Outlook Business: The consensus this year again seems to be that equity is the place to be in. There is near unanimity about the market taking all negative news flow in its stride.
Yatin Shah: I read recently that even if the Fed hiked by 25 basis points(bps), the monetary easing in China and the Eurozone will offset its impact. So, you will not see monetary tightening on a scale that will trigger redemption pressure in emerging markets. The second thing everybody is trying to understand is the fallout of the currency devaluation by China, which led everybody else to devalue their own, which, I think, is counterintuitive.
Again, detailed research shows that the reason for devaluing currency is to remain competitive in the export market. But the moment everybody starts doing that, global trade actually falls, because your purchasing power to import, too, goes down. So, that part is fluid and dynamic and it is anybody’s guess how things will pan out. From an India perspective, I think we are in for a good double-digit return in equities for the next two years.
Atinkumar Saha:I think one of the immediate risks is clearly the Bihar elections. If the verdict is against the BJP, that will indicate a slower pace of reforms. The poor monsoon is a challenge but not to the extent we all fear. Although everyone is saying India is much better prepared among emerging markets to weather the storm, given the shallowness of our market, once funds begins to flow out, the impact could be anything.
Outlook Business: Rajesh, you seem to be positive about the government’s approach and are willing to give it a long rope. But the issue is not just about reforms, as we appear to be in a cyclical downturn, exacerbated by over-leverage in the system.
Rajesh Saluja:Over the last five years,Indian businesses have built excess capacities and some of that has come with high leverage. They have also been used to working the system easily to get things done. This is just not happening anymore. From here on, businesses will have to go through the painful process of change to adapt quickly and find more efficient ways of doing business.
The Bihar elections won’t have much of an impact at the Rajya Sabha level, since the state only accounts for two seats. If BJP wins, that’s great, but if they lose, that will put more pressure on the Modi government to deliver. They will either go for a socialist approach to win in UP — which could be a dampener — or the government will have to move faster and be more responsive to the need for reforms.
The second point is that cyclically, the economy is on an uptick. So, whatever be the leadership at the central government, you will see 7-7.5% growth. Finally, it is not easy to pull out long-term money from India because their entire portfolio will get affected given the shallow equity market. So, barring a few emerging market funds and ETF’s or hedge funds that have faced challenges and moved some money out of India, the long-term money remains invested. So, even if Fed increases rates, there is likely to be more redemptions of investments in debt market, where currently there is an interest rate arbitrage for FIIs.
Outlook Business: Atin, you spoke of clients leveraging real estate to invest in equities. Could you elaborate?
Atinkumar Saha: To clarify, we don’t give advice on real estate. People who are leveraging on real estate are those who have a real estate portfolio of 60-70%. We are seeing that go into real estate as well as equities. We are not seeing a sell-off but they are not putting in any more money in real estate.
Yatin Shah: With wealth now moving from one generation to another, the first thing the inheritor is looking to correct is the over-ownership of real estate — they just don’t want to continue that legacy. The second thing, of course, is that three years ago, we were handling a capital gains situation. The natural choice was to buy real estate and save tax. Today, if I am biased towards financial assets, I don’t want to buy the same amount of real estate.
Rajesh Saluja: Cash has now become a big issue in real estate, with most money coming through the institutional route and not through individuals. Also, direct real estate and real estate investments are two different things. For investment purpose, people today are looking at the financial asset route rather than looking at direct real estate, except for commercial real estate, where people are always looking for opportunities. REITs in commercial estate are around the corner and will be a healthy way for clients to participate for fixed income kind of returns.
Atul Singh: This is healthy. Like any other asset class, you need advice. Advice can come through a structured PE approach or via other vehicles such as NCDs, where you have a layer of due diligence.
Outlook Business: Are you not seeing stress? Developers are resorting to fresh borrowing to pay their coupons. Ultimately, the underlying product is a physical asset, that, too, in a market where inventory is piling up.
Rajesh Saluja: There definitely is stress. Debt has more risk than equity, because in equity, you are giving the developer four years to complete the project, but when you do debt deals, he needs to service that debt every quarter based on sales. If sales volumes slow down, it can be a challenge. So, debt is linked to the current market conditions, while in equity, you have more time to execute strategy. Our realty funds have been mostly equity.
We haven’t had defaults. There are often delays in getting approvals in many cities. A strong legal agreement with remedies for default protects us in such situations for exits. But if you talk of the broader market, yes, there have been NCDs raised at very high rates and, consequently, we now have developers who are probably in deep stress. Today, if you look to raise a real estate fund, you need to focus on the developers who are cash rich or in the general ward and totally avoid developers who are in ICU.
Outlook Business: What gives you the confidence that those in the general ward won’t land up in the ICU?
Rajesh Saluja: It really depends on how you structure a deal. If you want to go into the specifics, we co-invest along with the developer. Any developer willing to shell out cash in this market has to be financially well off, which means that he is in the general ward. So, there are no cash-out deals, where the developer has the land and you end up funding him for construction. In the second arrangement, all the money gets pooled into an escrow account and we jointly sign cheques.
Right from the selection of the contractor to vendors and payment, everything is jointly controlled. An SPV controls the piece of land, which is not in distant suburbs but within city limits. You are dealing with a developer who has a 10-year track record, who has delivered 5 million sq ft and commands a decent premium.
Outlook Business: Yatin, you were very bearish on real estate last year. Do Rajesh’s comments make you feel bullish on the sector?
Yatin Shah: We are doing exactly what Rajesh mentioned. There are whole pockets of structured opportunities in the sector, as there is no big institutional funding in this asset class; it is completely dependent upon private money and PE money. Take a look at Piramal, which has tied up with Canada’s pension board for a real estate fund and its deals with Warburg Pincus and Goldman Sachs. All of them have invested at the entity level. Real estate is entering our clients’ portfolios as financial instruments and its allocation continues to be around 5-7%. Like in any other industry, good promoters will continue to get funding, while bad promoters will not.
Outlook Business: Rajesh, what is your take on real estate prices? What kind of returns do you think they will generate?
Rajesh Saluja: I am bearish on it from a direct investment perspective, especially in luxury segment. Direct real estate, at least in certain cities, is extremely overpriced. The rental yields are pathetic, even as capital values have gone up dramatically. So, I would say that when you look for good returns, you need to compare it with other asset classes. I don’t see it happening till another wealth cycle gets created.
The wealth cycle is where the whole economy grows, businesses grow, promoters grow and liquidity again enters the system. But this is five to six years away. The game-changer clearly will be REITs. All the wealth advisors are waiting to see what will really happen in that space because that is a good way to expose your clients, especially people who want fixed- income return with proper due diligence and no maintenance.
Outlook Business: Atul, are you advising clients to look at real estate?
Atul Singh: We don’t advice on direct real estate; as Rajesh said, the fundamentals are not very attractive there. But I agree with fund-based opportunities and looking at pockets of distress and getting a part of client money allocated there — up to a certain point, maybe 10%. It is not at the top of the asset class that we advice on.
Outlook Business: And you, Vishal?
Vishal Kapoor: We are seeing a shift from directly held real estate into real estate through regulated financial product with far better visibility. But you have got to go with quality providers, as in any other asset class.
Atul Singh:There was very significant flow into real estate over the past five to 10 years, but in recent years, we are seeing significant flows into fixed income, as the view was that ultimately rates will come down to a level where the risk-reward will actually turn more unfavorable. Right now, it is slightly skewed towards favourable, but a good part of the rally has already happened. Reports indicate that 50-60% of incremental rupees that get saved in India goes into real estate; if that flow stops and gets redirected into equity, that will be a game-changer. Already, HNIs are leading the trend; over time, the middle class will follow.
Yatin Shah: Just to add to Atul’s point. Currently, our savings rate is 24% of GDP and just 2% goes towards equities. If that 2% goes to 5% in the next three years, we are talking about inflows of $75 billion and that’s a huge number.
Outlook Business: Will disillusionment with realty be the trigger for flows?
Yatin Shah: It will be because of real estate and also due to real interest rates turning positive. The Indian mutual fund industry is worth ₹12 lakh crore and that is just 7% of aggregate bank deposits. In a developed market such as the US, it is four times the bank deposits. So, the level of financial instruments that will come into personal portfolios is humongous. This can be a big driver in the next three years and a good counter to foreign money. If net flows of ₹54,000 crore for the first six months is any indication, I think domestic investors are buying the story.
Atul Singh: The single-biggest reason why we are where we are is because of domestic money. Had this money not come, the situation would have been much worse.
Yatin Shah: Also, this flow is yet to make money. If they make money, you will see super inflows.
This is part two of Outlook Business' 4th annual roundtable, Upper Crest. You can read part three here.
