Markets have been quite volatile this year. But investors who reacted to every rise or fall often found themselves on the losing side. Kalpen Parekh, MD and CEO, DSP Mutual Fund, talk to Activity area on the approach investors should take when there is an interaction of factors beyond their control, the positioning of the CMA’s portfolio in the current environment, activity around passive products, and much more.
Excerpts from the interview:
February through today has been a wild swing for the markets. What caution would you advise?
Worrying about the markets and acting on every short-term event is not healthy while building a sustainable portfolio. We assign weights to concerns that are material, that may last longer, may impact companies’ earnings or business models, and if not, we don’t really care.
There are events that go in opposite directions and happen in very rapid cycles – within about 15 days.
So how do we react to these opposing events, which occur frequently? We have created a wide variety of styles in our backgrounds. Some asset pools are clearly defined around quality and growth as a strategy. There is another pool defined around quality and value. The third pool is fungible. It will navigate according to the market cycle. But we’re not very responsive to, you know, shorter events.
That said, current geopolitical events can have profound implications. In the short term, what worries us is that energy and commodity prices remain high. Over the past 5-7 years, our macroeconomic variables have remained strong, but these events can be a turning point in our macroeconomics, whether in terms of deficits, higher government borrowing, inflation or currency. A reasonable part of our portfolios is partly commodity intensive, and this has an impact on the margins and profitability of some of them.
Kalpen, who holds a master’s degree in management studies in finance and a bachelor’s degree in chemical engineering, has 23 years of experience. Prior to joining DSP, he was responsible for business growth at IDFC MF, Birla Sun Life AMC and ICICI Prudential AMC
Are we at a point where markets could correct due to weak earnings?
The market is already pricing this in (earnings weakness). But the real data will come in the next few months. The benefit of lower costs and cost savings, and therefore improved margins, is behind us. But the good companies have improved their execution, and the leading companies in each sector have significantly improved their finances. Whether metals, commodities or technology companies, all saw their margins increase until last year. Starting last quarter (Q3 FY22) with higher energy prices and higher input costs, cement, consumer, engineering and automotive companies started to face challenges on the edge of the margins. There will be many sectors where the advantage of tighter cost structures and improved profitability will disappear, and they will need to be competitive in the new environment.
Considering this phase of high input costs and inflationary pressures, would you be shuffling your portfolio?
We like companies with good ROE, reasonably good free cash flow, little or no debt. In this construction, we have been reasonably overweight Banks, NBFCs and IT and are happy with our weightings in these sectors. Looking at the concerns discussed earlier, these sectors are not very affected by the concerns. So we don’t want to make any big changes at this point.
There is a small portion of the portfolio that has been impacted by these worries and the price has corrected a lot. Stocks here are available at lower average valuations than the past 3-5 years as stock prices have reduced downside risk. Cement and consumer businesses are two such segments. The automobile is another and the one where we have increased our weights.
As for the automobile, does the shift from fossil fuels to electric vehicles bother you?
EV is a very big, age-old thing that is playing out globally and will be happening in India as well, but over the next 10-20 years. In between, there will be near-term demand for fossil fuels as we see today. 18 months ago, we launched a frontline natural resources fund, which invests around 40% in metals, 20% in gas, 30% in traditional and new global energy companies. When metal stocks fell and oil prices temporarily fell to zero, for no very technical reason, we introduced this fund to our investors. The theme made more returns than any other sector.
Valuations in many of the sectors you mentioned have gone up a lot…
We make sure that at the extremes of valuations, we cut some earnings. Now, since the peak, some tech stocks are down 20-25% and we are reallocating at this point. So these are small adjustments that we continue to make. Generally, most of our funds have a holding period of 5 to 7 years. Many stocks have been in the portfolio for 8-9 years. Our fund manager’s temperament is that you accept corrections and thrive on volatility. Now is a good opportunity for someone less invested in the markets to build an asset allocation.
Do you see a repeat of the tantrum of 2013?
Our central bank has assured that we will not see the type of fragility of 2013. The government and RBI have been very focused on controlling inflation and bolstering our foreign exchange reserves. Thus, the temper tantrum can be a limit; its intensity would be much less according to our hypothesis. Overall, many governments have had a lot in terms of stimulus over the last 1 to 1.5 years. Relatively, India did not give a very large stimulus. To that extent, we are in better shape. But if rates rise very sharply globally, our interest rates will also rise. But the biggest threat is that energy prices and inflation remain high.
For nearly three consecutive years, IIDs have weighed on the markets. Can they continue to anchor the market?
Everything is cyclical, be it liquidity, interest rates or inflation. In this context, I don’t want to extrapolate these flows ad infinitum. Whenever other alternative asset classes like interest rates rise enough and offer a positive real rate of return, investors can increase their exposure to fixed income securities or the gold price trend begins to rise. improve, then it can create a credible alternative. But until that happens, there is a structural force to this tendency towards reasonable discipline, long-term investing, which becomes part of every new investor’s rule book.
There are a multitude of passive fund launches in the industry. With SEBI’s strict categorization standards, is passive/intelligent beta the only way forward for the industry?
On the first level, I think the customer base investing in the industry is growing; so don’t worry if it comes in passive or active. Now can I say that passive funds will give the best return compared to active funds? The global data point indicates that it is very difficult to meet the benchmarks. But so far in India, there are more managers who have been able to consistently beat the benchmarks, although I don’t take that story lightly; benchmarks are becoming more and more efficient thanks to smart beta products. I think these trends will accelerate, which is why we’re seeing more funds launching into the passive space. Investors should not think of active or passive funds in binary terms.
New AMCs are coming to market with a lean, technology-driven approach. Do you see them disrupting the business?
Technology is a huge enabler, and anyone who doesn’t embrace it and move forward with it won’t have a place in the industry. Our consumers use technology in every other sphere of their lives and why would they give us special treatment. We need to move upmarket and become more user-friendly. DSP was among the first to invest heavily in technology.
As organized stock portfolios compare to mutual fund portfolios, should regulations be tightened up for the former?
We took a small stake in Smallcase. As a trend, we consider it (curated portfolios) to be very progressive, which opens up so many new investors to the cult of investing. Anything that helps expand the market is good. Thereafter, it depends on our ability to execute and add value to that investor. There is no doubt that it is a competition for us, because it is from the same portfolio that the money goes elsewhere. But which category has no competition? We cannot live on our past laurels. We must be on our guard. These new platforms with smarter thinking will keep us on our toes and hopefully make us better.
April 23, 2022