Overweight On India But No Substantial Earnings Upside In Sight: Fund Manager Anindya Chatterjee

India is a large market for us and over all roughly around a quarter of a billion dollars of our fund is invested in India that underscores our confidence. We are a long term investor. So when we invest in companies we hold for three to five years. Our strategy is very long term in nature. We are looking beyond the noise and the immediate volatility and taking a long term view. In that sense we are very overweight in India relative to the benchmark. Our benchmark is MSCI EM Global and MSCI EM Asia. We are in a substantially overweight stance as far as India is concerned. That kind of reflects our view on the market.

India valuations have always been rich relative to other emerging markets. It’s at a premium and for good reasons. I don’t see that premium either widening or narrowing substantially from this point. Unless this geopolitical uncertainty goes beyond a scope that I cannot think of right now. Otherwise India does have more resilience relative to many other emerging markets. So India does command that premium for good reasons. The entire globe is today growth challenged. It is very hard to find companies that are growing double digits in EPS (earnings per share) with reasonable valuations. So the sectors that we are focused on in India are unfortunately very rich in valuations. It’s not richer today in valuation than it was one year back in my perspective but I don’t see that changing so much.

It’s a good question. It depends on the sector and the company. So we are looking for a combination of a reasonable value and reasonable growth with a reasonable degree of earnings visibility. A company which is sustainably growing at 25 percent year on year, we maybe okay if the valuation in terms of a PE (price earnings) multiple is 25 times. If a company is growing at 10 percent year on year, the valuation would be different that we would be comfortable with for that sort of a company. The company that we are looking at must qualify in this parameter of a PEG (Price/Earnings to Growth) ratio.

Valuation is always a worry for India,  it’s always at a premium. I don’t think at this point it’s an especially stretched valuation. Because the market has actually not gone anywhere in the last few months in particular and if you take a five year chart of India in dollar terms you will see the market has not done much. So people forget and just look at the last one and a half year rally.

Absolutely. So it’s a bottom up market and a stock specific market. The stocks we are invested in have grown in their earnings and have not really stretched in the earnings multiple.

You know there are lots of misses and I can never fall short of counting all the mistakes I have done. I wish I had some of the NBFCs, I wish I had timely bought some of the cement companies. I missed some of those. But our focus is on companies where there is possibility for us to ride this wave of rising middle class. Our focus is on how to capture the upside from this rising middle class consumer, domestic demand focus. The banks that we hold, the private banks, are either positioned as consumer or corporate banks that can leverage from domestic demand. Or we invest in exports that provide or can leverage on the long term sustainable comparative advantage.

It’s bottom up stock picking. It’s not that TCS will never be in our portfolio. So at every point of time it’s a bottom up decision of what is included in our portfolio and we try to take a medium term approach on that.

It was a relative decision. I do not want to talk about one particular company as such. But if you discuss this competitive advantage that India provides, I think there is still a long way. The entry level compensation of IT engineers in India has hardly grown in the last 10 years. Even now they get less than $10,000 and graduating engineers with an under-graduate degree in the U.S., in Silicon Valley, they are getting six figure salaries. The gap is so big there is a long term sustainable comparative advantage without doubt. There would be cycles where U.S. companies may or may not invest in their IT infrastructure and the integration process. I would take a seven to ten year view and I would maybe balance my weight.

See first of all we have a bias on midcaps. So you know across the portfolio in each sector we have a bias on midcaps. Mindtree or Cognizant is a different size than TCS. It kind of highlights our focus, that we are a bit more focussed on midcaps. Our fund -the average portfolio market cap of constituent companies is about 3 billion dollars - compares with almost 10 billion dollars for the Index. We are very different from the index.

They looked expensive and I was not very confident of the growth in earnings that they could show, so of course it was a miss. I wish I has a couple of really good NBFCs in my portfolio.  But the banks that we have, are probably best in class, not just in the country but in the region, if not in the world. HDFC bank has generated, I think a more than 20 percent annualised return in dollar terms in the last 20 years. There are very few such banks in the world.

See the consumer sector is very rich in valuation, always has been. And it’s been a challenge to pick stocks there. Either there would be regulatory risks like ITC has faced...

That’s why it is not a very large weight. Of course it is a sin stock that way, but it plays on a lot of stuff...on aspiration of moving from beedi to cigarettes for example and also on aspiration of discretionary consumption and also on the demography that so many people are attaining adulthood and would be in that age to do that. So, all of that is in favour of ITC besides the strong management, global brand and reach and distribution. So it is incredible. But, you know, the tax is going to keep on hitting it and that’s a big regulatory risk besides you know the warning signs and all of that.

I had a larger weight on the stock and have trimmed it somewhat.

So BPCL was a sizable position that I had, and it is a great company. It is not an energy company as such. It is really an energy marketing company and it is more of a retail story that way. The fact that it has thousands of distribution points, not just in the metros and the urban areas and the semi-urban areas, along the highways. It can leverage its infrastructure in many ways. I think it has prospects in e-commerce as well you know, logistics and distribution. So, BPCL is a phenomenal growth story as well. It is domestic demand, consumer, marketing and maybe a piece of the new economy can also come into that.

I have looked at it, you know they are extremely expensive or illiquid. Liquidity is very big in this. I cannot go and buy a Blue Dart just because you know it can expand on that for example but it is not liquid enough for me. So, there are limited opportunities, that will satisfy this reasonable valuation and reasonable growth.

So, investments have been challenged in India for a long while now. The growth that we’re seeing now is more driven through non-infrastructure initiatives so far.

Yeah, there are evidences that the investment has picked up in roads and we’ll certainly have a look at that. So, it’s not that we’ll never invest in infrastructure in India.

So, software exports for example do look challenged when it comes to dollar term earning growths at this point. The pharmaceutical sector, Dr. Reddy’s, Sun Pharma and all the others have seen a separate challenge from the FDA initiative in a crackdown on their facilities. I think the fact is that exports are not growing and imports are shrinking even faster in India. Investments are weak. So, it does share the same growth challenge environment as it is today in the rest of the world. It is hard to find double digit earnings growth.

We’re probably on the recovery path, but a substantial upside in earnings is not visible yet.

That was a mistake. I don’t know why it has come out in my portfolio in some of the more recent interviews. It is probably the smallest position I had and people make mistakes. So, that was the one mistake we made.

No, I don’t want to comment on a particular action. And Taro is one of our holdings in the U.S. and Sun Pharma is the largest stake holder in Taro. Taro actually is a gold mine in our view. It has great products and it’s very reasonably valued and its under-followed, so we stay invested long term. I don’t think we voted against it.

I don’t have the power to predict the index. I don’t know where it’ll go. So, what we do is look at sectors and companies and take a medium, long term view and stay invested. Doesn’t matter where the index goes. For example our benchmark is MSCI EM. Since the inception of the fund the index has almost gone nowhere. If we were focused on the index and taking up bets where the index would go, we would be going around nowhere and our fund is up by more than 60 percent.

So, directionally if you take the medium term, I think there would be better days ahead. There is a mean reversion prospect favouring emerging markets at the least. So, I would say that the prospect of indices doing better, going forward, look better to me.

Rate hikes should be digested by now. It’s been a hide and seek play for a long time. As and when the Fed hike happens that’s a challenge for many infrastructure companies that I’ve been avoiding, for example those companies with large debt. So, the companies in which we invest in India, the software services, the pharmaceuticals, consumer companies, there is no debt. So debt would suffer, companies that have large debt would suffer, but overall for emerging markets it would be a challenge and rising interest rates cannot be that great. But if growth comes back, then you know people would be able to ride and tide through this interest rate hike and we don’t expect interest rate hike be so rapid and strong and all that.