Gush of Cash in Stocks Is `Real Problem' for India Top Fund

(Bloomberg) -- Investors who poured record amounts into Indian stocks, sending valuations to the highest in Asia, risk being sideswiped by a correction, according to the nation’s largest money manager.

“The real problem at this point of time are high valuations and the local exuberance,” said Sankaren Naren, chief investment officer at ICICI Prudential Asset Management Co. “We have had a long period from 2011 without any big drawdown in stocks. It’s tough to convince mutual fund investors that stocks may fall.”

India’s equities have set multiple records this year as mutual funds plowed a record $14.7 billion into stocks, more than double the inflow from overseas investors. The flood of local money amid poor returns from property and gold has helped the $2.2 trillion market brush off concerns about how last year’s currency ban and a new tax regime were hurting company profits.

The S&P BSE Sensex has risen 33 percent in dollar terms this year, and is vying with South Korea’s benchmark for the top spot among Asia’s major markets. With a one-year forward price to earnings ratio of 22, the market is also the most expensive in the region. The advance has subdued price swings, leaving the measure of expected volatility below its five-year mean for most of this year, data compiled by Bloomberg show.

“We would like to see bouts of volatility,” Naren, who oversees the equivalent of $43 billion in assets, said. “Periodic volatility ensures that investors don’t go out of their risk bucket.”

Here are the highlights from his interview with Bloomberg News:

What is your investment strategy?  

• “We’re getting constructive on defensive stocks that offer a higher margin of safety and valuations are not high. We are positive on power stocks as they have not delivered over a 10-year period. We expect an annual 7-8 percent growth in power demand. Also, no new power projects will come up till the existing operations exhaust themselves”
  • NOTE: The money manager held 2.3 percent of NTPC Ltd. at the end of September after adding 4.5 million shares of India’s largest power utility, data compiled by Bloomberg show
• “We like banks in the retail and corporate space”
• “We are also positive on financial supermarket banks” or lenders that offer a wide suit of products including mutual funds and insurance
• “We’re bullish on pharma stocks as Indian healthcare spends as percentage of GDP will go up compared with other parts of world.” Naren said he expects margins to recover.

What is your outlook for fund flows?

• “Local fund flows into stocks will continue as long as real estate and gold don’t yield more than 2 percent. India is under-invested in equity relative to gold and property”
• “The government’s move to dis-incentivize physical assets has accentuated the push to financial investments”
• “Investors who came in 2007 understand the risk but not those who came after 2011. And most mutual fund investors in India have entered after 2011” 

When do you expect company earnings to recover?

• “Investors’ margin of safety today is built on expected earnings growth over the next two years. We expect earnings to recover in the next two years”
• “During this recovery period, market returns will be lower than the earnings growth as earnings cycle will peak”
• “If the market continues to rally despite low earnings, then we have no answer”

Read: Profit Recovery in India ‘Not Strong’ for UBS to Halt Downgrades

What are the other risks to India stocks rally?

• “There are two big risks lurking -- rising crude oil prices and the dollar strengthening”
• “If Brent goes up to $65, it adds $5 billion to India’s current-account deficit. We keep a watch on oil prices everyday”

To contact the reporters on this story: Santanu Chakraborty in Mumbai at schakrabor11@bloomberg.net, Candice Zachariahs in Mumbai at czachariahs2@bloomberg.net.

To contact the editors responsible for this story: Divya Balji at dbalji1@bloomberg.net, Ravil Shirodkar, Candice Zachariahs

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