We are going through a massive transformation
Ravi Gopalakrishnan, Head of Equities, Canara Robeco AMC
26th March 2016
In a nutshell
Ravi believes we are going through a massive transformation as an economy, since the Government is addressing issues that have been neglected for decades, including the power situation, bank NPAs etc. Transformation is never an overnight process, but its benefits are more structural and long term
Midcaps tend to outperform large caps in a bull market, but one needs to be selective and bottom-up focused to pick the right stocks at reasonable valuations, after due evaluation of the business, its management and the valuations (B-M-V).
This B-M-V process has powered strong alpha generation in Canara Robeco's Emerging Equity Fund over the last 7 consecutive years, and Ravi believes his bets in the roads, power transmission, cement and auto ancillaries spaces will continue to help the fund generate positive alpha going forward.
WF: What is your overall call on markets over the next 12-18 months and what do you see as the key drivers?
Ravi: We are going through a massive transformation as an economy. I think the turnaround will take some time and only happen when earnings growth recovers meaningfully, although it appears to be bottoming out. For the market to move up from here, India has to do something special, because global headwinds still remain. India might follow movement in emerging markets, perhaps to a lesser extent owing to its relative strength. But as long as fundamentals of the economy remain in place, India should continue to outperform over a longer period of time. My assessment is that we may see traction on earnings growth by second half of 2016-17. FY18 could be a very big year for corporate earnings. The impact of some of the work carried out over the last 18 months will start trickling through the economy. Valuations are reasonable post the pre-budget correction so there is good scope for outperformance from here. We have had two consecutive years of bad monsoon. If, this year, agriculture is able to contribute in a meaningful way, there will be multiple positives in the form of pick up in rural demand, lower inflation, and allocation of funds to more productive components of the economy.
WF: After the recent correction, many fund managers are advocating large caps and believe that the midcap space is best avoided at the moment. You seem to have a contrarian view on this. Can you please elaborate your perspective on the large vs midcaps debate?
Ravi: We see opportunities in both segments as reasonable correction has happened in both. A lot of the frontline stocks are commodity related and they continue to remain under pressure. The choice here has to be more bottom-up. Even in the mid-cap space, there are good opportunities in the engineering, logistics and road construction space where the correction has been sharp. One will have to look at the portfolio in a balanced manner. Depending on your risk appetite, one should have a mix of good quality mid-caps as well as large-caps. The former show higher volatility but tend to outperform in bull markets.
WF: How are valuations in the mid and small caps spaces vs historical averages? Would you put them in fair value zone or above or below it?
Ravi: Mid-caps have historically traded at premiums to large caps in bull markets. With the recent correction, a significant amount of that premium has reduced. So valuations from a historical perspective have become reasonable. Investors need to be very selective when investing in mid and small cap companies. The mid and small caps space has to be looked at more from a bottom-up perspective. There are many companies in the mid and small cap space which have shown strong earnings, improving cashflows, and stable balance sheets and are run by capable management which continue to command premium valuations. These companies are relatively resilient in a bad market environment and generally witness a bounce back lead by a domestic economic recovery. After the recent market correction there are several such companies which are available at attractive levels.
WF: Midcaps are seen as better proxies to the domestic story than large caps. The domestic story however continues to splutter and is not gaining the expected traction. What ails our domestic recovery?
Ravi: The domestic recovery may appear to be slow, but the government is tackling certain issues which have not been addressed over the past few decades. The reforms that were carried out in early 1990s were relatively easier i.e. the low hanging fruits and easy to implement. One could see the effect of those reforms very quickly. However, the issues we are facing today-be it in the power sector or the NPA situation in the banking sector- are more complicated and the impact of corrective measures will be more structural and long term. That is why the entire system may seem to be on a pause mode currently.
WF: Which themes within the midcaps space offer the best value in your view?
Ravi: Many of the good quality stocks have corrected 25 -30% from the top without any material reason. Even previously overvalued stocks have also come down to reasonable levels as earnings growth disappointed. We find that we are able to pick up stocks as valuations have come to reasonable levels. We are finding opportunities in the roads and power transmission segment to be attractive. Cement is another area where growth seems to be bottoming out. Auto ancillaries also look interesting as the numbers look quite robust. Further, if monsoon plays out well, it might be a huge trigger for reviving consumption demand in rural India, supplementing the enhanced MNREGA allocation to the segment.
WF: Your Emerging Equity Fund has had an enviable record of positive alpha generation over the last 7 calendar years. This year has however begun on a choppy note. What's causing the current underperformance and how do you plan to steer the fund back to positive alpha?
Ravi: The fund's superior performance could be attributed to its portfolio construction process which incorporates the Business-Management-Valuation approach to stock selection and also to the adequate diversification, which has helped the fund avoid taking excessive risks. Considering the economic environment in recent years, the focus has been to invest in good businesses with a clean balance sheet. Good businesses offer economy led growth and operating leverage benefits while clean balance sheets avoid the issues associated with financial leverage. The recent volatility in equity markets has impacted both large cap and mid cap segments of the market. Good quality stocks which were till some time back fairly resilient to market volatility were also seen getting impacted. Inspite of the very short term underperformance vis-a-vis the benchmark the longer term performance of the fund continues to remain robust. We believe that in times of volatility, quality companies should continue to outperform and hence we have maintained the fund's key holdings in such companies.
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