I’d love to know how your funds performed over the past couple of months on an YTD basis. Did you manage to protect your funds or did the pressure cause them to buckle?
First, I won’t comment on fund performance, especially for a short period. However, it is important to remember that the Ukraine crisis was a geopolitical incident that occurred in February and that no portfolios are designed for this type of tail risk event. Portfolios cannot be designed to handle warlike situations. In the short-term, there are huge dislocations emerging, especially with the rise in commodity prices and inflation. Portfolios are not made to handle such extreme pressure. If this is the case, one will always have an environment that is designed to handle this type and not a normal one.
Equity investing is a long term product. You must be able to handle the short- and medium-term gyrations. Are you making any changes to your portfolio strategy. What is the broad hypothesis that you are using in your portfolio to look ahead the next 3 to 5 years?
First, the Indian economy has seen a strong and broad-based recovery since the pandemic. While certain sectors such as technology, pharma, and consumer were doing well in pre-pandemic, 2021 and beyond, we have seen a broad-based recovery in all sectors including infrastructure, commodities, real estate, and real property. This has a huge multiplier effect on a lot of other industries.
The Prime Minister tweeted that we have met ambitious export targets. This means that the Indian economy has seen broad-based growth post pandemic. That is why large parts of the market have started to do well in 2021. The problems facing the Indian economy today are mainly imported. We don’t have problems in the country.
Our economy is in fine shape. Global emerging market investors believe India is one of the best places to be a foreign investor. India has everything going right from a domestic standpoint, including the economic policies and the growth prospects. There is also political continuity unlike many other countries which face numerous challenges.
The environment is favorable for investment and we are beginning to see some early signs that there has been a revival in capex in a variety of sectors. Metal and cement have announced a few capex. The PLI scheme has been very successful, particularly in mobile phone manufacturing. Despite the massive increase in freight rates which has been a headwind to exports, exports have performed well.
Even before the current geopolitical events regarding manufacturing investments in India, there has been a large global pipeline. This geopolitical event will reorganize some global supply chains and encourage more people to consider India as not only a strong services hub, but also incrementally as a manufacturing hub. Some of the biggest multinational corporations in the world are looking to diversify their sourcing away from North Asia towards India. The economic environment is favorable, except for the recent rise in commodity and oil price prices. These risks will recede if there is positive progress on the geopolitical side. Then our strengths will be in play.
CRISIL estimates that PLI-led manufacturing will grow to around 12%-13% over the next five to seven years. Is this an accurate estimate or are you underestimating the impact of PLIs on newer segments?
PLI is a positive industrial policy. It is more defined than previous industrial policies, which were broad-based and did not have targets. They also often subsidised capital investment. Instead of focusing on value additions to the domestic economy, this time the PLI schemes – particularly those that were launched in mobile phone manufacturing – aimed to create domestic champions within certain industries.
PLI has been extended to other industries due to the success of mobile phones in the initial phase. One of the PLI Scheme’s beneficiaries, an entrepreneur, stated that the government has moved from being an approval authority towards being a facilitator for investment and manufacturing. The government is now asking entrepreneurs to tell it what they can do to make India a manufacturing center. This is a bottom-up approach that encourages entrepreneurs, especially on the manufacturing side.
The Finance Minister mentioned logistics 13 times in the Budget this year. This shows that our logistics are one of the most important problems in the Indian economy, both from a manufacturing perspective and clearly the government’s focus is on logistics. We are working to address the weaknesses in Indian infrastructure on the logistics side. PLI’s initial success has been great and we are seeing a lot more participants in different PLI schemes, telling us that they are finding a lot acceptance. This is a very pro-industrial government policy, my opinion.
The market is known for finding new worries every day. Now that the price war is over, there is a new concern about stagflation. How can you assess the potential for growth in a company when this is the case? How does equity as an asset behave? How can one spot outperformers that can move higher in this kind of environment?
Inflation in 2021 was caused by dislocated supply chain, high freight rates, and supply chains that were still not functioning normally after the pandemic. The situation is getting more complicated as the shortages of semiconductors persist and the Russia Ukraine war, which has triggered sanctions against Russia and Belarus, continues to be a problem.
It is more of a supply-chain shock than a disruption, and we don’t know how much longer this will continue. As optimists, I believe that we will all find a solution within the next few months. However, one cannot predict what will happen in warlike situations.
The US 10-year bond yield is the best indicator of inflationary expectation. However, it is not indicative of any significant structural change in inflationary anticipations. As such, the market consensus is that this is short-term inflation. We will see how it plays out as it is a function geopolitics that is almost impossible to identify.
The best place to invest in inflation is companies and businesses that have pricing power. They can pass on inflation to their customers. This environment is challenging in terms both of inflation and the availability of raw material.
Strong companies tend to emerge stronger in difficult environments. This is why it is important to focus on companies that have a track record of strong execution and market leadership, strong balance sheets, and pricing power. These are the companies that we are focusing on across all industries. The good news is that there are some industries in India, such as IT services, and over the long term, even manufacturing will benefit from this geopolitical crises. India will eventually be a beneficiary.
Could you please share the incremental changes that you have made in your portfolios over the past six months? Where have you been reading about value and hunting for it?
We are bottom-up and take a bottom-up view on individual stocks. The geopolitical climate today creates a lot of uncertainty. It is therefore more important to have a balanced portfolio than ever before. Balanced portfolios are vital when volatility increases.
We have re-balanced the portfolio whenever we had large macro imbalances. We also understand that inflation has come in a short term. We don’t know how inflation will play out over time. We are aware of this, however, we also know that certain industries will benefit from this geopolitical incident because some of these events have long-term effects. We are currently looking at industries and businesses which are beneficiaries of this. Manufacturing, particularly low-end manufacturing is one of the industries which is a beneficiary. IT services have been doing well regardless of the crisis. Some of the countries in eastern Europe are our competitors in IT service. India, as a country, should benefit from the difficulties of operating in certain geographies. India also has relations with Russia. Indian companies can become suppliers to Russia incrementally and replace global supplies.
How do you see your portfolio’s earnings profile one year in the future? Are you reducing earnings? How has the environment affected your earnings estimates over the past quarter?
The last three weeks have seen major changes, notably the huge spike in commodity prices. This will not show up in the quarter’s result. The June quarter result will show more severe stress and pressure as most companies have less inventory than they can use in this quarter. However, it will begin to impact a few companies in the next quarter. In many industries, earnings pressure will begin to build in the June quarter.
The past history of consumer staples has shown strong pricing power, just like the paint industry. The spike has been so big in the short-term that all these companies will also face margin headwinds in short term. These include industrials, infrastructure, consumer electrical, and consumer durables. Certain industries, such as IT services and pharma, are more neutral to the environment. Their financials should not be adversely affected.
Financials have had to deal with the pandemic in a more difficult way, but their asset quality has remained strong. India’s metal companies are also going to be huge beneficiaries. This current inflation will have a negative impact on earnings, especially in the June quarter.
