David Pezarkar, head of equities at Daiwa AMC tells Puneet Wadhwa about investments in developing markets, US quantitative easing and the macroeconomic developments in India. Edited excerpts:
What is the outlook for global equities as an asset class against the backdrop of developments in the euro zone and the US?
The outlook for global equities in the immediate short term is uncertain due to two major reasons. First, in the developed world, investors fear that sovereign debt crisis in Europe could snowball into a credit market event and engulf financial institutions in those nations.
Secondly, the recovery from the last recession is tapering off, and future growth prospects have been toned down as well. In the developing economies, inflationary pressures continue to result in tight monetary policies, and the resultant fear that these policies will lead to a sharp slowdown in growth.
Notwithstanding this, companies across the world have strong balance sheets, and we are seeing renewed M&A activity. Besides this, companies in the developed world that have a significant proportion of their revenues coming from emerging economies have been showing good growth in their profits, and this trend is likely to continue.
Large investors would also look to allocate a higher proportion of their assets to developing markets, given the situation in the developed economies. Such uncertain times create sustainable medium-term wealth creating investment opportunities, and investors should take advantage of such volatility as equities are currently priced quite reasonably compared to their long-term earnings potential.
Do you expect a third round of quantitative easing in the US? What will be its impact on the equity and commodity markets?
The second round of quantitative easing has not had the desired results, as the monetary base in the US has not expanded sufficiently enough to boost the credit markets there. The earlier rounds actually harmed US economic growth by fuelling a rise in crude oil prices and other commodities.
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The housing market in the US is the economy’s major weak link, and direct policies to tackle that market may yield much better results. We therefore do not think that the US Federal Reserve would look at a third round of quantitative easing.
However, in the event a third round does occur, we would expect an initial sentimental positive reaction in the commodities markets. As investors will realise that global growth is likely to be slower than previously estimated, the medium-term impact on commodity markets will be limited.
Equity markets across the world will react differently, as the commodity oriented ones would outperform if commodity prices rise, while those in the user economies will have a tempered reaction, as fears regarding inflationary pressures would re-emerge. Over the medium-term, however, equity markets will move in line with earnings growth, and markets with the most sustainable growth momentum will attract larger flows.
How are the foreign institutional investors (FIIs) viewing the macro-economic developments in India? What are their key concerns with regards to the Indian equity markets?
FII participation in most emerging markets has been muted this year, and India is no exception. This is because investors fear that harsh monetary policy actions undertaken to tackle inflation will result in growth being severely affected.
Recent economic data does suggest some softening as far as auto sales and cement dispatches are concerned. The FIIs would be looking for signals which indicate that inflationary pressures are being decisively addressed, and progress is being made on the reforms front, before investing substantial amounts into Indian equities.
Are you completely invested in the markets at current levels? Can you broadly outline your investment strategy for the next few quarters?
We have sufficient cash to meet redemption requirements, and take advantage of any attractive opportunities, if they arise. We are positive on the prospects for the equity markets over the medium-term.
Our investment strategy would be to position our portfolios towards companies with the most sustainable earnings stream, under adverse conditions. We would not skew our portfolio allocations towards the traditional defensive sectors at this point in time, as we feel that particular theme has played itself out over the past two years.
We would want to maintain a well diversified portfolio given the current situation, but within sectors, position ourselves in stocks with the most resilient earnings profile, and having sufficient cash generation capabilities to fund their next phase of growth.
How does India compare in terms of valuations with other emerging markets (EMs)?
Indian equity valuations are higher compared to other emerging markets, but this comprises a number of sectors like public sector banks, construction, metals, oil and gas, which trade at discounts, auto, cement, chemicals, industrial capital goods, which trade at par. Private banks, FMCG, media, pharma and software, which trade at a substantial premium. The sectors trading at a premium have valid reasons for their current valuations, and their ROE profiles do not seem to be structurally challenged.
While India’s ROE profile has certainly declined, this is partly due to increased capital expenditures to carry out capacity expansions, which are yet to be fully operational, higher interest costs, and increased competitive intensity. The first two factors are cyclical, while the latter is structural.