CIO Round Table: 'Debt returns are offering competition to equities'

On the earnings side, the macro drivers are positive. We expect the earnings growth to continue, says SBI Mutual Fund CIO R Srinivasan

Chief investment officers (CIOs) of India’s top mutual fund houses said at the Business Standard Insight Summit that debt was offering equities tough competition, as major central banks unwound their monetary easing and hike interest rates. In the session moderated by Business Standard Editorial Director A K Bhattacharya, they said that there was a need to create a vibrant debt market in the country. The panelists included SBI Mutual Fund CIO R Srinivasan, ICICI Prudential Mutual Fund CIO S Naren, Aditya Birla Sun Life Mutual Fund CIO Mahesh Patil, PPFAS Mutual Fund CIO Rajeev Thakkar and Kotak Investment Advisors CEO-Investment Advisory, Lakshmi Iyer. Edited excerpts:

How has the emergence of Covid halted all of you, and your way of doing business? And how do you see your businesses going forward?

Lakshmi Iyer: From a global central bank perspective, I think we are working very well from a period of injection of steroids to a liposuction stage — quantitative easing morphing into quantitative tightening. I hope we do not have to see a similar kind of scenario again, because that’s a very scary situation. Hopefully, the bulk of India is vaccinated. We are cherishing the change from the reel to the real world. From an investor mindset, I will talk about two asset classes.

From an investor mindset standpoint, on fixed income, the question always was kitna deti hai? — what kind of returns are likely? And for equity investors, what do I say, when you are looking at the numbers? The mindset was like Shiva in Bhramastra — mera aag se koyi rishta hai, main aag se nahin jalta. That, in a nutshell, is how I would describe this metamorphosis.

S Naren: No one would have believed that when Covid hit, India’s macroeconomic management would be better than the West’s. Inflation numbers in the US are coming in high. That happened primarily because of the Western world’s macro management. People thought you can print any amount of money, offer any amount of fiscal stimulus, and there won’t be inflation. That turned out to be a completely different experience two years later. We had a very good telecom system, and a very good internet and technology interface. So we could do the CoWIN app and a superb vaccination programme.

In 2020, people thought only China was unaffected and India was affected. In 2021, people felt that any loss-making company could be listed in India at any price and sold to any set of investors. Finally, we realise that you have to be rational and logical. Policies also have to be logical and rational. If you pursue illogical policies, the impact later is like what the US has realised today. Even as investment professionals, what we tell our teams is never irrational, because in 2021, across the world, people invested in loss-making companies. Today, you know what has happened to them. All these new-age companies would say there’s no need for profit. All you needed was sales. Today, all those companies and all those investors are suffering.

The last two to three years have shown that you have to believe in technology. But you have to be rational. You have to work things sensibly, and not start doing stupid things. That is the lesson. Today, if any country pursues macroeconomic policies that are stupid, and an investment professional does stupid things, the impacts are not seen today but much later. That is why it is imperative that when we are managing other people’s money, we have to be grounded and rational. Most of the time what you do rationally seems illogical today, but the benefit is seen years later.

In 2020, we used to tell people public sector units (PSUs) are attractive. They used to ask, how can anyone make money in PSUs? Now, suddenly, everyone is asking us, should we not buy PSUs? Today, those prices are very different from when we used to push them as great investment ideas. Every month we were asked, how can you have such a high percentage of PSUs in a portfolio? Today, people are asking, should you not add more PSUs to the portfolio? That’s why I believe rationality changes, views change. Today, when we look at debt, the situation is different. Two years back we never told people to look at debt. Today we are telling them to look at debt. We continually have to be sensible, logical and rational. I call it SLR.

Has the response from the investing community undergone any significant change, during this period?

Naren: During Covid most people sitting at home became traders. They picked a time when markets were very cheap, and made a lot of money. So they thought it was very easy to make money. They were very savvy initially. I’m a big believer in behavioural finance. I believe that at all points in time people will get consumed by greed or fear. In May 2020, we went out of the way to tell people to invest in credit. In October 2020, we told people to invest in value or PSUs. People said no, we will invest in quality at any price. Greed and fear are problems everywhere, and that is why people invested in so many negative-yielding bonds.

Everyone thought the yen would keep depreciating. Suddenly in the last two months (of 2022), it appreciated by 10 per cent. How can a current-account-surplus country like Japan have a currency which is always depreciating, but people believe it is now suddenly appreciating? They got the shock of their life. That’s why I believe that investors don’t change. There is a need for asset allocation, because investors don’t change. And that’s why asset allocation can bring easy returns to people over a long period.

Iyer: The problem in the investor mindset is, ‘heads I win, tails I win’. That’s number one. And, number two, in any asset class, tolerance levels are very different. In equities, tolerance is very high and they give a long rope and longevity is increasing. But in fixed income, when zor jhatka dheere se hota hai, the expectation is that this has to be Teflon coated. I think that mindset has not changed. That is probably the reason you’re seeing the gush of flows into equities.

Mahesh Patil: As an economy, India has emerged much stronger during the Covid period. The reforms we had done pre-Covid, whether in the banking and financial services sector, or the GST sector, all prepared us for this period. I must give credit to our policymakers, both the RBI and the finance ministry. They wanted to stimulate the economy, but they did that in a measured way without creating any bubbles. We were digitally ready. For the mutual fund industry too, the move to online was very seamless. That led to an explosion in growth, especially in the number of new investors. As an economy, I would say because of the disruption that we saw during Covid, India is now emerging as a kind of superpower.

And as the China-plus one theme accelerates after Covid, it will benefit Indian companies, going forward. If we look at this whole period, we are much more surefooted and stable, even when next year we’re looking at the global economy going into a recession. India has a large talent pool of information technology professionals and they flourished in this period, because we saw a lot of companies moving to digital. Digital adoption in this period by many companies has been much faster. And that makes our country much more future-ready to go into the next transformation.

Has the demographic dividend led to the strength of your industry? Or, has it been a problem?

Patil: I would say we benefited. A lot of young people — millennials — are also now looking at equities, because they are more tech-savvy, right? And digital platforms have made it easier for them to invest. They might not be large investors, but they are coming early, which is good.

R Srinivasan: From a market perspective, two things are important — earnings and valuations. Earnings have been the best in Covid. Earnings from 2020 to 2022 have been way better than what we saw between 2014 and 2020. Valuations have also been much higher than what they were, due to the significant easing that we saw, not only in India but across the world. And I also presume valuations have gone higher, because we are seeing a savings glut, especially in the kind of investor population we see.

Now, this investor population has specifically benefited from Covid, people like you and me. Apart from the personal losses, from a monetary perspective, Covid has been beneficial. We got our salaries. Most of us got our increments, and our spending went down significantly. Our net savings jumped, plus the asset pool that we had provided a huge wealth effect. We are seeing that in the form of revenge shopping. I couldn’t imagine this, but it’s been phenomenal.

Rajeev Thakkar: Not just Covid, but even before that, whenever there has been any problem, the investor mindset has been buying the dip. And the central bank’s response has been to throw money at it — increase liquidity and cut interest rates. Whether it’s a medical problem, financial problem or technology problem, it’s been pumping in liquidity, which worked till 2022. Now we are facing the consequences. Earlier, it was something they could do without repercussions in terms of rising inflation. This time they don’t have that option. Now, they seem to be committed to providing real interest rates for savers, and not cutting interest rates at the slightest pretext.

Given that, the situation today is that you have a whole set of people who haven’t seen a sustained equity downturn. People on this panel are old enough to have seen 1992-2003, when indices were nowhere. But a lot of people may have seen only an upward-trending market. Maybe you have a six-month or one-year drawdown at the maximum. From that perspective, I fear that people are probably overheavy on equities. I probably don’t share Lakshmi’s optimism.

I hope she’s right. But I don’t think that people are here for the long haul. In a slightly longer tenure, people may lose faith in equity. People have been accustomed to central banks bailing out markets, but this may not happen in the future. That is one. Second, people have been accustomed to dips recovering very, very quickly. There has not been an extended period of a downward or a sideways market, which is something that concerns me.

Iyer: The tolerance is because in the last two-and-a-half years, retail investors have barely seen a negative return in equities. The Midas touch is playing into their minds. I echo the concerns. There is a high-ended optimism that retailers have pumped into the market. Going forward in the next 12 months, is it going to be a bumpy ride? The answer is probably yes. We need to be guarded. But, in general, it’s been our experience and observation that you give a slightly longer rope to the asset-class called equities, because equity is always shouting, ‘rishtey main hum tumhare baap lagte hain’. And fixed income is shouting to investors, ‘abhi naa jao chodkar, yeh dil abhi bhara nahin’.

Is there some weariness, which is getting reflected on the equity side?

Naren: For two to three years, there was no need for money in the debt market or deposit market. If you look at the data today, last year’s credit growth has been some Rs 19 trillion. And deposit growth was only about Rs 15 trillion, and the government may have needed something like Rs 5 trillion from the banking system for the government securities market. So, after a long time, there is a need for money in the deposit market. And you would have seen multiple rate hikes on the part of banks in the deposit market.

For a long time, banks were funds-flush and core liquidity in the economy was very high. That also has played a role, rather than anything negative on the equity side. I would say that a lot of system participants are saying, ‘give me money in deposits’. Even from a market point of view, we’ve been telling people to invest in debt mutual funds, because if you go back two years, overnight funds would have given you 3 per cent. Today they give you 6 per cent. So, debt is becoming a much more raw structural asset class at this point.

From 2008 to 2021, you had two printing presses in Washington and Brussels. Both printing presses have closed, and even the Tokyo printing press is threatening to close. If all the printing presses are closed, then you have to depend on local savings for local needs. Debt becomes a structural asset class and you finally have competition for equity. For 13 years there was no competition for equity because there were three printing presses. That is more the reason than anything that has happened in the equity market. It’s more the attractiveness of debt as a structural asset class. No one will now believe that the US Fed is going to start printing money.

Is there anything more at play which has clouded the perspective on equity a little?

Patil: Interest rates are going up. In the last few years, with low interest rates, everything moved into equities. Now, debt is an alternative you can look at because the risk-reward for debt is looking fairly well balanced. The other concern is that there is a lot of talk about how an increase in interest rates is going to impact the global economy. People are talking about US inflation, Europe being in recession, and whether it will be for some quarters or will it bounce back, and what impact it will have on corporate earnings growth.

We are getting into an uncertain period, and that is weighing on your mind. We have seen that markets have been in a corrective phase. That is the uncertain period we are getting into in the next calendar year, which investors are worried about. And the narrative about the slowdown is gaining momentum. We have seen some smart money moving out. But I think India’s structural story is very strong. So, wherever corrections happen because of these concerns, it will be a good opportunity to buy. One should also look at debt as a part of the allocation, if you are putting in money in the next one or two years.

Srinivasan: Let me start with a disclaimer. Fully 100 per cent of my money is in equity. Even incremental savings go there. Having said that, our house view is negative on equity. We are underweight on equity because valuations are too high. We run a fundamental model based on three pillars — earnings, valuations and sentiment. On the earnings side, the macro drivers are positive. Even on the micro level, earnings have been very buoyant and we expect the earnings growth to continue. This year we expect 12-13 per cent, but we started with 18 per cent. So, earnings are positive, but there are also downgrades.

Thakkar: In the last 20 years I have seen quality companies. They were quality companies then, and are even today. They were trading at 10-11 times their earnings. Today they are trading at 80-100 times earnings. I see a time correction if not a price correction, where prices go nowhere for a prolonged period in the so-called quality and non-quality bucket of stocks. At the same time, one is seeing value in certain pockets on an absolute and relative basis, compared with their history. Financials are coming with clean balance sheets and looking at credit growth.

Are there any exogenous factors which may change your view?

Thakkar: The exogenous factor is the whole issue of how overweight on equity people are. I think for a one- to three-year period people should not be in equity, which they will learn the hard way.

Is there anything to be changed on the regulation side?
 

Iyer: From a regulatory point of view, a lot of things are being worked on. There are a lot of best practices which other countries are trying to replicate.

Naren: We don’t have a vibrant debt market. We have managed to create a derivative and an equity market. We need to create a market which is easy in debt as well.