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Outlook
Profit
2 May 2008
Nikhil Walavalkar
Ater
a sustained bull run across global equities for
seven consecutive years, world markets seem to
be retreating finally. Considering that Indian
investors now have the option of investing abroad,
we posed the question on how to approach the world
market from an Indian investor's perspective to
Ajay Srinivasan. Excerpts:
What is your outlook on equity markets across
the world, particularIy emerging markets and India?
If
I look at the overall equity market, there is still
a reasonable amount of uncertainty. At this moment
we are cautious on equity markets around the world.
I think, going forward, if earnings growth rate
holds up, equities will only become more attractive
as valuations have come down.
Globally,
I think emerging markets will continue their outperformance
for the eighth consecutive year. There are multiple
reasons. First and foremost, valuations are reasonable.
We think, given the correction, emerging markets
look reasonably priced. Second, the earning resilience
shown by these markets.
Emerging
markets' earnings are less susceptible to downside
in the broader sense. I think there are good growth
prospects though these economies will surely be
somewhat impacted by the US slowdown, especially
export-oriented economies and their equity markets.
The last factor is the macro fundamentals such as
strong GDP growth and the domestic consumption theme
that supports emerging markets. Add to this the
fact that emerging markets are not as leveraged
as the US, the picture only looks brighter.
We
also
think emerging markets will be the beneficiary
of cheap money which is being pumped by central
banks around the world. We think that the first
six months of the year could be a bit of a challenge
but as the US starts recovering, we think, from
June / July onwards, the liquidity will be back
in emerging markets.
As we can see, India has borne the brunt of risk
aversion. As people turned wary of taking risks,
they cut their India exposure. But I think given
that FIls hold 43 per cent of the market free-float
in India, near-term performance is going to be
driven by global factors, whether you like it
or not. The other factor will be the relative
valuation of our markets versus others. India
is much cheaper than it used to be, but it is
still not cheaper relative to other markets that
FIls look at.
The
second factor specific to India is that while the
softer global economy, inflation and elections play
a key role, I think, on the flip side, the stimulus
to consumption specially from the last budget will
start kicking in from the second half of this year.
So this is the time to look at fundamental bottomup
stock picking against the broad momentum-based themes.
Ajay
Srinivasan
AGE: 44
EDUCATION
Ajay holds a BA with Honours in Economics
from St Stephens' College, University
of Delhi and an MBA from the Indian
Institute of Management, Ahmedabad.
CAREER
1987
Srinivasan was hired by ICICI while
still a student at the Indian Institute
of Management, Ahmedabad. He spent four
years at IClCI, primarily in project
appraisal, before moving to ITC. He
managed lTC's in-house funds for a while
before he got his first big break setting
up lTC's brokerage business.
1998
Joined Prudential as managing director
of Pru-IClCI, Prudential's Indian fund
management joint venture with ICICI
Bank. As a member of Prudential Corporation
Asia's board, Ajay also oversaw the
development of Prudential's retirement
business in Asia.
2007
In July 2007, he was appointed
as chief executive, financial services
and director, corporate strategy and
business development at the Aditya Birla
Group. In his role as chief executive,
financial services, he sets the strategic
direction for the Group's financial
services business. |
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Now
that Indians are allowed to invest in global markets,
do you think it is an option they must exercise?
The
answer to this question lies in the perception of
risk-adjusted return. Risk-adjusted returns are
a function of differential returns between the markets
adjusted for currency and other risks. Let me share
with you the experience at least in three other
markets that have opened up recently — Korea,
Malaysia and China, wherein off-shore investing
was allowed in the past decade. If you look at both
Korea and Malaysia today, about 25 per cent to 30
per cent of the total mutual fund assets are in
schemes that are off-shore. Korea is slightly less
than Malaysia. China is very much like India where
investment outside China has actually not picked-up
in a big way. I think to understand the reason behind
this one must go back to either the Korean or Malaysian
example.
Take Korea. In the initial phase the domestic market
was strong, so the Koreans did not think of investing
outside the country.
But subsequently these economies, particularly,
Korea went through a period of consolidation and
we saw increased investor interest in markets outside
Korea. China and India were two beneficiaries of
this movement of capital. The won started depreciating,
so did the ringitt. However, the minute both the
currencies started appreciating people pulled back
because they found a large part of their returns
eaten up. So we actually saw a large period of lull,
followed by a sudden increase in investment and
then a slowdown again. Now China is going through
the same phase. Chinese investing outside the country
has not picked up because they find home markets
still attractive.
If one were to consider other markets for the
sake of diversification, what would you recommend?
When
you are looking to diversify you have to look at
two factors. First, look at the correlation between
the markets. If the market is highly correlated
to the one that you have already invested into,
then you won't get the benefit of diversification.
The second factor is the attractiveness of the market
itself. At the end of the day, if you are investing
in a market that is not going anywhere but it is
negatively correlated to India then you may not
necessarily gain anything by investing in that market.
So you got to look at both these things. Keeping
these two factors in mind, there are three interesting
markets at this point
in time.
Within Asia, Taiwan is interesting given the recent
elections, plus the country's focus on highend
technology, which has been an underperforming sector
for a long time now. On the flip side, though, is
the Taiwanese dependence on exports. In Asia, Korea
is the other interesting market. In Latin America,
I personally like Brazil and Mexico and I think
both of these are big beneficiaries of what is happening
around the world.
So broadly these are three markets that look interesting
from a diversification point of view, but then Indians
do not have that much access to these markets today.
When global liquidity is driving equity markets,
does international equity investing offer true geopoliticaI
diversification?
The
correlation between markets is really interesting.
If you look at the highs of the markets around
the world since October 2007, the MSCI World index
lost about 15 per cent and the MSCI Emerging Market
index lost about 17 per cent and the weekly correlation
stood at 0.83, which indicates a fair high degree
of correlation.
Basically,
markets are very broad and have been moving similarly
so far and, therefore, financial de-coupling is
actually not happening. I think that's the first
point and, therefore, diversification at least
on the broad categories doesn't seem to have happened.
But there are individual markets where you could
find a fair amount of difference.
For instance, there is increased correlation between
India and Hong Kong over the last three years.
The correlation with China over this period reduced
and now we have almost no correlation with the
Chinese markets. So for Indian investors, China
may be a good place to look at just from a correlation
point of view.
But while de-coupling in financial market is not
happening, I think economic de-coupling is slowly
happening. The emerging markets may face head-winds
from slower external sector but because of domestic
consumption and infrastructure needs, these economies
are slowly beginning to de-couple. When that happens,
you start seeing earnings de-couple and that,
in turn, will lead to de-coupling of financial
markets, though I have to say this has not been
the case so far.
What
is your expectation on the currency front? And keeping
the currency consideration in mind, how do you expect
returns to pan out?
After
appreciating most of fiscal 2008, the rupee has
obviously weakened in the last couple of months
but we think there is a high probability that
the rupee will keep appreciating against the dollar
owing to rising foreign institutional inflows.
Inflows are expected to resume towards the second
half of this year.
Second,
the high interest rate differential against the
dollar will again buoy inflows as we don't see
interest rate necessarily coming down in India,
while in the US rates have already seen a significant
cut.
On
the flip side, the budget deficit is going up along
with rising crude which makes a case for letting
the rupee appreciate. Having said that, at this
point in time given the uncertainties and the way
things are playing out in both financial markets
and currency markets, I definitely wouldn't take
a bet based on currency views only.
Will you subscribe to the view that developed
equity markets are less risky than their emerging
counterparts? Definitely.
Developed equity markets are less riskier compared
with emerging markets. At the end of the day you
want risk and returns to go together! Emerging markets
are attractive and people expect greater returns
because there is greater risk. This has borne out
in the past too as these markets have delivered
much better returns. I do think emerging markets
will be the beneficiary of liquidity as soon as
the US starts to settle down. As investors turn
confident and sentiment improves, the sea of liquidity
will look for places that offer good returns. Money
will, thus, move to emerging markets as long as
valuations are attractive.
What is the track record of mutual funds in other
markets? In India there still seems to be a lot
of imperfections in the market which means active
funds can continue to beat the benchmark
indices for a while
In
Asian markets, ex-Japan, the track record of the
active fund managers in beating the benchmark
has been very good. But it is important
to understand where this alpha is coming from?
The alpha comes from broadly three sources; one,
from the efficiency of the market and that is
why, typically in the developed markets it is
tougher to beat the markets. The second source
is the fund manager's expertise and I would expect
that fund managers across the world are probably
as good as each other, so that should not necessarily
be a factor. But the third factor, that is important
in my view, is the fund objective and stated benchmark.
Between
2004 and 2006, in the Indian market, several funds
beat the market benchmark by a reasonable margin
because they had exposure to mid and small-caps
which were not part of the index. If you are invested
outside the index and if that sector does well
you will automatically do well.
Subsequently.
when large-caps started moving, funds found it
difficult to beat the benchmark because they were
working in a very different universe. Again to
give an example from the region, if you take Malaysian
markets, for instance, there are three stocks
that account for about 60 per cent of the total
market cap of the benchmark index.
So
if you have the right view on these three stocks
then you can beat the benchmark easily. Beating
benchmarks often has to do with the construction
of the index and the objective of the fund that
you create.
Keeping
this in mind, looking for active fund managers
with a long track record is a best way to start
investing in most emerging markets. But if you
are going to enter more developed markets like
the US market, then buying an ETF (exchange traded
fund) or buying anything that tracks the broad
markets is probably a good way to proceed.
Post
sub-prime do you think debt funds overseas could
be a good hunting ground?
There are broadly three factors to look at —
risk-free rate, credit spread and currency risk
as far as debt fund investments are concerned.
Looking
at the expectations of continued differentials
in interest rates in favour of India and the outlook
on the rupee, we don't generally see the risk-reward
favouring overseas debt at this point.
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