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The Mutual Fund Show: Choose The Right Sector To Beat The Market

Picking the right investment theme is key to outperform equity benchmarks.

Investors looking to put in money for the long-term should opt for consumption and financial themes, Krishna Sanghavi, head of equity at Canara Robeco Asset Management Company, said in BloombergQuint’s weekly series The Mutual Fund Show.

Consumer goods—considered a defensive investment in times of volatility—are a good bet given that the population of the country is growing at 1.5 percent a year, he said. Financials, on the other hand, are prevalent mainly due to the size of the economy, low retail loan penetration and a skewed nature of physical savings towards the sector.

A systematic investment plan for six to 12 months, Sanghavi said, is “worth the effort”.

Gajendra Kothari, managing director and chief executive officer of Etica Wealth Management, agreed. “The real challenge hinges on getting the sector right.”

Watch The Full Conversation Here:

Edited transcripts from the conversation:

How does a lay investor identify the business cycle through mutual funds?

Krishna Sanghavi: Some of these themes are slightly difficult for an individual retail investor to capture on his own. Imagine the customer doing his own business. It must be difficult for him to conduct activities like tracking, monitoring. For them, the biggest theme is consumer theme because India being the kind of population we have, the growth profile, the demography, product premiumization potential which we have, the kind of under penetration of any product category we have. In Indian context, consumer is the biggest theme where one can invest for far longer potential without even bothered to monitor weekly, monthly, quarterly moment of those companies. If somebody has to invest in thematic and Indian consumer is single biggest and slightly more longer-term nature. It’s not something that you could be monitoring every 6-12 months.

Second thought is also the financial services theme. Those themes are far more structural to India, far more dependent on how India is going to do. Even in financials, the sheer unmet demand that we have. The size of economy and retail penetrations are so low in terms of loans taken, the physical financial saving debate is still moving more and more to financials. Somewhere those people are going to benefit materially. If somebody doesn’t want to put in effort or doesn’t have time or expertise to handle it, consumers and financials are best.

But if somebody wants to track what the government is doing and that’s what brings me to infrastructure as a thought. Typically, infrastructure gets a boost when the government of India decides to allocate more money to it. In a bad year of fiscal, they may decide to allocate less money. But in a good year when the fiscal is improving, government has the resources to commit money for infrastructure. Those things may not be a secular thing. Consumer is the best theme and financials follow.

What will be your advice to consumers when they are buying consumer related themes? Are you saying that if you want to invest in consumption themes, don’t invest in short term and invest for 4-10-year perspective?

Krishna Sanghavi: Yes. Some of these themes are so long term in nature and so people are willing to pay premium for some of those visibility of growth. The moment you want to walk with some of those sectors with high visibility, the market expects you to pay a slightly higher price because the visibility factor is supposed to take care of those.

Let’s monitor global commodities as a space. There are too many variables as something happens in China, Saudi Arabia and U.S. Prices of commodity change and underlying profitability of those companies materially get impacted. Market is never going to pay a significantly high premium, those stocks historically have never traded expensive because of their sheer nature of visibility.

In Indian context, private sector banks have shown amazing visibility over 5-15 years depending on the kind of companies we choose. Those strengths are so secular due to 20-25 percent credit growth, perhaps matched by similar profit growth. Then the visibility lets the investor to take a higher call. Because all he is riding is companies doing well over a longer period and upfront higher cost gets absorbed in a five to seven year growth cycle.

Financials are caught in a storm. Does this give somebody who has got a slightly longer term view to go and invest in financial services fund? Or he or she at worst do an SIP and best to buy it and wait for the dust to settle?

Krishna Sanghavi: Financial as a theme is far more pervasive. Let the fund manager at times decide whether he wants to buy a bank or a non-bank. Let him buy an insurance or a private bank or a PSU bank. Let the fund manager make those kinds of choices.

From an investor perspective, it’s the best time to get into a financial service theme. Investment in any of these stocks with the fall is welcomed. If you want to be hesitant or conscious, then take a SIP. You have elections happening. You have one in December and one in April-May. It’s best to wait in terms of timing, but I am not saying don’t invest. Do an SIP for next 6-7 months as it could be an ideal situation. Theme is permanent. Let the fund manager pick and choose of within that theme, which one will do better. With rising interest rates, banks will do far better. So, those relative choices will happen. But from a theme and for a customer, it’s the time to be there.

For somebody who would have investments in debt funds and liquid funds and has withdrawn that money and sitting on a pool of money and can do a lumpsum too. Would you recommend an STP approach to it?

Krishna Sanghavi: I will, provided that originally that money was meant to be kept in equity and essentially with that asset allocation thought. So, basic appetite and need for equity is there. The environment perhaps is saying that let’s take some time and make that six months more productive by utilising to buy on every tip and every volatility, that will be a good approach.

Is the business cycle turning for worse in any of the spaces and maybe you should avoid SIPs, STPs and lumpsum?

Krishna Sanghavi: Rupee has depreciated significantly in the last one year. The kind of momentum and support you got last year may not be equally visible a year after from equity markets perspective. It is not that business segment is going to suffer. I am trying to link business cycle with that of the financial markets. We see companies getting re-rating and de-rating as it’s more driven by expectations of future earnings. NBFCs are partly impacted because of expectations of higher interest rates but you can offset that by either having the ability to price your product to customers which is specialized NBFCs or alternatively shift to banks, etc. So, we will not be worried.

Or I can think of a new theme like infrastructure. Lot of things have not happened as per the expectations of last two years. Interest rates are already on the upper end of range. Look at 12 months down the line, irrespective of elections, new government or same government combination. They will still be awarding road projects, power transmission projects, railway network, upgradation projects. You have the luxury of taking the time. Think of 6-12 months’ time and be a financial beneficiary of those themes.

From a mutual fund perspective, how does an average investor try and make use of themes?

Gajendra Kothari: All mutual funds have sector rotation strategy built in. At any point of time, there are 12-15 sectors. Not all of them will be performing. All diversified funds anyway are playing sector rotation game. One of the most popular fund manager Prashant Jain through HDFC Top 200 and HDFC Equity fund has said that he could like to be ahead of business cycle. Two years back, he started investing in corporate banks and industrials which we have seen has been delayed and that’s why it resulted into underperformance. So, all funds play sector rotation. In past, there are various funds which focus on sector rotation only. So, at any point of time, they will be only in 4-5 sectors and keep rotating in good sectors and coming out of not so performing well sectors.

After this re-categorization, this theme has lost its way. There are no more sector rotation funds. Earlier these funds were called opportunities fund like DSP Opportunities Fund or UTI Opportunities Fund. But now they have merged into value category.

You can play sector rotation in two ways. One, you can play through an advisor and tell him to put 25-30 percent of money in sectors that aren’t performing and then you can keep rotating. Right now, infrastructure isn’t performing. So, we can put some money there. Because it will perform at some point of time. The risk reward ratio is much better here. The risk is lower, and reward is higher, but you will have to wait for it. Peter Lynch used to tell that a lot of money can be made if you are in the right sector at the right time, but it’s not too easy the way it sounds. You need the right sector and business cycle calls. That can be intimidating even for an astute fund manager. One way is to play through an advisor where we pick sectors which have not performed well. Last year the pick could have been pharma, couple of years back it could have been IT and then you have to keep coming in and out. This can only be a tactical call. It is not strategic call.

The second way is to play through fund game. You have 4-5 funds which have concentrated 4-5 sector strategy and then you invest and forget about it. Retail investor by himself should not go directly. He should go in pure diversified equity fund and let the fund manager decide which sector will play out. There is not much of difference between the returns from diversified equity fund and pure sector rotation fund over a long term unless you can time it. Buy and hold it won’t work there much.

Why are you recommending Aditya Birla Sunlife Equity Fund?

Gajendra Kothari: This is multi-cap fund where the fund managers can take the call. All these funds are pro-cyclical. Because it is business cycle fund, the sectors which are not performed earlier, he has invested heavily into it. All these funds would have very low investment into defensives like healthcare or IT. These could be more cyclical in nature like industrials. Even financials are part of this funds because as economies do well financials will do even better. So, this fund is consistent performing fund in last 5-7 years. This can form a 10 percent part of the long term portfolio and it is great to be in.

DSP Equity Opportunities Fund. Is this slightly different from other funds and why have you chosen it?

Gajendra Kothari: These are the funds which do well on sector rotation. The focus is purely on sector rotation as a theme compared to normal diversified equity fund. These funds have a high concentrated ratio into these given sectors. This fund has been a consistent performer. Overall not more than 15-20 percent of portfolio should be in these funds. Either you can go with Aditya Birla or you can have a small top-up with DSP Equity Opportunities Fund. You can’t have all 4 into it as it wouldn’t make sense.

You also recommend Franklin India Opportunities Fund. Why ?

Gajendra Kothari: After the SEBI’s recategorization many of them have toned down their focus on sector rotation and they have made it broad-based, whether it fits into large, mid-cap or multi cap category. Even this has been a good performing fund. All funds for 3-5 years, the returns have been broadly similar. In short term, you may have to wait long.

The L&T India Business Cycle Fund was launched when the business cycle was down and did initially well for first 1-2 years. But for last 1-year track record, the fund has given minus 11 percent return vis-à-vis Nifty +2. So, these funds can have long periods of lull before they shoot up like anything when the cycle turns around.

What is the top theme right now?

Gajendra Kothari: For a more defensive investor, it is pharma because there is still lot more juice left. If you have 2-3-year view, then pharma should do well. But if you have 5-6-year view, you go for infrastructure theme as the risk reward ratio is far better here compared to any other themes.