|  Mr.
Prashant Jain, Chief Investment Officer (CIO), joined HDFC Mutual Fund
consequent to the acquisition of Zurich India Mutual Fund in 2003. Earlier, he
was the CIO at Zurich India Mutual Fund. He has a Masters degree in Business
Management from IIM, Bangalore. He has also obtained a Bachelors degree in
Mechanical Engineering from IIT, Kanpur and done his CFA from AIMR, USA.
In an exclusive interview with Personalfn, Mr. Jain gave his
views on interest rates, equity markets and the investment philosophy at HDFC
Mutual Fund. The interview was conducted on August 30, 2007. Pfn: How do you
see the ‘India Story’ unfolding? Are there any disappointments in terms of
expectations that you had? Mr. Jain: In my opinion, the growth rate of the Indian
economy will continue to remain high. It may actually accelerate. This view has
been consistent for over 10 years and the reasons are well known - demographics,
rising incomes, the easy availability of consumer loans, low penetration of
consumer goods, breakup of joint family system and increasing urbanization,
rising reach and impact of media and changing lifestyles etc. What is additional
this time is capital spending; and we are seeing a huge capex cycle, both on
infrastructure and on the manufacturing side.
If you look at any ultra major power project, it will cost
almost 4 billion US dollars, which is roughly 0.5% of our GDP. Even if the main
equipment is imported, still there will be a meaningful impact on the GDP. A
number of ultra mega projects are coming. Airports have been privatised, and
likely investment in this sector will be substantial. If you look at steel,
planned capacity addition is between 20-30 MT (metric tonnes) over next 5-7
years. This will cost US$ 20-30 bn. This is 2%-3% of GDP over this time frame.
Apart from these, large investments are taking place in ports, metro projects,
railway projects, manufacturing sector etc.
I think serious capital inflows into India have just begun.
This is because, over the last 2 to 3 years, the India and China story has
become common knowledge. Foreign investors have understood the opportunities, so
these countries should continue to attract more capital inflows.
Thus, GDP growth should continue to be high and actually
accelerate. Of course, there can always be a quarter or a half percent
fluctuation, depending on how demand for housing behaves which has become rather
unaffordable right now or how agricultural behaves depending on monsoon.
But profit growth rates will slow down. In last few years, we
have seen profit growing at 25% to 30% a year, which is not sustainable. You
can’t expect cyclical sectors like cement and steel to keep on growing at 30%
CAGR. Also, appreciating currency will impact some sectors. Interest and
depreciation will begin to rise in capital-intensive sectors. And finally there
are cost pressures like - real estate, manpower costs, material costs; lastly
there are no easy and significant cost savings. Overall, I think profits should
grow between 15%-20% a year over the next 2-3 years. Some sectors will grow
faster, and some slower. In any case, 15% is the sustainable rate of growth,
given nearly 10% real growth in manufacturing and services and around 5%
inflation.
Pfn: What in
your view will be the biggest challenges for the Indian economy over the next
say 5–10 years? Mr. Jain: At present, economy appears to be in a sweet
spot. There is nothing much you can do about the demographics or about
urbanisation. These are trends which will continue to progress. Unless the
policy framework deteriorates significantly, growth rates should by and large
sustain. Of course, if policy framework is right, growth rates can further
accelerate. One concern is asset inflation i.e., real estate prices. When real
estate becomes very expensive, it can adversely impact consumption. Housing is a
top priority. If lot of money goes towards houses, then people will postpone
other purchases like cars etc. Real estate purchase reduces disposable income
from lots of families for long periods of time. So high real estate prices are a
concern. High realty prices also increase prospects of NPA’s (non performing
assets) for banks etc, and increase the cost structure of manufacturing and
services alike.
Coalition governments have so far not significantly impacted
growth. But if there is a serious disagreement and parties are not able to work
together, it is not good for economic growth. Though economy will not stop
growing but it can cause some kind of a slow down. I think infrastructure
problems are getting addressed. By and large if you see, telecom, road and
airports have made progress; power is making serious progress. Unlike the West,
we are not a leveraged economy, the households and companies are not leveraged,
therefore cyclicality in demand is low and that is a key strength.
One potential risk could be global inflation and interest
rates. Though presently interest rate concerns have eased, inflation and
therefore interest rates could be an issue in future. Food grains, commodities,
and even Chinese export prices are now rising. Should inflation and therefore
interest rates go higher, it may temporarily impact capital flows, and which in
turn may impact growth adversely. But even then, clearly, India should fare much
better than rest of world.
Pfn: What kind
of returns do you see the stock markets represented by the BSE Sensex delivering
from a short-term (1 year) and long-term (3-5 years) perspective? Mr. Jain: The recent rally once again highlighted the
fundamental truth of equities – they are unpredictable in short to medium run,
and therefore 1-Yr prospects are hard to forecast.
Though the recent high inflows have probably been a result of
some India/China funds raised, on a broader scale, I think what is happening is
that foreigners are taking a long-term view of investments here on one hand and
lowering there cost of capital for Indian investments compared to past. India
and China are now witnessing a shift in global asset allocation in their favour.
This is driven by a powerful combination of large size and high &
sustainable growth rates of these economies. Appreciating currencies and a
confused US economy outlook has made this trend stronger.
The above may result in higher P/E multiples for Indian markets
over medium-term. This is because P/E multiples of India are still reasonable,
considering the growth rates here, and more so in relation to the low interest
rates prevailing outside India. Whereas this had to happen one day, so far one
used to think that this would happen when the local interest rates align with
global rates. But the sequence now appears to be changing – the multiples may
change first and local interest rates may follow. Given the relatively small
size of our capital markets compared to global flows, foreign capital can
virtually force higher multiples upon local investors.
This creates a dilemma for the local investors to which there
are no obvious answers. The dilemma is, whether to benchmark fair P/E to Indian
interest rates today or to the way foreigners will price Indian equities (or to
future interest rates). There are no clear answers. On the balance however, in
my opinion, for someone with moderate tolerance for volatility and with a
genuine 3-5 year view, the answer is clear. Patience and inactivity in Indian
equities should be well rewarded in future as well as it has been in the past,
though clearly the reward will be a lot less generous.
To sum it up, it is advisable to remain invested while being
tolerant to 10%-15% volatility, as over a 3-5 year time frame in addition to
growth, P/E’s can go higher if our interest rates align with global rates, which
is a reasonable expectation as well. The timing of the returns as always is
uncertain.
It however needs to be emphasized, that interest rates locally
may not fall significantly in the short to medium run because of the huge capex
cycle that is underway e.g., so far none of the large steel projects have
borrowed. But if they start borrowing, then it will put pressure on interest
rates, particularly when you want to restrict the inflows from outside to
prevent currency from appreciating.
Pfn: How easy or
difficult is it to beat the BSE Sensex going forward? Mr. Jain: In our case, different funds have different
indices. The market tends to look at the best performing index at a point of
time. So when mid-cap index was doing well, people were looking at broader
indices; and now when Sensex is doing well, they start looking at Sensex, which
is not fair. In my view, Sensex is a concentrated top-heavy index, so I don’t
think that it is a preferred index. But if you are saying how easy it is to beat
broader benchmark indices, then, it is tougher than it was 2, 3 or 4 years back.
Still I am hopeful of beating the index over medium to long-term, though the
margin should be moderate compared to the past. Why it has become difficult
obviously is because, in the market, there are more players, more people are
searching for stocks. Further, in a bull market, particularly with large doses
of foreign capital, which has at times a different way of looking at things and
is sometimes not very well informed, excesses are bound to be created which can
result in underperformance over short to medium-term. |