AMC Speak 5th March 2014
March is usually a good time to invest in mid and small caps
Sankaran Naren, CIO, ICICI Prudential MF


Naren shares with us the rationale for launching the 3rd edition of ICICI Prudential's Value Fund series now. He believes that a delay in interest rate cuts due to a shift in the goal post, coupled with seasonal weakness of midcaps in March offers an attractive proposition to invest in value stocks this month, through the current NFO. Why do mid and small caps traditionally weaken in March? When should one become a growth investor and forsake value investing? How will 2014 pan out for equity and debt markets? Read on to understand Naren's candid perspectives on all this and more.

WF: What are the themes and the sectoral emphasis for the 3rd edition of the Value Fund series? Are there any new themes that are likely to find their way into this edition?

Naren: In our base thesis, till the period August 2013, the biggest worry in the economy was the current account deficit moving sharply upwards; we saw that as the main risk in the economy which was one of the prime reasons for launching the US Bluechip Equity Fund in 2012. Once the current account deficit came down, we could clearly see that the steps taken to cut current account deficit would lead to reduction of inflation. The lowering of the current account deficit logically leads to a sequence of triggers - lower inflation, fall in interest rates and consequently, growth. This has enhanced our conviction that from the medium term perspective, there is a significant improvement in the outlook of equity.

At the current stage of launching the Value Fund-Series 3, from a market point of view, we see that we are almost in the same situation as we were when we launched the first two versions. But from the economy point of view, we have seen continuous improvement in current account deficit over the last 4-5 months. We have seen a sharp drop in the wholesale price index to 5.1%; the consumer price inflation has also fallen to 8.79% and is expected to fall even further.

While we are currently in a more advanced part of the economic improvement cycle, in terms of the capital markets, we are in a near status quo position as when we launched Value Fund Series 1 and Value Fund Series 2. This is because of the delay in reduction of interest rates by the RBI as a result of changing the benchmark to CPI. As a result, we want to offer investors the opportunity to enter value stocks available at very attractive valuations. Our contention is that a year ago, if one were questioned about interest rates in a scenario where the wholesale index price was at 5%, and repo at 8%, it would be obvious that interest rates would be lowered. Currently, the scenario has panned out leading to a very fair chance of rate cuts; this provides investors the opportunity to profit, and hence the launch of Value Fund Series 3. We think this is a very good time to invest from a long term point of view.

Another important factor with Value Fund Series 3 is that we were keen to raise and deploy the corpus in March. Our analysis indicates that liquidity in the system is generally tight every March, which results in mid and small cap stocks performing poorly during this month historically; they then rebound thereafter when liquidity returns in the new fiscal. Value Fund Series 3, like its earlier two editions, will focus more on mid and small caps. We think that the delay in interest rate cuts coupled with this seasonal element makes investing in good value stocks in the mid and small caps space in March an attractive proposition - hence the timing of the launch of Value Fund Series 3.

WF: Which are some of the sectors and themes that you find attractive from a value investing perspective today?

Naren: When Value Fund Series 2 was launched, our expectation of a fall in the inflation rate was proven correct. From a Value Fund Series 2 and subsequently Value Fund Series 3 perspective, we believe that one of the macro themes is how to capitalize on the downward cycle of interest rates; this theme would be part of our consideration on how the portfolio is constructed. At the time of launch of Value Fund Series 1, the movement of the current account deficit and inflation rate was fluid. However now the direction is clear; that is one aspect we will have to consider in our portfolio. Secondly, with the passage of time, there have been periodic worries on China's growth; therefore, at this point of time, we are averse to considering a global commodity centric portfolio. So, domestic rate sensitives will be a clear priority now.

WF: Some analysts and fund managers would argue that when the economy is showing signs of bottoming and moving ahead, even if it is a slow trajectory, it is time to really invest in growth. From your perspective, when does growth investing become a lot more sensible and when is value investing relevant?

Naren: Our analysis of the 1998-2000 cycles and subsequently, the 2003-2008 market, indicates that value tends to do well at first. Subsequently, a certain theme captures the market's imagination and becomes the leader of that bull market. For example, in the 1998-2000 cycle, the growth market included technology, media and telecom. In the 2006-07 market, it was infrastructure. Once the value phase of the market has been cashed in, some theme becomes predominant in the subsequent bull market. At that point of time, it may make some sense to look at growth investing but you have to remember that your margin of safety is also a lot less.

WF: While the domestic environment is gradually improving and hopes are soaring for a stable government post elections, on the global front, some analysts argue that all is not well especially for emerging markets. We are now moving into an era of lower global liquidity and higher US bond yields - which should mean lower allocations to emerging markets in the medium term. Is this a risk that one should worry about in the Indian context?

Naren: When we had a strong commodity boom, a country like India which is a big consumer of commodities, also needed a lot of capital flows to finance the resultant current account deficit. On the other hand, if you have a market where commodities are going nowhere or going down, the need for capital flows is much lower as is the situation today which is apparent from the fall in the current account deficit from $6-7 billion to about $ 1billion or lower. We believe that the current economic environment suits commodity consumers like India in the emerging market space as compared to commodity producers. So the need for capital flows to solve India's macroeconomic problem has certainly come down today.

WF: What is your call on the markets as we are about to enter the new fiscal year?

Naren: The equity market in the first half of 2014 is an election driven market; one of the biggest handicaps in an election driven market is to assess when the returns will come. If you look at the close-ended funds we have launched, our view has been that returns are likely to be front-ended and the opportunity is going to be in the pre-election phase or in fact, in the pre-April phase. This has been the kind of framework that we have had. When we talk to foreign investors, many believe that flows may actually accelerate in the post-election phase. In the post-election phase it is not clear whether the market will perceive the elected government to be pro-growth, and hence, one would be uncertain about whether to invest into that rally or stay away. We will have to wait and see, but our belief is that returns from equity this year may be more front-ended and therefore, we would like to raise investor money at the right time.

We believe that interest rates will fall from here on, which will offer an attractive profit potential in long duration fixed income. While this is a straightforward decision at this point of time, most investors are hesitating to adopt this strategy.

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