Interview with HDFC Mutual Fund - Part 1
Oct 12, 2007

Author: PersonalFN Content & Research Team


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.

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