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Midcaps, smallcaps fairly valued: S Naren, ICICI Prudential AMC

Largecap is generally a more defensive theme, says CIO of ICICI Prudential AMC.

, ETMarkets.com|
Last Updated: Mar 07, 2019, 08.07 PM IST
We are overweight on power utilities because this sector has seen 10 years of no growth.
In a conversation with ETMarkets.com, S Naren, Executive Director and Chief Investment Officer at ICICI Prudential Asset Management says he believes PSUs as a pack is cheap. Naren, who helps oversee around Rs. 3.2 lakh crore of assets, is of the view that earnings are due for a strong rebound in fiscal year 2020. Edited excerpts:

Mutual fund inflows have slowed down off late, we have seen equity inflows fall to two-year low. How does it impact you?
S Naren: Our view has been that the best type of inflow is the SIP and STP and that flow has continued and that is the best type of inflow if you look at the mutual fund industry. If you look at our five-year SIP from here, I think it is one of the best products to invest in. So I think as long as the SIP remains a big part of the inflow we would be pretty happy. SIPs have grown significantly over the last few years. They have been growing. And we would be even comfortable if the quantum of SIPs remains at this kind of level, but it is very important that people do not stop SIPs when the markets are down, that is our hope and I hope the investors stay with that.

Do you fear that investors could stop SIPs as we draw closer to elections?
S Naren: We do not fear, but what we always have to keep stating that because end of the day what we want to explain is that SIPs are the best products in the investment market provided you invest when the markets are volatile and not only when the markets are up.

What theme do you think is the best play in the Indian market at this point of time and why?
S Naren: See frankly, till oil corrected we were worried about themes which required a lot of borrowing costs and things like that. Once oil has corrected, we are in a framework, but if you ask me we are very comfortable with credit as a category, accrual as a category, along with the equities. In equities, there were times when we used to be negative on small and midcaps, but right now we are positive on almost all the categories.

Smallcap and midcap stocks have seen a significant rebound in the last few sessions. Do you think it is a temporary thing or do you think it is here to stay in the run up to elections?
S Naren: See, that is very difficult to say, but we have been recommending five-year SIP for all investors in small and midcaps. Since Diwali we have been continuously doing campaigns on that saying that please invest in SIPs in mid and smallcaps over the next five years. So do we think that there will be volatility this year? The answer is yes. Are we at a time when we are worried about mid and smallcap valuations? The answer is no. Can mid and smallcaps become undervalued at some point of time? It is possible. They are now fairly valued. So that is the kind of situation.

Is Nifty a correct benchmark to play the India story at this point or do you think that there is some sort of a decoupling in that sense?
S Naren: See, our view is that largecap is generally a more defensive theme, but if you are asking me what is the way which I prefer personally over the next five, 10, 20 years it would be out of a 500-stock index kind of portfolio because if you look at it even globally it is the 500-stock portfolio, which has actually been most favoured, no one talks of Dow Jones, everyone talks of S&P 500.

Do you think largecaps are fairly valued at this point of time?
S Naren: I would say some of the mega caps look slightly overvalued and there are a number of largecaps which are cheap also at this point of time.

Any particular sector which looks really overvalued?
S Naren: See, we have been believing that consumer pack is overvalued for quite some time, but it hasn’t worked. While we have been saying it for the past two years or three years, frankly consumer pack has never corrected meaningfully.

I think PSUs as a pack has been very cheap and it has corrected very meaningfully. That is the kind of situation we are in and barring the consumer pack and a few quality stocks I think the rest of the market of fairly valued.

You spoke about PSU pack, apart from Bharat 22 have you meaningfully deployed funds into state-run companies’ stocks?
S Naren: We have big holdings in many of the select PSUs. We pick PSUs where the outlook for the next five years looks good. These stocks are all trading at single-digit price-to-earnings with dividend yields of more than 4-5% and we think that kind of a segment is something for us to look at. There are no sector biases, in fact, it is non sectoral. We would like to look at all the sectors, we are not looking at only financials.

Have you added PSUs in your portfolio off late?
S Naren: Yes, certainly I think we would have our highest holding of PSUs in the last three to four years.

Talking of earnings, they have still not really caught up the way people wanted and downgrades are still continuing. So, when do you think we can see a concrete earnings recovery in earnings?
S Naren: If you see sectors such as financials, they are seeing earnings growth. I think next year will be a very good year for earnings. FY20 would be very good year for earnings that is our view. I think more than 20% to 30% earnings growth we expect in largecap index in 2020. I think earnings is due for a good rebound.

What is the basis of this earnings rebound?
S Naren: The market repair, the economy repair, the non-performing loan repair -- all those things have happened. So, now we are in a phase where earnings growth is something which is just about to come.

What impact do you think different election scenarios can have on the Indian stock markets and why, what are the different scenarios you think we can see, and what will be their likely impact on the stock market?
S Naren: No fund manager has any clarity on elections or how markets respond to elections etc. So, our view is that India is a good growth story and from a long-term view India is an attractive market. Is the market dirt cheap like what it was in 2013-2014? The answer is no. So, clearly we are not seeing as attractive market as it was in 2013-2014. So, from our point of view what we also do is we recommend funds which are more defensive compared to the funds we would have recommended in 2013-2014 because we are in a different phase in the market.

But you have seen many election cycles. So, what are your thoughts?
S Naren: We are in the middle of the road in the election cycle this year if you ask me because valuations are not cheap, the positioning is not very very negative towards equities.

Sentiment towards credit has been negative and I think there clearly the opportunity is much more immediate. In the case of equity, we believe that middle of the road funds which are hybrid kind of funds where you look at asset allocation kind of funds -- they are the best kind of categories at this point of time other than SIPs.

Of late are you seeing more fund inflows towards your midcap and small cap schemes for the last few days?
S Naren: Nothing like that. We have been marketing SIPs in the last four-five months, we will continue to market SIPs, we think that is a way to invest.

What do you think the market is already discounting in terms of election results any thoughts there?
S Naren: Election is not something I have a mandate to talk about, I believe that we are in the middle in everything at this point of time. In equity we are in the middle, in debt we are very very positive.

Recently we saw carnage in certain pack as pledge shares were sold off by lenders how intense you think the situation can I mean currently there is a poise but do you think the situation can really arise from it?
S Naren: I do not think there are any major systemic problems in this year. I do not think there is anything much to worry about n that area and I believe that in any economy there will be some leverage. Without leverage, there is no economy so I do not think it is something that we really worry about.

What are your views on NBFCs at this point of time?
S Naren: NBFCs in our opinion on the debt side we have to selective look at them. They give you very good opportunities. On the equity side we are much more positive in favour of banks vis-à-vis NBFCs at this point of time. So the view is mixed and debt we are reasonably positive based on specific work that we have done in each NBFC so it is rather more specific than individual. In the case of equity we have been underweight there.

Has it called for more due diligence than before?
S Naren: We have always believed in it. We have always been careful. We have done our own work on all the NBFCs. Historically, we believe that if there is any sector where growth is just too much you have to be a bit more cautious that is our broad view. Similarly, any area where there is no growth, you have to be much more positive that is our basic principle. On that principle that is why we have moved to more cautious products within equity and we have been cautious on NBFCs and HFCs and that is a framework we have at this point.

Within banks private banks, PSU banks where is the preference?
S Naren: We have been positive on all the banks which have got a good corporate book with a good CASA franchise These are the two things that we look at because, we think that banks who have a very good CASA franchise have a very very good long term outlook.

What are your thoughts on defensive place, particularly IT where we have seen decent rally for the year to date?
S Naren: In IT, we moved to an underweight position but now after the recent rally, it has underperformed meaningfully. Now, in the last few weeks again it has underperformed meaningfully so we are looking whether to go from some of the winners in the IT pack.

Apart from banks that we spoke about, which sectors are you overweight currently and why?
S Naren: If you look at our portfolio, we are overweight power utilities because we think that the power utility sector has seen 10 years of no growth. We are positive on corporate banks because we think that corporate banks have a huge outlook potential over the next three to five years given that they have lesser competition from NBFCs, I believe that it is another very interesting sector. We are very positive on the healthcare sector in the long run and we have been positive on sectors which have not done well like telecom. So these are some of the sectors where I would say we have a meaningful position.

You mentioned healthcare but healthcare has been reeling under pressure for the last two-three years.
S Naren: So frankly, as a framework we like sectors which have done badly where the outlook is good for the long term rather than sectors which have done very well and are continuing to do well.

So do you think it is a good time for investors to pick up pharma space?
S Naren: Yes with a long-term view I think it is a very interesting sector at this point of time. As India ages, more and more money will be spent on pharma and that will help.

Which sectors are you clearly avoiding, clearly staying away from?
S Naren: Right now, we are not in that camp because we are no longer in the euphoria kind of situation. There is no euphoria in the market. So, if there is euphoria, we will be negative on something. If you look back at our interviews a year back, we used to be pretty negative on small and midcap. But now we are broadly neutral on all the equity segments.

One macro question that I missed out, economic growth has been slowing down, what is bothering it and what are your concerns around it?
S Naren: I think it is a cyclical problem. What happened was many of the NBFCs were the ones which were actually lending large sums of money and creating growth in some of the sectors. With NBFCs having their own funding challenges, there has been a slowdown. So I think it is only a cyclical slowdown which frankly we do not worry about when I look at the economy on a three to five year basis. I think this kind of cyclical slowdown is something which we were expecting. We did not know when it did come but it has come and now I do not think we worry about it over the next three to five years.

Do you have any projections for FY20 in terms of economic growth?
S Naren: We do not have because I find this entire concept of GDP and gross value added and this and that, factor costing and all that very complicated and I feel that economics has used all kinds of jargons to calculate GDP which I find difficult to use.

By how much do you see Nifty, Sensex growing in FY20 if you can?
S Naren: I actually believe that investors should look at the next three to five years in equity. I believe that if you are looking to invest with one-year view, debt is a great asset class. If you are looking in equity, I would ideally invest with a three to five year view and not a one year view because one year has lot of constraints like how elections move, what happens in the US, what happens to US interest rates, what does the Fed do, what happens to US, India, China trade treaty. So that is why if you ask me what we have been trying to do is recommend investing through SIPs over the next one year with a three to five year horizon.

We have seen FII inflows which are relatively lower than emerging market peers. So what are your thoughts there considering that domestic flows have also slowed down?
S Naren: I think last year China was doing very-very badly and people had been massively underweight China. So, I think it is part of that cyclical recovery in China which is responsible for this. I think once you look at the five to ten year view the way Indian corporates are, I think most of the foreign institutional investors are pretty positive on Indian corporate from that horizon.

The regulator has allowed mutual funds to invest in commodity derivatives, what are your plans on launching products in that asset class?
S Naren: Yes, we look at what options we have and what kind of products to look at at this point of time.

Do you think the area is very challenging considering there are lot of things to be looked at in terms of warehousing, quality control? Do you think we are far away compared to developed markets considering that we have just digested a huge scam?
S Naren: The point is that you should have more and more asset classes which can actually deliver the money for the investor. I believe that we have a lot to learn in commodity derivatives and given the problems that have happened in the commodity derivative markets. We will approach it slowly and carefully and invest because we already have a lot of investor money so we look at all such new opportunities.

Are you seeking more clarity from the regulator on aspects such warehousing, quality control?
S Naren: The circular has just come so we will do it at some point of time.

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