WF: What do you make of the recent spike in oil prices? Is oil now becoming a concern that can impact our macro situation? How do you see oil prices impacting our equity markets?
Tushar: We believe this oil price spike is largely a seasonal phenomenon. There is always a pre-winter stocking up that happens in the West, and this year it is a little more pronounced as US inventories have come off between May and now. There is of course the Saudi Arabia political situation that is also contributing to the spike - and it is relevant given that Saudi is the world's largest supplier of oil. But we will need to see how that situation plays out to figure out whether there can be a more permanent impact on oil prices arising out of evolving scenarios in the Gulf.
We also need to bear in mind that last year, there were huge floating inventories of oil in tankers across the world - and that contributed to an oversupply situation. Now, those inventories have been run down and the demand-supply situation is more in equilibrium - which is why oil prices have bounced from depressed levels to more sustainable levels. I don't think there is any fear at the moment of oil spiking to $100 levels which is when it starts seriously impacting our macro situation.
The fact is India benefited over the last 2 years from abnormally low oil prices, and that benefit has been put to good use. You can't expect bonanzas to continue forever. So I don't really see oil impacting our equity market in any material way. The impact may come on the fiscal level, but that too if prices return to the earlier highs. High crude prices while damaging the fiscal deficit did not necessarily mean weaker equity markets, if you remember.
WF: Developed economies' central banks are tapering off liquidity which has been at the heart of sustained buoyancy in asset prices, although they seek to reassure markets that interest rates will not be steeply hiked. How does liquidity withdrawal alter the outlook, if at all, for global markets and our market?
Tushar: To understand likely impact, one needs to appreciate the quantum of the liquidity injection and the current plan for a calibrated withdrawal. Between 2008 and now, the US Fed's balance sheet has gone up 5 times - that's the magnitude of liquidity that has come into the system. What the Fed is doing now is only allowing bonds that are maturing to run off their books without re-issuing them. There is no further liquidity injection and the process of these bonds running off will take years. So it is a very gradual tapering off. What the Central Banks are trying to do is not to get back to the old normal in a hurry, but make a gradual shift over time from the new normal to something closer to the old normal. No Central Bank is keen to destabilize the market by any aggressive attempts either at sucking out liquidity or increase in interest rates.
If you think about it, what's underpinning the asset markets in recent years is exactly this perception that the Central Banks have put out in the market. Markets don't like uncertainty and they love certainty. There is an air of confidence in the markets about the predictability of Central Bank behaviour - which means risk perception has reduced significantly - and that in turn emboldens market participants to take risk.
So, if you ask me, liquidity withdrawal or interest rate hikes seem unlikely to upset global markets - there is little perceived risk of any surprises on either of these fronts. It is always surprises that upsets markets - what and where and when such a surprise can come from is anybody's guess.
WF: What is your outlook for Indian markets and what do you see as drivers going forward? Has the market run too far ahead of fundamentals? Should we brace ourselves for a mean reverting correction?
Tushar: When you think of the possibility of a sharp mean reverting correction, you need to consider what might induce such an event and the probability of occurrence of such events. There could be three clear possibilities:
Earnings growth disappoints
Domestic liquidity dries up
FII inflows dry up
Let's take earnings first. While there is a lot of disappointment on earnings, it is not perhaps as bad as it looks. EBIDTA margins have actually increased - they aren't getting reflected in the bottom line largely due to one offs including provisions and charges. Also bear in mind that the next 2 quarters of earnings - Oct-Dec 17 and Jan-Mar 18 will have a low base effect helping them at least optically. Oct-Dec 16 was a disaster due to the impact of demonetization, and that spilled over into the next quarter as well. So, the next 2 quarters will most likely post healthy earnings growth over previous year. As better earnings come in, markets will look less expensive. In that context, the possibility of earnings growth numbers causing a sell off seems a little remote.
Domestic liquidity continues to remain strong and the prognosis continues that equity will outperform other asset classes - which means no reason to worry about an imminent collapse in domestic flows into markets.
FII inflows have been robust - not just into India - but into emerging markets as a whole. The Moody's upgrade is another fillip for fixed income flows.We have already discussed the global scenario on flows into asset markets. So here again, there doesn't seem to be an imminent threat that is visible on the horizon.
That said, fact is markets are relatively expensive. Markets have already done very well in this year, and to expect the same momentum to continue may be a stretch. So I would say while the downside is limited, the near term upside is capped too. As reported earnings numbers start looking better, markets can move higher.
WF: HSBC has globally adopted the PB/RoE model as the primary filter for stock selection - can you take us through the rationale behind adopting this model and how this model is playing out in the Indian context in terms of helping you identify stocks?
Tushar: It is quite fashionable to talk about processes - but in many cases, articulation is vague and adherence therefore is patchy. We at HSBC Mutual Fund can proudly state that we have a very well defined process, it has got a specific name and it is very well articulated. And adherence to the process is a global best practice that is never compromised.
The aim of any investment process is to identify within your universe, companies that are relatively more profitable and available cheaper relative to universe. That's exactly what our Price to Book / Return on Equity or PB/RoE model seeks to do. It is this disciplined process that leads to repeatable performance of our funds.
If stocks were priced to perfection, all companies will be on a straight line on the PB/RoE line - signifying higher valuation corresponding to higher profitability. But the reality is that when you plot PB/RoE on a graph, the dots are scattered all across the graph. Logically, companies below the line means they are relatively cheaper for the given level of profitability, above the line are relatively more expensive and on the line are well priced on the PB/RoE metric. We look at 1 year forward RoE as the basis for plotting this graph.
Here is one example of our process - captured in a single live interactive screen. For our multi-cap strategy, HSBC India Opportunities Fund, we have the above scatter plot screen which shows how our overweight and underweight positions in the fund stack up on the PB/RoE metric. In an ideal world, you would want to see as many red dots (overweight positions) as possible below the line with only a few reds above the line. Vice versa for the blue dots (underweight positions).
This is not to say that an overweight position in a stock that's above the line is frowned upon. The line is our first level filter. If we believe for example that the RoE for a company is set to increase dramatically in the coming years or that is the cheapest relative to its sector, we create our projections and take into consideration an implied RoE rather than just the 1 year forward RoE. If the stock looks attractive on the basis of the implied RoE, it can well be a buy, though it currently sits above the line. Essentially, what we ask our fund managers to do is to clearly justify, with financial projections, why they believe a stock above the line is a good buy. If there is a good case, we go ahead. What this cuts out is impulses and whims - it instils a strong sense of discipline in the process of stock selection. What it does is to institutionalize the process and push towards consistency of performance - which is what finally delivers long term value to investors.
WF: Does adoption of PB as a metric exclude new age internet based stocks which will never look attractive on a PB basis, but which are at the centre of the global bull market - like the FAANG stocks?
Tushar: Some stocks are added in portfolios even if they don't ostensibly fit into the PB/RoE framework - like the example I gave earlier of stocks where we believe average RoEs can move up sharply in the coming years or where the book value is understated due to some reason. The key is for the fund manager to demonstrate why they have conviction in the future projections that they have put together, that justifies buying a stock that's significantly above the line. If you can establish that then there is a case to buy. If one cannot demonstrate visibility of earnings we preferto stay away from that stock. What this does is that we stay away from start-ups, from unestablished businesses - but it certainly does not compel us to stay away from well-articulated business stories that can demonstrate growth and in effect high RoE (e.g. Internet stocks) - if we can see good visibility of earnings that justify a particular price. What our framework does is to force an independent reality check on us, to prevent us from getting carried away by momentum and news flow.
The PB/RoE mechanism also serves as an important risk control mechanism. We look at the weighted average PB/RoE of a fund and compare it with that of its benchmark. When a fund manager takes a call on some "expensive" stock given the rationale of future RoE growth and is still broadly in line with benchmark valuation on PB/RoE at a portfolio level, he is given that leeway - provided of course that he is able to demonstrate conviction in those so-called "expensive" stocks.
WF: How are you positioning your equity funds in terms of thematic and sectoral preferences in the current market context?
Tushar: From a thematic view, we are slightly overweight domestic cyclicals. Among global cyclicals, we are overweight only Aluminium and recently steel - which is a sector that has a lot more protection in India and therefore relatively less exposed to global swings. In the early stage of the economic cycle - which is where we are now - we believe consumption will continue leading the way. Within domestic cyclicals, we are therefore more overweight on financials, building materials and select industrials. We are not overweight yet on core cyclicals as we believe there is still some time before the capex cycle starts to turn.
We are underweight real estate, IT and pharma. We are not looking at pharma right now as value buys - we believe structural changes have taken place in pharma companies' ability to address the US market as effectively as they used to. One has to also remember stock prices in Pharmaceuticals are down as a result of sharply lower earnings, the P/E's are still close to their historical averages.
Product labelling of HSBC India Opportunities Fund (HIOF):
Mutual fund investments are subject to market risks, read all scheme related documents carefully.
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