Dalal Street Voice: Invest in thoroughly researched companies to ward off market volatility woes: Dr. Joseph Thomas of Emkay Wealth Management

The most important principle to ward off the discomfort from market volatility is to ensure that the portfolio is invested into companies that are thoroughly researched and have the potential for above-average growth. Once this aspect of selection is done diligently there is little to worry about the portfolio because the assurance of performance is there in the process of selection itself, Dr. Joseph Thomas, Head of Research at Emkay Wealth Management said in an interview with Zeebiz’s Kshitij Anand. Edited excerpts:

Q) Though the Budget 2022 has largely been stable, the ongoing geopolitical events have fueled risk-off sentiment in the stock markets. How should long-term investors view this?

A) The Budget statement was positive and brought some cheers to the markets. It had a lot of substance in terms of some of the basic proposals that it presented for long term growth.

The budget offers continuity on the proposals and reforms instituted in the earlier budgets and provides a direction. The accent on infrastructure, the extension and expansion of the PLI scheme, earmarked share for private sector in defence production and research, provision for affordable housing are some of the things that are positive for the economy.

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While these benefits may accrue to the economy over the coming few years, there is definitely headwinds like the liquidity normalization in all major economies including the US and India, high levels of inflation, and rising market yields.  

The process of normalization of liquidity, and the rise in money market yields is gradually bringing in normalization of returns from equity. This normalization has brought down the returns across market caps and sectors.

In many different waves of downward movements, since the last three months, the equity market has been correcting downwards offering opportunities for investors to commit to the markets afresh, and benefit from the phased or systematic investments.

It is also important not to get carried away or taken aback by the volatility in the markets. This is because if one has a portfolio of well researched and carefully chosen stocks of growth companies, over longer time periods, the portfolio is bound to perform well.

That is the case with well managed funds with a track record of consistent performance. There has been continuous and persistent exit by foreign investors from the domestic market.

These exits result from mainly factors that are related to the US economy, and with US economic growth is well in place, and US inflation at high levels, the yields have started rising.

Q) Why are FIIs cashing out from Indian markets?

A) The US Fed is about to complete the accelerated winding up of the bond buying program, and a rate hike is likely very soon. The liquidity glut which was caused by the monetary expansion is coming to an end, and some of these funds which were sheltered in emerging markets are back the country of origin. The same phenomenon was witnessed last time around during the tapering of the quantitative easing.  

Q) What about high PE stocks?

A) There is yet another reason for the general weakness in equities. When inflation moves up, it becomes difficult to sustain high P/Es, and when inflation sustains above a certain level, like 3.00 % to 3.50% in the case of US, a contraction of market capitalisation happens.

This has been proved by data of the last three decades. It may also be pointed out here that the fiscal consolidation path and the enhanced borrowing program, outlined in the Union Budget, have not been looked at with favour by some of the international rating agencies.

Q) What is your take on the December quarter earnings and what is the kind of projections you foresee for FY23?

A) The net sales growth in BSE 500 companies has been encouraging, with all major sectors excluding auto components and ancillaries display a positive, high double-digit growth.

The top sectors were consumer goods, IT services, chemicals and fertilizers, metals and mining and oil and gas, while real estate, telecommunications, pharmaceuticals, cement etc. have low rates of growth, in the high single digit level.

Factors that would be of relevance in the coming days from the perspective of earnings would be the rate of GDP growth, the pick -up in demand especially retail demand, the level of moderation in inflation especially commodities including metals etc.

An acceleration of the rate of economic growth is probably the most important factor that could scaffold earnings growth. Much would depend on the easing of inflationary pressures and the availability of credit. Given the volatility in the markets, and the normalization of liquidity, any corrective downward movements may be made use of as opportunities to make long term investments in equities.

It is equally important that portfolios which have a good track record of delivery of performance should be invested into. The stock selection which the portfolio managers make will assume greater importance as the market realigns itself to the new realities of growth and earnings. The appropriate mode to invest will be a phased approach or systematic investment plans.            

Q) Last two months have been volatile how have you positioned your portfolio to tackle volatility amid external headwinds?

A) The most important principle to ward off the discomfort from market volatility is to ensure that the portfolio is invested into companies that are thoroughly researched and have the potential for above-average growth. Once this aspect of selection is done diligently there is little to worry about the portfolio because the assurance of performance is there in the process of selection itself to a significant extent.

Periodic portfolio reviews, booking of some profits occasionally, and also utilizing the cash available to accumulate stocks that become cheaper, would also add strength to the portfolio. At peak portfolio returns, it becomes amply clear that abnormal returns may not be sustainable, and hence brining in a blended approach to the portfolio with a combination of growth plus some amount of value, that is, a moderately blended strategy will help in protecting the value of the portfolio on a relative basis, that is, in relation to the benchmark.

Exposure to overseas equity is also a mechanism by which a certain kind of hedge is created against the depreciation in the local currency, for those who may be wanting to spend in foreign currency in future for various purposes. But this should be carefully done, as the probability of overseas returns should be theoretically much higher than the prospects of local returns in future for overseas investments to make sense.                    

Q) Inflation might certainly become a pain point for the economy as well as RBI – what trajectory you foresee for rate in next 12 months. How should investors position themselves to tackle the change?

A) The pressures on account of high inflation or price level is bound to be there in the first half of this calendar year. Oil prices have been moving up as a result of the demand picking up to the pre-pandemic levels, and the limited capacity for output and supply expansion by OPEC+. The main reason for domestic price level would be fuel prices emanating from high prices of oil in the global markets.

The Russian invasion of Ukraine has paved the way for sustained high prices for a longer period of time. Much would depend on how this conflict develops and how prolonged it would be. The inflation based on CPI was a shade above 6 % last month, and it may well stay there or move higher in the next two months. Inflation is very high in the US, UK and Europe too, and policy responses may come through in the next few weeks. Market rates and yields have moved up already, both in India and abroad. Market rates have moved up since the last two to three months.

Therefore, any action from the RBI may not be of any direct consequence as such. Also, in the last policy statement the RBI has indicated that an accommodative stance will be followed for a prolonged period of time, that is, till growth becomes sustainable. Investors in debt funds should focus more on very short end of the curve or short-term funds till we see the yields stabilising at higher levels.

Rates are bound to rise not just because of inflation but more importantly from the limited space available for primary gilt issues as the quantum of borrowing is large. Those who are at the short end but more tilted towards the mid segment, may continue to hold the positions.

This is possible as the accruals may be high in some of these funds, and the portfolio maturities may ensure that around 20 % to 30 % of the portfolio gets reinvested on maturity at the ongoing yields. It is also possible that there may be bonds at attractive yields available for purchase and such opportunities may be encashed for holding till one year or two years. So, the rates are set to rise, and it is prudent to stay at the short end.                  

Q) Small & midcaps have clearly outperformed in the past 2 years with handsome margin – how should investors view the space in FY23?

A) Yes, both these segments have performed well in the last couple of years. But if you look at the returns as of today, it is quite evident that returns have normalized, with normalization of liquidity and the likely rise in interest rates. I must add here that even the large cap space has the returns normalized over the last few months. Something that must be borne in mind is that when it comes to expansion of market capitalization or growth, there is greater consistency in the performance of large caps, and a much lesser consistency in the mid cap space, and probably only occasional spurts of performance in small caps.

Therefore, in any portfolio allocation, a major component of the allocation should be to large caps, followed by mid- caps and blended strategies. While one may go with small cap funds from the mutual fund space, you should also look at the Alternate Investment Funds (AIFs) which focus on investments in the small cap space. AIFs, since they are for fixed periods, and mostly for three or four years, the fund manager will be under no pressure on a day-to-day basis, and he will be able to make studied choices which are likely to work out well over longer investment horizons.

This unique opportunity offered by AIFs is something that deserves active consideration.  It can be safely ruled out that the kind of returns seen in the last two years may not be probable this time around, and the approach to investments should be in a graduated fashion or phased manner.      

Q) If someone is running a portfolio with deep red – what should be his/her strategy before the financial year-end. Hold positions or exit stocks. If exit, then which stocks/fund should the investors' exit from?

A) This is a very personalized thing, and recommendations on exit, entry or hold may differ from portfolio to portfolio, and also with reference to specific stocks. Fundamentally price performance should be looked at as the first criterion to understand the portfolio. As a senior equity research analyst, myself, I may be looking at trimming portfolio size in case of large number of holdings, and insignificant holdings. Usually, the tail end of the portfolio adds very little to performance, and often becomes a drag on performance.

It is also important that all bad apples are eliminated because they have the capacity to contaminate the entire basket of stocks. One needs to take cognizance of stocks that will provide growth and with it returns. This approach to selection becomes more important as net selectivity would decide the extra returns that you may be able to generate when benchmarked against the index. 

Also, in any portfolio we need to bring in not only diversity in terms of sectors and market caps, but also in terms of the fund management styles, and all of this one may be able to realize by choosing a combination of direct stocks, Mutual Fund Equity Schemes, PMS and AIFs. But I may reiterate here that this review is a portfolio specific thing and should be looked at from the individual’s risk appetite and risk preferences.      

Q) FIIs clearly remain net sellers but retail investor force is something that is keeping market float at every support. How do you see FII activity in near future?  There is a saying that when FIIs exit – it is usually the best time to book profits?

The FII activity that we have seen so far in the last few months is likely to continue like that into the near future. They have their own reasons for their actions, and these are factors which are mainly US-centric. The exits result from mainly factors that are related to the US economy, and with US economic growth well in place, and US inflation at high levels, the yields have started rising. The Fed is about to complete the accelerated winding up of the bond buying program, and a rate hike is likely very soon.

As I had indicated earlier, the liquidity glut which was caused by the monetary expansion is coming to a close, and some of these funds which were sheltered in emerging markets are back the country of origin. The same phenomenon was witnessed last time around during the tapering of the quantitative easing last time around too. There is yet another reason for the general weakness in equities and that is sustained inflation.

But the most interesting aspect of markets is that the retail investors through SIPs are putting into the market in toto amounts upwards of Rs.10,000 Crs, month after month, which actually counters the effect of exit by FIIs to some extent. Thing will start turning around with the liquidity normalisation coming to an end, and the upward rate cycle getting kindled.    

Q) The recent selling was largely seen in high PE s tocks which low PE stocks did not see much sell-off. Can we say that smart money is now moving out of high beta counters and richly prices stocks?

A) See, these are linked to the investment styles and preferences which tend to evolve or move with time. Stocks even at high P/E, and high P/E stocks have a justification in terms of their supply demand positioning, and at some pint of time when price saturation happens, comes the sell off. The reasons that may be quoted for the selling may be many and varied. In case of anticipated volatility or price saturation, it is only natural that high beta stocks may be exited. These are all aspects of the strategies that are generally followed in entering or exiting markets.      

Q) Govt has notified the first phase of the green hydrogen policy. What does it mean for markets and which companies are likely to get benefited the most? Also, does that mean that companies with high ESG ratings will be considered for investment by foreign funds?

A) The green hydrogen policy is consistent with the objective of net zero carbon emission to be achieved by all the countries of the world, and policy towards this has been announced by all major countries, about thirty of them. This is nothing but a drive towards de-carbonization of the environment and a technology that is critical for us. But the benefits of this environmentally as also commercially will accrue only over a longer time frame.

The total investments required for this is estimated at US $ 5 trillion.  From this you can make out the kind of size and scale that is envisaged. Some of the major industrial groups have already put out their intentions to be part of this. There is an existing hydrogen market like steel, refineries, chemicals etc. but it has scope in many other fields like aviation, shipping, power generation etc. At this juncture green hydrogen projects are mainly announced for Europe, Australia, Middle East and to some extent South America.

Ad decarbonization starts happening green hydrogen projects will start having their feet firmer, but the revolution is certainly going to happen. ESG norm in investing is already in place, and in India too special funds which follow this norm have also been launched. It will become more relevant as years pass by, and the ESG ratings of companies will be looked at more often.              

(Disclaimer: The views/suggestions/advice expressed here in this article are solely by investment experts. Zee Business suggests its readers to consult with their investment advisers before making any financial decision.)