Visible Transformations – Near-term painfor Long-term Gains
“Most of the time we are punished if we go against the trend. Only at an inflection point are we rewarded.” ― George Soros, Soros on Soros: Staying ahead of the Curve
With Modi government making changes at the helm, we continue our belief that he can take the country to the next level of growth. It is important to grasp government’s serious intent on restructuring the economy, which is a five to ten year story. We at QuestPMS would like to term this phase of the journey as transformational stage of India’s new economic horizon. In fact, till drought warning the other day, we believed that the whole economic turnaround should be on the horizon during the early second half of FY16. Deficient monsoon or drought kind situation may delay the whole process of economic recovery by further two or three quarters. However, we strongly believe, India is at a cusp of major economic turnaround over next 9 to 18 months depending upon the quality of monsoon.
After the initial euphoria of change in government being over, we believe, it is time for a reality check. We need to understand the following few factors in order to decide our investment strategy and make big money in the market over next 3 to 4 years. First, the performance of Modi government and structural change it can bring to Indian economy. Second, the risks both domestic and global associated with the economy. Third, strategically, what can benefit India and how it is placed in the current global context? Fourth, what investment philosophy could be winner over next few years? And lastly, how are we at QuestPMS, positioned in the given situation.
First, the Visible Transformations in the first year:
The new government led by Modi assumed office at a time when confidence in the India story was waning. Unabated corruption and indecisiveness had paralysed the whole decision making process. People had been left helpless against ever-climbing inflation and economic insecurity. Urgent and decisive action was needed.
Modi government systematically went about addressing these challenges. Runaway inflation was immediately brought under control though with some luck due to declining oil price. The languishing economy was reasonably rejuvenated, building on stable and policy-driven proactive governance. Discretionary allotment of natural resources was replaced with transparent e-auctions. Significant changes have been brought about in work culture, nurturing a combination of empathy as well as professionalism, systems as well as breaking of silos.
Modi is bringing about a fundamental change in the paradigm of doing business in India. Modi’s biggest hit is making India count globally.The general consensus in Indian industry is that corruption at the highest level has seen a dramatic decline.We have government that is switched on 24×7 with PM leading from front and has been able to restore trust in the government.
There is a clear sense of direction and purpose to what the government wants to achieve. Yes, things are taking longer than one wished – but there is a plan to turn around the economy and it is in the midst of execution.Quite a few of government’s initiatives are still “work-in-progress”, battling constraints imposed by parliamentary politics, legacy problems or administrative / technical limitations. Hence their impact, even of the “enacted initiatives”, on the future outcome of economic variables will take time to bear fruit. We believe, the government’s vision, direction and strategy is right. This is just the beginning. We are not far away from inflection point.
Near-term pain : Domestic
Indian markets have been volatile with a negative bias, during last 3 months, on worries over reforms and corporate performance but the country is on the cusp of a turnaround engineered by government spending and a relentless focus on fighting inflation and ending redistributive policies.
However, the prediction of a below par monsoon may have serious repercussions for the Indian economy and is one of the major concerns driving us to believe the economic growth pick-up may be delayed by another 2 or 3 quarters. El Nino’s return after five years with predictions of droughts may also spike food inflation in India and may slow the pace of easing interest rate cycle by RBI. Further, rural incomes and spending could come under further stress not only due to weak monsoon but also due to weak agricultural commodity prices.
Other near-tem pains include the government’s obstacles of passing reforms legislation through Parliament (as the opposition is focusing on polarizing issues like land reform, and retain control of the Upper House) anddelay of addressing balance sheet problems for PSU banks as the government wants to fix the governance problem and then recapitalize them so that the current NPA mess is not repeated. Also, appetite for private investments is significantly slowing down as many companies are having stressed Balance Sheet, rules of doing business are changing to bring governance in system and the end of crony capitalism.
For the Modi government, Lalit Modi episode could turn out the beginning of unfolding of political drama in the days ahead. The Modi government could face crisis of credibility. Also, the Bihar election is shaping up to be a crucial political battle with the anti-BJP alliance and BJP’s poll strategy thereof will determine government’s political trajectory over the next few years.
Pain due to Global factors :
The rising U.S. dollar and the fear of interest rate hikes by Fed is redistributing growth throughout the global economy. The greenback’s ascent to the highest in a dozen years on a trade-weighted basis is eroding the competitiveness of the U.S. and countries whose exchange rates track the dollar, including China. It’s also pushing down commodity prices, hurting producers such as Brazil, and threatening other emerging markets where companies borrowed in the U.S. currency when it was cheaper. On the flip side, the euro area and Japan are cashing in as their companies gain the edge in world markets that economies need to boost growth. The likes of India are benefiting too, by not only lower commodity prices but also by paying less for their energy imports. Also, with Greece unable to reach a deal with the European Union to stay in an EU bailout program, the drama continues to fuel volatility in the global financial markets.
Investment strategy :
“Every cycle is unique, so using historical market data works better as a way of defining risks, not as a way of knowing exactly what’s going to happen next”.
We expect India’s growth cycle to recover over next few quarters. As the growth cycle recovers, investors tend to shift from quality to growth stocks, and we see the process is already underway.
QuestPMS has been performing exceedingly well compared to all the benchmark indices and over various time periods. This has been mainly possible because of our focused approach of investing into growth stocks at an absolutely reasonable price.
QuestPMS has performed exceedingly well for the quarter ended June 2015. The PMS is up 8.7 percent when compared to fall in Sensex by 0.6 per cent and fall in Nifty by 1.4 per cent.
Our MULTI client portfolios have also performed exceedingly well with a positive return of 9.1 per cent for the quarter compared to fall in Sensex by 0.6 per cent and fall in Nifty by 1.4per cent. Portfolio performance since inception for MULTI is positive 20.1 percent vis-à-vis Sensex and Nifty return of 3.2and4.1 percent respectively.
Also, for our new MULTI – 2 investors too, the performance for last quarter vis-à-vis benchmark indices is heartening at positive 5.5 per cent whereas the Sensex and Nifty are negative 0.5% and 1.3%.
The domestic investors have started increasing exposure to financial assets, particularly equities – via mutual funds and are mainly focused on small and mid-cap category because these stocks are relatively cheaper than some of the large-cap names. Also, small and midcap stocks are likely to gain more in up markets, just as they ran the risk of faring worse in down markets. As Quest philosophy and expertise has always been in picking small and mid-cap ideas – this bodes perfectly well for the QuestPMS portfolios.
Looking at the strength of our current portfolio, we expect it to do exceedingly well from hereon over next 2 – 3 years. We expect the infrastructure sector to do extremely well in the ensuing 12 to 18 months. QuestPMS portfolio has been constructed with a view to take full advantage of the bull-run in growth stocks. Currently, infrastructure, engineering and related stocks (interest rate sensitive) comprises almost 48 percent of our portfolio.
We expect the average EPS for our portfolio companies to grow at a CAGR of around 30-35 per cent over the coming three years and the one year forward (Mar-2016E) PE works out to around 14.2 times. We expect margin expansions in our portfolio companies on the back of incremental capacity utilization on the one hand and reduction in raw material prices on the other hand.
During last 4 years, the Quest family have donated around Rs 15 crore towards various causes for upliftment of society, of which around Rs 6 crs is in the current financial year till date.
As mentioned earlier, it has been our stated policy to use Quest profits for various charitable activities that includes running the Quest Foundation, which is involved in carrying out spiritual activities like managing Iyengar Yoga classes and discourses on ‘Bhagwat Gita’ by Chinmaya Mission. Quest Foundation and Quest Founders are also involved in various charitable activities including educational, medical and general aid to poor and needy.
The country is going through a “governance transition” which many industrialists are finding it difficult to deal with and have already got a rude awakening as reflected in the criticisms of the Modi government from various quarters. With natural resources no longer available for a song and banks insisting on higher promoter contribution as equity, industrialists will prefer to sit tight than expand. This may lead to lower capex and hurt growth and investment in the short run.
Modi is running the government with a 5 to 10 year view. For him, stock market is not of prime importance. What is more important is attracting investment and generating job growth. He may take his time. But there is hope because we see the man as hard-working and making fundamental changes, which will bear fruit in future.
At this juncture, we strongly believe that investors can earn significantly higher returns by enhancing their exposure to equities. Our belief in the Modi government, the wisdom of FIIs – who have been heavily investing in India for many years and now the huge inflows into domestic equity mutual funds strengthens our confidence in the Long-term India story. Also, let us not forget that in a formidable change of trend, domestic equity mutual funds have seen strong inflows with thirteen successive months of net positive inflows adding up to $15 billion. This is almost equal to net cumulative inflows over the past 12 years (Jan 2004 to Apr 2014).
As Uday Kotak in his interview with Forbes India says : “I see huge scope for personal saving moving towards the financial sector, away from traditional avenues like gold and real estate”. In the same breadth, Morgan Stanley expects that domestic investors are likely to become a dominant force in the Indian capital market over the coming decade. Morgan Stanley estimates that domestic flows are likely to top $300 billion in the coming 10 years. To put this number in perspective, domestic households have put only $50 billion and FPIs about $135 billion in the previous 10 years. This gives us aspiration to get bold by advising our investors (including Multi and Multi 2) to put more money in their existing PMS accounts or open new PMS accounts.
We, at QuestPMS, believe that favorable market forces (India is only growing in slowing world economy, lower inflation and reducing interest rate regime, decline in commodity prices, requirement of massive infrastructure development, easy availability of capital etc) combined with superb top-down direction of PM Modi can achieve astonishing results in coming years. Be ready for happy and healthy investing for next 5-10-20 years. It’s going to be India’s day and decade and so don’t get distracted with minor hiccups on the way which is all set to create massive wealth for early birds.
June 30, 2015.
DISCLAIMER: This communication does not constitute or form part of any offer or recommendation or solicitation to subscribe or to deal with QuestPMS. The views expressed by Ajay Sheth, Portfolio Manager QuestPMS are his personal views as on the date mentioned. These should not be construed as investment advice to anyone. This communication may include statements that may constitute forward looking statements. The statements included herein may include statements of future expectations and, are based on the author’s views, observations and assumptions and involve known and unknown risks and uncertainties that could cause the actual results, performance or events to differ substantially or materially from those expressed or implied in such statements. The author does not undertake to revise the forward looking statements from time to time. No representation, warranty, guarantee or undertaking, express or implied is or will be made. No reliance should be placed on the accuracy, completeness or fairness of the information, estimates, opinions contained in this communication. Before acting on any information contained herein, the readers should make their own assessment of the relevance, accuracy and adequacy of the information and seek appropriate professional advice and, shall be fully responsible for the decisions taken by them.