Utpal Sheth is the CEO of RARE Enterprises. He has more than two decades of experience across the entire spectrum of the capital market. With the theme of ‘What Next?’, Utpal shares his views on capital market scenarios.
There have been enough discussions on how the COVID scenario will play out. According to Utpal, rather than basing an assessment of capital market scenarios on a view about the economy in this highly uncertain time, it would be more useful to create multiple scenes. These include:
Optimistic scenario - This is when life comes back when we knew it earlier by the end of June.
- Realistic scenario - This is when life comes back, and we knew it more first by the end of September.
Pessimistic scenario - This is when life comes back by the 4th quarter of this year.
In these three scenarios, the economic implications will be dramatically different. Let us consider the optimistic scenario first. Credit fund is a small part of the debt fund market. It makes a lot of sense for investors to continue to pursue mutual funds both in equities and in debt. Mutual funds serve many objectives for these investors. It is wrong to bait on mutual funds with the same rush. You must recognize that the Indian banking system has an NPS of 9 - 10% at this stage, and it has risen by 11%. Hence it will be wrong to assume that mutual funds will have zero credit loss.
The equity markets are factoring in the optimistic scenario at this stage. If it needs to be re-calibrated to either the realistic scenario or the pessimistic scenario, we will see re-calibrating markets, leading to a lower crisis. At this point in time, the indices are not very representative. This is because they are highly correlated to the top 10 stocks.
The realistic scenario, on the other hand, will have a high economic cost attached. It remains to be seen whether this economic cost is borne by the government or by the private sector and the household or by the financial system.
We have been waiting for the economic stimulus or physical support since the initiation of lockdown. Whenever it comes in, its significance will be seen. Irrespective of the economic stimulus, one will have to be very cautious and prudent in building their portfolio and their stocks. We are now in a scenario where it is only the leaders or the strong players in each sector who will be standing tall. These players are expected to become even stronger. The weaker players in each industry will be significantly hurt.. That leads us to an investment approach where we need to look at concentrated portfolios and leaders who are the part of these portfolios.
The adaptability of those leaders will also be essential. While the quality of management is also crucial in any investment approach, it will become paramount in this uncertain time.
The last scenario, which is the pessimistic scenario, can put India back quite a few years in terms of its progress. Not just GDP growth rates but also our per capita income and consumption patterns will be forcibly leveraged at corporate as well as individual level. So that could lead us into a long economic winter.
In each of these scenarios, there will not be a second wave which will lead to the second round of shutdowns. We should all be clear that we are facing this scenario for the first time in our lives. So, prudence is the name of the games far as asset allocation is concerned. For stocks, one should stick to the leaders. The evaluation of the leaders should be a little more favorable to the investors.
One must not lose sight of how the next five-ten years will evolve, in whichever scenario we consider. We will see decades of lower competitive intensity going forward. There will be many years of improved pricing power, higher entry barriers, prudent capital structures by corporate and better return on capital employed, and equity going forward. This is because everybody’s return and risk frameworks have been revised.
For each management team and company, their adaptability will be at the premium. Business models, revenue models, pricing models and customer engagement paradigms will change a lot. But it is not that this change is only because of the current COVID-19 scenario. A lot of these changes have already been in motion. But COVID-19 will accelerate these changes. Satya Nadella of Microsoft has gone ahead and quantified it. He has mentioned that we have had more than two years of technology adoption happening in these two months. Those companies that will survive this difficult time will emerge far stronger and valuable. Those companies will move forward faster.
As we say, the only thing to fear is fear itself. So, there should be a balance of prudence and vision for all investors.
Q&A
They appear to be diverging at this point. Markets are voting machines in the short run and weighing machines in the long term. So in the long run, they will converge again. There is no need to be worried. It is better to look for specific opportunities than worry about the indices.
The debt market has gone through the most uncertain time in the last two years since the IL-FS crisis happened. Some of the outcomes were better, others were avoidable, and some were unavoidable. There is no point in looking in the unpreventable results.
The financial discipline in the corporate sector and individual level will be at a new high. The depth of the debt market about credit papers was pretty shallow. But now there is some improvement there. This whole debt market challenge has motivated RBI and plays a far more active role now than ever. But one should not cry over spilt milk.
Pharma seems to be at a favorable position at this point in time. The potential for pharma is quite a bit with the changing global scenario.
Direct to consumer sector will come back, but India’s consumption appetite is not going to fall. It may be calibrated because there has been a significant increase in household debt to GDP in recent years. People will be far more reluctant to take on incremental credit.
There is a difference between debt funds and credit funds. The recent challenges have been in the credit funds and not across debt funds. Within debt funds, there are liquid funds, income funds, gilt funds and so on.
Being glued to the market is not the best way to find quality leaders and management teams. You can see it from a distance. It helps you to sift the signal from the noise. So, one should not take that as a handicap but take that as an advantage. In this new age where disclosures are so good, companies interface with investors and put everything on their websites, and so on. Investors are very well positioned to take these calls. You have to make these investment decisions very few times a year. The lesser action you have, the better long term rewards you get.
FII is a relative opportunity game. Forget what is happening in the immediate context. But in the long term, the USA, China, and India are going to be the three most important markets. It would be inevitable for FIIs to have a proper allocation in each of these markets.
While we may be the smallest of these, we have the potential to be the fastest-growing of these. Right now, fast-growth might seem like a dream, but it is not always going to be like this. Happy days will be back.
Closing comments
Every crisis brings opportunity with itself. We should look at this as being one of the most significant opportunities. How we play is very important. Play for leaders that will compound for ten years rather than looking for valuation at this point in time. You will be proud of yourself ten years from now.
