arms of the government. The very low rates globally also support higher infra spends. Equally, if not more important than stimulus, is to ensure that pending dues of enterprises is cleared.

The economic outlook for FY21 remains challenging. This is likely to be a temporary setback. However, long term structural growth factors of Indian economy like favourable demographics, competitive costs and reforms, likely shift of manufacturing from China, low oil prices and low export dependence, are positive and will revive growth strongly in FY22 and beyond.

Someone rightly said, “Sometimes you need a crisis to get your adrenaline flowing and help you realize your potential”. India will come out of this crisis stronger, so instead of focusing on the near-term negatives we should look beyond.

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