Foreign investors have not given up on the long-term India story. They are still looking for bottom-up ideas because this is still a country with a very good entrepreneurial talent, a low hanging fruit for smart people to grab and make money, Ridham Desai, MD, Morgan Stanley India, tells ET Now.
Edited excerpts:
What should a long term investor do?
We have all gotten very comfortable with this low volatility and withstanding what is happening in the midcap, as you rightly pointed out, the Sensex is sitting there, it does 100 points here and there, it is not doing big jigs.
It is possible that in the next 12 months, it may actually move around a bit and we can isolate the factors which may cause it to but it could do a little bit more than what it has done in the last three years, more in line with history rather than what has happened in the last three years.
Long term investors, should always buy equities and we are coming out of a period where equities have been a terrible asset class for a 10-year investor. The trailing 10-year return on the Sensex has been 5% compounded annual. You have underperformed fixed deposits! If you are not a taxpayer, oh my God it has been a terrible moment to be invested in the largecap index! If you bought and the reason is because 10 years ago we were at the start of a really punitive bear market, that timing, that base has mattered. You would have bought it in the middle of 2008 and the Sensex post that went down 50%.
Exactly eight nine months later, the 10-year CAGR returns are going to improve sharply because by March of 2009, the Sensex had got cleaned out. But yes, long term investors have not really had a good run. I measure this by what equity risk premium they realise, which is the difference between equity returns and bond returns and those are negative.
So, these are unique moments, the last time it was negative was in 2002 and in hindsight it proved to be a superb moment to buy equities with a five, seven-year view. The subsequent 12 months were still very painful. So you could still have a lot of pain in the next 12 months or you may not be getting returns. I do not expect much pain but I do not expect much returns either. Maybe after that, you could get better returns from equities.
You have been making this point that Indias earnings versus GDP that good old comparison, we are at a multiyear low. We have to normalise and for that we have to grow higher than what we have done historically. Where do you think this earnings push will come from because there is a limitation in this market in terms of an earnings recovery. Some companies do not have capital, some companies do not have demand issues, some do not have pricing power. The case of such a strong earnings recovery has to be led by three or four large groups, which could be those large groups which are at an inflection point?
One is the corporate banks. I would say we have already ended the cycle of bad loans. Recognition has not been completed which I think will get over in the next couple of quarters or so. And therefore, the turnaround in the corporate banks in terms of earnings will be pretty sharp. Resolutions will take place so and that would be a pretty sharp turn.
The consumer sector will do pretty well in the next five years. We are at the inflection point in terms of consumption. I was mentioning this earlier that Indias per capita income is $1700. We are opining this is going up about 10-12% every year for the next few years. Out of this $1,700, the average Indian today spends more than half of it on food but there is only that much food that they will consume. So food will cap out at say $100. Non-food expenditure will grow very rapidly.
More people will go to schools and colleges, more people will resort to leisure, tourism, entertainment and other stuff which we take for granted. But a large population in this country does not have the ability to spend on that stuff. They are now joining the consumption basket and it applies to even basic clothing.
So, everything beyond food is up for the grabs. So, those sectors will do very well. Private sector banks will continue to do their 15-20% growth because they are grabbing share from the SOEs. The ones that will struggle likely are the SOEs. We should see a big recovery in industrial earnings because private capex is coming back.
You have changed your weightage also…
We have added chunky weight to industrials by downgrading technology. We were bullish on technology…
That was a great call. It was a painful call for better part of 2017 but look at how it has come back.
I do not know if it worked out or not, but it worked out because we were focussed on valuations. Now, the valuations are more full and there is more juice in buying industrials. There will be better earnings there and a slew of industrial stocks look quite attractive. Industrials will generate a lot of earnings. Commodities should be fine, so steel, cement I think will do well. One, because the economy will pick up and two, because we are not expecting any major upheaval in global steel prices.
So, commodities should be doing fine. So, if you see most of the sub classifications that you get everywhere, there is a bit of lift to earnings with the possible exception over the medium term for SOE banks. But over the short run, even SOE banks will show a lift because they will participate in the turnaround in the corporate banks due to the end of the NPL cycle.
What is the India pitch right now because we are staring at elections next year?, All these investors who are coming down here today and over the course of the next two days, talking about India opportunities, what are you selling to them?
Foreign investors are generally disillusioned. They have lost faith because of recurring disappointments on earnings which has not been the case with other competing markets. India competes with other emerging markets like China, Brazil, Russia, they have all shown better growth than India in the last two, three years. They have participated in the global upcycle because the global economy has been on a rise, India has not.
A lot of these investors are disappointed and they have pulled out capital. If if you look at foreign weightages on the average EM portfolio, while they are still overweight, the overweight position is at seven-year lows. It is back to 2011 levels.
However, foreign investors have not given up on the long-term story. India still attracts them from a long-term perspective but the most compelling reason for them to be here at the summit is to look for bottom-up ideas because this is still a country with a very good entrepreneurial talent, a low hanging fruit for smart people to grab and make money.
Are they concerned about corporate governance issues, the quality of companies and managements in India compared to the rest of Asia?
Yes, that is the new de jure. I do not think it is a general concern but everybody is hyper aware that they need to look through financial statements and make judgement. That abandon only happens in raging bull markets, we are nowhere close to that. By the time we get into a raging bull market, then everything is par for the course and nobody cares about corporate governance.
But there is general awareness about governance and in fact that is rising actually because of the greater capital that is going into the ESG pool. So, there is more focus on social, on environment and on government issues and a lot of investors end up asking these questions to their companies.
Companies are also demanding this from their suppliers and customers are in turn demanding it from their companies. Everybody seemingly wants to be more conscious. We have only hit the tip of the iceberg, Morgan Stanley does have a lot of global research on ESG and this will grow geometrically in the next few years. You will find this increasingly part of your debate. So, governance is only one angle of the ESG framework.
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