For value to deliver, interest rates have to go up: ICICI Pru’s Naren


At the start of 2021, given the market outlook, you suggested asset allocation funds. Since then, there has been a rally in equity. So, do you think this rise is unjustified?

Today, the global equity market is largely driven by central bankers, given that central banks have flooded the market with money; first from 2008, later in a lot more aggressive manner from March 2020. If this trend continues, market valuation is bound to expand. At the same time, policymakers have kept debt interest rates very low. As a result, these are challenging but interesting times for fund managers both in India globally. The exception to this is China where markets have witnessed a reasonable correction post some of the stringent measures announced by their government ex-China we have seen a situation where globally markets have been only going up.

As an asset manager, is it possible to predict what central banks will do?

In the time from World War II till 2008, central banks stayed away from printing pumping of money into the global financial system. Hence, we do not know the likely long-term side-effects of quantitative easing worth $25 trillion thus far. Unfortunately, there is very little economic literature which helps us understthis aspect. Probably two decades later, we will be in a much better position to understthe impact of these decisions. Till then, from a mutual fund point of view, we are committed to believing in asset allocation that while valuations expdue to factors which are difficult to guess, at some point in future, they will revert causing potential losses to investors who don’t remain disciplined. While it is impossible to predict when this will occur, the possibility remains it could play out when central banks decide to tighten monetary policy. What we can state with confidence is that practising asset allocation will work favourably in such times.

There are a number of IPOs coming to the market. Is that a sign of the market topping out?

At this point, we believe it is very important for investors to practice asset allocation that we should make choices based on earnings connected to 2021 or 2022, invest in names which have steady operating cash flows, dividend yield, etc. The key learning from 2007 is that investors who invested in IPOs based on 2014 earnings were in for a disappointment. There is a fair amount of froth in many parts of the markets, particularly in new-age areas. Unlike Asia which has seen periodic market corrections, since 2012, US equities have barely witnessed a meaningful correction. Today the number of loss-making new age companies trading at stretched valuations is very high in the US compared with dividend-paying, cash flow-generating old economy oriented companies.

The other outlook that you mentioned was a potential shift from growth to value at the start of 2021, a call which has played out. Do you see this continuing? Or are growth value stocks more or less equally attractive?

For value to deliver, at some point, interest rates have to go up. If interest rates remain at zero globally, we believe that growth may make a comeback. One of the reasons for value to work of late was on account of a phase where investors felt that liquidity could be withdrawn sooner than later. So, if there is no normalization of monetary policy anytime during 2021 or 2022, growth will be back in spotlight. Having said that, incipient inflation is increasingly becoming visible across many areas as can be seen through prices of commodities (energy, metals, agricultural commodity, US homes, etc), all of which have seen a sharp spike. However, the Fed believes this is due to transient reasons. On the other hand, sustained rise in prices mean that interest rates have to go up, that generally is supportive of value stocks. And you can see that today, for example, there is a shortage of semiconductors, which has resulted in many auto stock companies shutting down in September all this is a reflection of covid creating supply shocks. The supply shock, along with accommodative monetary policy, has led to a significant rise in prices. We will know whether inflation or supply shock is the only problem over the next six months to one year.

The relative valuations of large- versus mid- small-cap companies, at the end of 2019, marked a high point for large-cap stocks. Since the pandemic, mid- small-cap have recovered quite a bit; is that significant?

Small- mid-caps tend to deliver high returns over 10 or 20 years, but the risk associated with them is also much higher relative to large-caps. If an investor is ready to stay invested for such long time frames, then they should definitely consider small- mid-caps. However, the reality is that investors often are guided by past returns tend to ignore the risks associated when making investment decisions. On shorter time frames, large-caps are better placed as those companies are fundamentally robust, are cash rich, can withsteconomic problems much more comfortably than small- mid-caps.

What is happening to credit risk funds since April 2020 is a tendency to be cautious. Yield to maturity (YTM) across the board has come down. From here, do you see the economy recovering therefore credit risk delivering good returns?

We believe credit is one of the most interesting but often misunderstood categories. Investors during 2019-20 realized the risk associated with credit risk category. Currently the YTM is low in credit risk funds from a historical perspective given the market situation, investors can also consider categories such as arbitrage equity savings as YTMs have fallen. However, we believe the risk in credit risk funds is lower now since many of the riskier names have managed to raise capital.

In the current market, it seems IT stocks have led the rally have done spectacularly well. Will IT continue to have leadership?

Being a practitioner of the contrarian value investing style, IT sector currently appears fully valued to me. But my colleagues who practise growth investing believe that IT is currently one of the most favourable growth sectors can even uplift the Indian economy, like in the year 2000. According to them, IT is one of the sectors showing all the indicators of phenomenal growth. The only challenge that the sector is currently facing is that of attrition, rather than anything business related. So, IT right now fits a growth portfolio than a value portfolio.

You recently completed a 10,000 crore new fund offer (NFO). A lot of investors who came into that NFO others probably have never seen a bear market. What do you say to them?

We launched a flexi-cap fund because it has the ability to invest across market capitalizations. i.e. large, mid small. So, within the equity space, flexi-cap has the potential to invest in any segment that appears reasonable. Investors who came into the market after 2011 have not seen a sustained correction. I personally have the benefit of witnessing major falls which occurred in 1992, 1996 to 1998, 2001-02. It is why we have been constantly trying to popularize categories such as balanced advantage or asset allocation category, equity savings multi asset which will help moderate negative experience during market correction in equity. Investors must remember that equity is not a risk-free asset class, but the categories we have popularized are definitely more defensive than equity.

Besides reminding ourselves , we keep telling prominent media houses that it is wiser to popularize asset allocation defensive categories than aggressive categories when markets are high.

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