Upper Crest — THE PRIVATE WEALTH ROUNDTABLE

A belligerent Vladimir Putin, a decisive Brexit referendum, a virulent US presidential election run-up, volatile India-Pak relations…2016 could arguably go down as a year where geo-political tension was at its peak. Not surprising that global and EM equities rose and ebbed as political drama played out in just about every developed and emerging market. Back home, with the passing of GST and other incremental positives, the benchmark Sensex has delivered a 10% return in FY17 till-date. The long awaited correction in realty prices has slowly started manifesting itself in select urban pockets. While gold has been off the radar, alternatives such as start-ups and venture capital are finding favour with HNIs. But as we approach 2017, there are more questions than answers on just about every asset class. Against such a backdrop, Outlook Business got together the country’s premier wealth advisors to gauge which way the wind will blow

Outlook Business: Last year, the view in the room was optimism laced with a dash of caution. As it turns out, the environment today is far better than last year. Interest rates have come off, the economy is showing signs of revival, inflation is cooling down and we also had a good monsoon. So, are there any factors that can offset this recovery and have an impact across asset classes?

Sandeep Das: For the past three consecutive years, we have had high interest rates, poor monsoon, weak economic activity… all of which played out in a sequence. Today, we are looking at the reverse — better monsoon, easing interest rates. We expect another 25 basis points cut in December or in early 2017 and increased consumption led by the 7^th Pay Commission. So, we are overweight equities and expect it to yield a good return in the coming year.

Outlook Business: Himanshu, is that your view as well and is there a specific trigger for equities to outperform, because usually you need one big push factor...

Himanshu Bhagat: We are bullish on equities as well. But, there is also a disconnect between the current market valuation vis-à-vis corporate earnings. Hence, any kind of a shock can trigger more volatility. I don’t think there is any one thing that will change the outlook, unless there is a dramatic change in the crude price as we have been a big beneficiary of the same. Apart from that, I don’t see any other event that can derail the momentum.

Rajesh Saluja: The one factor, probably, will be improved earnings which will play out from the third quarter. The transmission of lower interest rates and the impact of GST on branded consumer goods will also act as a kicker. In fact, compared with most other emerging markets, which have gained anywhere between 10% and 30%, we have hardly moved 7-8%. Even our P/E premium, within the MSCI global index, at one point, was the highest at 40-50%. Today, it is just 15-16%. So, optically we may look expensive, but there are very good opportunities both within the index and outside of it. So, our view is to stay invested in quality businesses where earnings growth is strong and these typically will be pharma, FMCG and the likes.

Sharad Mohan: We, too, are overweight equities. If you look around, all the variables which are internal to India are playing out really well. Our view is that financials, energy, and pharma will benefit the most, while IT and commodities will struggle. The big risks are external to India and have a lot to do with what happens in Europe, the Brexit fallout and the US elections. But given India’s underlying growth story, the impact of all these events will be transient.

Outlook Business: Atin, what’s your view on valuations?

Atinkumar Saha: As far as valuations are concerned, we believe it’s no longer cheap. We normally look at equities from an asset allocation perspective and that could vary based on the risk profile of our clients. From that perspective, we are neutral on equity with a positive bias in 2017. If you look at equity MFs from a long-term view, there is no reason why one needs to be skeptical. Returns for large and small-cap funds over a five-to-10-year period have ranged anywhere between 15% and 25%. In the near term, though, we are keeping an eye on corporate earnings, which continues to be sluggish. While the coming quarter will be marginally better than the previous, there is no reason to believe that the numbers will be great. We expect a better performance somewhere in the second half of 2017 with GST getting implemented and rural consumption playing out. The other area of concern is around private investment, which is yet to pick up. Government spending cannot make up for a weak private investment cycle.

Outlook Business: Where do you see the risk to earnings?

Saha: Right now we are only seeing demand in staples and discretionary, but nowhere else are we seeing increasing demand. Capacity utilisation is hovering around 70% and that number needs to get better. Utilisation levels have to be at 80-85% for India Inc to think of fresh capacity creation. So, we will continue to look at an overall muted earnings growth till such time that the investment cycle picks up and leads to fresh creation of assets.

Outlook Business: Rajesh, you spoke about earnings being the primary factor that will drive the market. Where does your bullishness stem from?

Saluja: Clearly, the private investment cycle is a good 18-20 months away, but I think the biggest investment is happening through the VIDS (Voluntary Income Disclosure Scheme) route. Look at it this way, the scheme is going to fetch the government a good Rs.40,000 crore, which is a big boon. Also, not many have noticed and factored in their estimates, the subsidy and crop insurance by the government. $25 billion worth of crop has got insured and that means the government is trying to bring stability to rural income, which was always dependent on monsoon. By taking out that variable, the farmer, who was till now worried about the next monsoon and the need to save for a rainy day, will now have money to spend. Besides, the 7^th Pay Commission, too, will come into play and have a spill-over effect.

Outlook Business: But won’t it take time to play out...

Saha: ...there is another bottleneck which we need to be aware of and that is the inability of the banking industry to leverage on the macros. With NPAs of Rs.800,000 crore, a chunk of bank credit is still stuck in cyclical companies. So, the private investment cycle taking off will also hinge on the easy availability of finance. But we are looking at some bit of a succour which was evident in Urjit Patel’s statement on bad loans. In that sense, banks and leveraged companies will have a little more space to re-engineer and make a fresh start.

Outlook Business: The non-transmission of lower rates is by design, as banks want better NIMs to cover the NPA pain. So, are we being presumptuous that because the RBI will be growth-driven, banks will also follow?

Atul Singh: Well, in terms of interest rate transmission, will corporates borrow because funds are available at 7% and invest it in building productive capacity? The answer is no. I think there’s far too much capacity in the system and, from a private sector perspective, merely reducing the interest rate will not kick-start the investment cycle anyway.

However, though the investment cycle has not recovered, the government is trying to keep the momentum going through defence, railways and infrastructure. The consumption story continues, thanks to the 7^th Pay Commission, besides interest rates are already on the mend. We can always argue how much of it is getting transmitted or not.

While the impact of monsoon on consumption might play out with a lot more certainty, the impact of reforms on the economy is, at best, going to be patchy. For example, the short-term pain of implementing GST itself will be massive. Assuming that it gets implemented on April 1^st 2017, there will be massive de-stocking, inventory reduction by companies, which will actually take the steam off revenue growth.

Outlook Business: Is the market glossing over the challenges of implementing GST and the impact on the consumer?

Saluja: No. We don’t have all the answers right now. A lot of work is going on to see who is going to benefit and who is not. Maybe the branded MNCs will benefit the most, logistics costs could come down, and so forth. So, how it all transmits down to the bottom-line is something we will know once GST is implemented. But, for now, the intent of the government to push things through is what has created optimism in the market.

Saha: I think India is never going to see any policy that gets implemented in toto. So, a lot of dilution will happen before the final contours emerge. So, the moot point is that the customer is yet to comprehend how GST is going to change his life. But I think the impact wouldn’t be as harsh as one imagines, because there are always ways to mitigate the higher rates so that it won’t become a burden on consumers. I am hugely positive on GST implementation.

Das: I want to comment on the transmission of interest rates. Let’s look at it this way: a banker has Rs.100, he has to put Rs.4 in CRR, Rs.21 in SLR, and Rs.10 in regulatory capital cost. The balance is Rs.65. Of the Rs.65, 40% is reserved for priority sector lending. That means the banker now has Rs.39 left to lend. Now, how do you price that? So, transmission will take time but it will happen for sure.

Saluja: There is a market outside of banks such as CPs, etc. There is enough money available for anyone who has a good business. Even existing corporates can raise money through CPs and bring their overall costs down.

Mohan: At current rates, AA rated bonds can raise money with a 200 basis points premium. So, there is money that corporates can raise and banks are not necessarily the only option.

Outlook Business: It’s not the availability of capital, but to assume an earnings trajectory of 15% without bank credit really flowing, seems a bit incredulous 

Singh: True. Credit growth is not going to pick up just by reducing rates. Unless there is demand, there won’t be a pickup in credit. Look at the consumer side; one can see reasonable credit demand with most of the bank’s loan-book growth coming through consumer loans and mortgage loans. In this case, one can clearly see that the transmission has occurred. Mortgage rates have come down from 11% to 9-9.35%. But on the corporate side, we have a demand constraint and without that, credit growth is a very different picture.

Outlook Business: What’s your take on financial sector stocks, Rajesh? 

Saluja: Within financials, PSU banks are facing far too many challenges. For now, lower interest rates, reclassification of loans, allowing them to restructure some of those bad assets will provide a breather. There will be some sort of a consolidation.

Outlook Business: So, for now, is it a sector to ignore?  

Saluja: At least for the next couple of years.

Outlook Business: Anybody here who has a contrarian stance on stressed banks?

Singh: Even if we assume the NPA story is going to get better from here, from a fundamental standpoint, PSU banks lack the structural pro-activeness needed to compete effectively in the market place. In the last 18 months or so they have actually ceded market share to private sector banks. While banks are a clear proxy for the economy and you cannot really ignore them if you are optimistic about economic growth, most public sector banks are a different story, not because of NPA issues, but owing to their inability to compete.

Bhagat: We also have to look at why these banks got into trouble. There are many factors which includes bad governance. Having said that, there are some very decent assets which can be taken off from the system. But whether the government is keen to do that or not, we don’t know.

Saluja: But you are seeing a lot of ARC activity because they see it as an opportunity.

Outlook Business: Do you see ARC as an opportunity?

Saluja: No, we don’t but funds with a 10 to 20 years kind of horizon may still see value. But from an investment point of view, it’s always about choices and today there are better choices. For the last 10 years, banks were forced to go and improve penetration in the rural segment. But since most of them were stressed, they didn’t want to spend capital. That was an opportunity which the NBFCs have capitalised upon.

Saha: NBFCs have managed to fill the gap in an operationally feasible manner. So, unlike banks which have restrictions, it becomes easier on the NBFC platform to execute a lot of things at a low cost. So, there is an alternative platform which is doing that at a lower cost and the need is to expand that by investing in technology. Look at Bandhan, they have managed to transform into a growth bank.

Outlook Business: Besides private banks and NBFCs, in which other pockets do you see value?

Bhagat: Pharma offers a good buying opportunity. We also like auto and ancillary stocks.

Singh: All consumer-related sectors whether it is staples or consumer discretionary. We also find value in IT and pharma as these are globally competitive businesses, though there is a little bit of a re-thinking on IT. In the past when IT was written-off saying that labour arbitrage was dead, these companies found their way back. So, we are advising clients to buy good IT services companies.

Das: There are quality stocks in the IT basket, but you have issues around Brexit, you have order cancellations, you have visa fee going up. So, in the next one year IT companies will have to reconfigure themselves.

Saha: We are very bearish on IT as global financial services are not doing well. IT budgets have been slashed, translating into weaker demand. Second, the sector is witnessing pressure on margins. It hasn’t showed up much due to the rupee depreciation. Also, in our estimate, we don’t think large companies, including TCS and Infosys, are up to speed in reengineering or adding value to command a premium.

Mohan: Our view is that evolution to cloud technology from domestic IT companies has been minimal and that’s where overseas companies have taken a leap. So, our house view is that one needs to wait as far as the IT sector is concerned.

Outlook Business: So, how are you positioning your clients?

Mohan: I think we are at a very interesting place where both equity and fixed income are looking good. Within fixed income, one can still get decently attractive yields. So, our ideal allocation is half equity and half debt and for sophisticated clients, we are suggesting a 10% play on real estate, PMS and private equity.

Outlook Business: With most of the rate cut behind us, is there more juice left in fixed income?

Singh: The 10-year yield has come down, but the RBI, in its latest policy, has shifted away from inflation to growth. So we think there is more to come in terms of rate cuts. You could have 25 basis points this year and another 25 basis points in the first quarter of next year. So, the market will shift from playing on duration to accruals. Because accruals will continue to be a critical part of fixed income allocation. Now, within accruals, spreads of AAA papers have collapsed quite significantly and are now below the long-term average. But AA and AA+ papers still have reasonable spreads left. So, I think the action will shift there.

The other thing to watch out is that the difference between Indian 10-year and US 10-year is about 550-560 basis points, which still is about 70 basis points higher than the long term average. So, on a relative basis, Indian yields are still far more attractive to global investors on an exchange depreciation-expected basis. So, money will keep flowing in, and there will be downward pressure on the 10-year yield as well. In that sense, there is no reason to move away from fixed income.

Bhagat: We could be even more granular in terms of AA or AAA papers of housing finance companies or NBFCs. So there is definitely some juice left.

Outlook Business: Sandeep, are you asking clients to increase their fixed income allocation?

Das: Yes, we are recommending fixed income as there is room to play both duration and accrual gains. We have already seen in September how foreign investors bought Rs.10,000 crore worth of bonds.

Saluja: A large part of duration is over, now people are chasing yields. The appetite for yield even among MFs and pension funds, too, has increased, especially in the 3-to 5-year duration basket. We, too, are suggesting the same basket as there is still some action left.

Outlook Business: Moving onto real estate, Atin, you had mentioned last year that clients were reducing real estate and investing in equities. Is that continuing?

Saha: Yes, clients are moving away from real estate and getting into financial assets. Equities have been a big option. The only difference this time around is they are finding it tough to monetise real estate. Our advisory has been restricted to select real estate funds. But even there, the client experience has been very bad (low single digit return) and thus, clients are not positively inclined towards these funds.

Outlook Business: Rajesh, you had mentioned last year that a lot of developers were in the general ward. Have any of them landed in the ICU?

Saluja: Real estate is not dead. Even today there is very good opportunity in the space. With the real estate bill being passed, developers are a little scared about not completing projects on time, as that could result in customer litigation. Also, with black money having gone out of the window, the sector is going through a churn.

Outlook Business: Where do you still see opportunity? 

Saluja: In mid-income housing, there is a supply-demand mismatch. Homes in Vikhroli, Chembur and adjoining areas in Mumbai are going at Rs.20,000 to Rs.25,000 per sq ft. Today, Rs.20,000 in Mumbai has become mid-income housing. Within residential there is mid-income, there is group housing and luxury. Then you have land where cash flow has slowed down. At the higher-end, residential investments have slowed down because until a whole new wealth cycle gets created in the private sector, that segment is not coming back.

Commercial had slowed down in many areas but now you are seeing a pickup because of the yield, as the assumption is that fixed income over the next three-four years will fetch lower return. So, people are open to buying a property where you are getting 8% yield. In Hyderabad, there is a waitlist for commercial properties of 6,000 sq ft and above, because no supply had come to the market.

Another sweet spot is developers who have approvals but can’t continue construction, as they are not able to generate cash. Existing buyers are not willing to pay because it is construction-linked. Now the developer has to service monthly debt, so how does he pay? That’s where the funds are stepping in. So, both on the equity and debt side there are opportunities available. It is a matter of how much risk you are willing to take, your developer-selection criteria, the location and so on.

Outlook Business: Is the skew towards buyers or investors?

Saluja: They are actual buyers. Investors have gone out of the window. That’s why luxury is stagnant and also because of the fact that a lot of cash went out, it has stagnated investor demand. We feel over the next 12 to 18 months there will be good pickup; mid-income will see traction across the country. Mumbai, Pune and Bangalore are the three markets where there is going to be an impact. NCR, Chennai or even Kolkata, hardly any sales are happening there. But in Hyderabad, demand has picked up again as the political situation has sort of eased out.

Outlook Business: Given that funding is a non-issue, where do you see the price trend over the next 3 to 5 years?

Saluja: Funding is increasing, PE funds are coming in and domestic money is being raised. In fact, money is now chasing good developers. You will see REITs coming in. You will see a big market there where investors can buy and owners can monetise their assets. On the residential side, the whole game is going to change. We are already seeing Chinese investment in real estate in Delhi and Haryana.

Singh: Whichever markets were investor-led have turned sluggish because a large part of this money has been pulled out. Good developers continue to have access to funds because a lot of private equity funds, global and local have entered the fray. Good developers will get access to funds and they will be able to deliver.

Saluja: At some point, pent-up demand of the past 4-5 years could cover up locations where there hasn’t been much supply. I am not talking about Dwarka, Gurgaon and Noida where there is clearly a lot of supply and it will take some time for it to get sorted out.

Saha: Commercial is actually doing better. Even in the suburbs of Mumbai, Navi Mumbai and beyond like Airoli.

Outlook Business: Sharad, what are you advising your clients?

Mohan: Compared to what it was a couple of years back, the situation is less stressful. Inventory, which used to be 60-month plus, is now under 40 months. With launches on the mend, we are slowly seeing demand-supply equilibrium. Real estate funds have given 8-12%. In an absolute sense they may not be good, but given the state of the asset class, they are not bad either.

Singh: Investor preference has shifted from pure real estate private equity funds into real estate debt. So, you lend to these developers at 18-20% and have regular cash coming in as well. You don’t have to lock-in for 6-8 years. It is being looked at as a high-yield debt opportunity more than a real estate play.

Bhagat: Of late, structured debt in real estate is in vogue.

Outlook Business: What is the downside risk?

Singh: It all depends on the developer’s ability to pay. But the debt structure assures that you are at least getting some cash back. The risk is of default, there is no question about that. But rather than opting for a single NCD, which a lot of clients were previously opting for, a structured pool gives you diversification. Of course, any high-yield investment has its own risks, so you need to control your exposure and pick the right manager.

Das: We do not offer advice on real estate. But as a bank, we are seeing a clear movement away from physical to financial assets. I think the way forward is again to take exposure through a financial product which is time-tested.

Outlook Business: Rajesh, what markets and segments would you bet on?

Saluja: Hyderabad is a good opportunity, but our focus would be Mumbai, Pune and Bangalore. These are three markets where one can find self-liquidating residential mid-income properties. As far as segments are concerned, commercial is also good. But we would still advice our clients to wait for REITs, because that is going to be a game-changer. Investing at 8-9% yield with capital appreciation will be fantastic. I think by mid or end-17 we will have our first REIT.

Outlook Business: Coming back to equities, what’s everyone expecting in 2017?

Das: I see returns between 12% and 15%.

Bhagat: Similar, 12-15% post-tax.

Saluja: Last year, I said 15-20% and we delivered more than 20%. Because as a private wealth advisor I am not looking at the index, I still believe 15-18% is bare minimum. I am biased towards large-cap because of all the risks that continue to exist. Though unlikely, but even if the US were to hike rates or something in China goes wrong, the impact of the subsequent knee-jerk reaction will be severe on mid- and small-caps. So, my advice would be to remain largely focused on large-caps with good businesses.

Singh: The market is fairly priced. So my view is 15% return similar to what the earnings expectations are. Because, there is no other way of predicting where the market is headed.

Mohan: We expect earnings growth of 12-15%. One can look at market corrections as opportunities to rebalance the portfolio.

Saha: Our bias is towards large-cap and we are focusing on sectors such as consumer discretionary, staples and cement and we believe that over the next one year they will fetch the best return.

Outlook Business: Finally, Clinton or Trump and the impact on the market?

Das: I think it’s not just about Hillary versus Trump as there are different dynamics at play for each of the three legislative bodies, that is, the Presidency, the Senate and the House.

Bhagat: Doesn’t matter who wins.

Saluja: If Trump wins, it will be a short-term negative and, in my opinion, that would be a good buying opportunity because as Sandeep mentioned there are too many dynamics at play. So, even for Trump to carry out his agenda he needs the support of Congress and that is not going to be easy. Though he is perceived to be more business-oriented than Hillary, if he does get elected, it will be a different story.

Singh: Best case is Hillary. If she wins, it is more of a status quo. If Trump wins, the initial impact would be the emerging markets rally fizzling out.

Mohan: Trump winning is a low-probability event but you never know. But like I said in the beginning, the impact on equities will be transient.

Saluja: For all the hype around American imperialism, Trump cannot ignore the fact that corporate America today is far more closely integrated with the world than it was ever before.

Outlook Business: On that note, we conclude our 5^th private wealth roundtable. Thank you very much, and wishing all of you a great year ahead.