Informist, Thursday, Sep 19, 2024

--PGIM CIO: See equity returns over 2-3 yrs below nominal GDP growth

--CONTEXT: PGIM India MF CIO Vinay Paharia in interview to Informist

--PGIM CIO: "Micro bubbles" present across mid-caps, small-caps

--PGIM CIO: Exuberance in railways, industrial, defence, power stocks

--PGIM CIO: Disparity in stock price gains, earnings growth last year

--PGIM CIO: Low growth, low quality stocks outperformed last year

--PGIM CIO: Gains in low quality stocks driven by liquidity

--PGIM CIO: Mkts dangerous when they seem easiest to make money from

--PGIM CIO: Tide turning in favour of high growth, high quality shrs

--PGIM CIO: Investors used corrections post Jun to buy quality cos

--PGIM CIO: Bullish on pharma, consumer discretionary, IT, fincl cos

By Anshul Choudhary and Apoorva Choubey

MUMBAI – Investors should brace themselves for lower pace of equity returns over the next 2-3 years as the exuberance seen in several mid- and small-cap stocks may not be replicated, given that the extraordinary performance over the last year was driven primarily by liquidity chasing quick bucks, according to Vinay Paharia, chief investment officer at PGIM India Mutual Fund.

Frothy stock valuations in some pockets of the market suggest that equities have borrowed returns from the future and thus, returns could be lower than India's nominal GDP growth over the next 2-3 years, Paharia told Informist in an interview. Over the past 10 financial years, returns from the benchmark Nifty 50 index have outpaced India's nominal GDP growth rate five years and underperformed an equal number of times. In 2023-24 (Apr-Mar), India's nominal GDP grew 9.6%, while the Nifty 50 rose 28.6%.

At the core of Paharia's view that equity returns could be lower in coming years is his belief that liquidity will not keep chasing low-quality and low-growth companies forever. These "micro bubbles" present across the mid- and small-cap segments suggest that some investors are being swayed by the prospects of easy money while ignoring the risky nature of stocks, said Paharia, who oversees nearly 236 bln rupees worth of equity-oriented assets.

While Paharia is bullish on India's long-term prospects, he believes these pockets of exuberance, such as that seen in mid- and small-cap companies in the railways, industrial, defence, and power sectors, along with some public sector units and recent initial public offering counters, have very little room for gains. The low growth and low quality companies have outperformed the high growth and high quality companies by 35% during the past year, he said.

"Last one year, if earnings growth of NSE 500 was X, the return was 3X...for mid- and small-caps, if the earnings growth was X, the returns were 5X," he explained. Hence, there has been a disparity between stock price gains and earnings growth in the past one-odd year, he warned. The Nifty MidCap 150 and Nifty SmallCap 250 jumped 56% and 63%, respectively, in the previous financial year, far outpacing the Nifty 50's gain.

"I have said this before that markets are more dangerous when they appear the easiest to make money from," said the money manager, who has over 20 years of experience in Indian financial markets. As the gains in these low quality companies were driven by liquidity chasing high returns and not by the fundamentals of the underlying business, these stocks could witness a "material principle decline", he cautioned.

TURNING TIDE

With investors chasing high returns, low quality companies witnessed inflows, which led to high growth and high quality companies underperforming in the past year, Paharia said. PGIM Mutual Fund's schemes, which continued to favour high growth and quality companies, also underperformed the benchmarks during this period.

The fund house classifies high growth companies as those which have sales growth higher than their average five-year compounded annual growth rate historically, according to a recent note. It defines quality companies as those which have return on equity higher than their average five-year return on equity.

The PGIM India Midcap Opportunities Fund, which has assets under management worth over 114 bln rupees, has given returns at a compounded annual growth rate of 18% in three years, while the Midcap 150 index has risen at a compounded annual growth rate of about 25% during the same period, according to data on Value Research. Paharia is not bothered by the short-term underperformance, as he considers these cycles an essential part of investing.

The tide is already turning in favour of high growth and high quality companies, Paharia highlighted, adding that these stocks have outperformed low quality ones by about 10% since the start of June. Investors have churned their portfolio by using the sharp falls in stock prices post the General Election and interest rate hike by the Bank of Japan, which triggered unwinding of yen carry trades, he said. This liquidity shift, away from low quality and growth stocks, has been the reason for the fund's outperformance in the last three months, Paharia said.

While the extraordinary performance of last year may not be replicated, there are still plenty of investment opportunities in Indian equities, in high quality companies, even in the small- and mid-cap segment, he said. The fund house's conviction that opportunities are present across the market is evident in the fact that it launched a multi-cap fund last month, which, according to Paharia, has received better response than previous offerings.

In the long term, India is poised for robust economic growth, which will create wealth for equity investors, said Paharia. "We have a stable currency, our interest rates are reasonable in the context of what they have been historically...our central bank has been ahead of the curve in managing the crisis," he said. Even globally, he sees changes that are working in favour of India. Several world economies are facing an economic slowdown and grappling with inflation and currency-related challenges, while several global players are also looking to diversify their supply chains away from China, which can benefit Indian companies, he said.

OVERWEIGHT THEMES

The fund house seeks out companies which have a high growth track record and have high quality of business fundamentals. Paharia is currently bullish on four sectors--healthcare, consumer discretionary, information technology, and financials, as these not only offer the potential of high growth and robust return on equity but are also available at comfortable valuations.

Paharia expects IT companies to improve the pace of growth as demand is expected to recover with the reduction in interest rates in the US. Moreover, several issues such as rise in cost, pressure on margins, and attrition, are also stabilising, he said.

The Nifty IT index has risen over 20% in last three months, but Paharia pointed out that these gains came after a significant period of underperformance. Noticeably, the Nifty IT was up 18% in the last three years, as against a 44% rise in the Nifty 50 index and 59% rise in the Nifty 500 index during the same period.

Apart from IT, he expects domestic healthcare companies to benefit as global investors look for alternatives to China for manufacturing. Contract development and manufacturing companies will be the major beneficiaries of this shift, Paharia said. He is also bullish on domestic branded healthcare companies, which he believes are available at attractive valuations compared to their counterparts in the fast-moving consumer goods sector, and hospitals that are increasing capacities and becoming more organised.

Among financials, some private banks and non-banking financial companies were a "no-brainer" owing to their attractive valuations, he said. "Questions are raised like, are deposits a challenge? Wouldn't the NPA (non-performing asset) cycle go up? Or, wouldn't rates going down result in margin compression?...One does all of that scenario analysis and notices that the return on equity still remains healthy," he said.

He is also bullish on some other smaller segments such as asset management companies, which are likely to benefit from increasing participation in markets. He also likes some automobile ancillary companies which get bulk of their revenue from exports. "... many of them are actually seeing breakthroughs in their research and development programmes for electric vehicles," he said.

In the coming months, he expects lower interest rates to help advanced economies recover from the slowdown and aid Indian exporters. For India, lower rates may give a boost to consumption, especially automobile sales, which are showing signs of slowdown, he added.

Lower interest rates will also help increase money supply in the banking system, and that could address issues of slower deposit growth, Paharia said. Additionally, from a pure stock market point of view, one of the big reasons why high growth companies underperformed low growth companies was because interest rates were going up, he added.

"High growth companies are high duration assets and low growth companies are low duration assets. So, when interest rates increase, high duration gets a negative impact which is bigger than low duration," he said. But, when interest rates fall, high duration assets have a much higher benefit compared to low duration ones, he said.

Thus, interest rate cuts are one of the big triggers for high growth companies, as per the fund house.

Late Wednesday, the US Federal Open Market Committee cut the federal funds target range by 50 basis points to 4.75-5.00%, after 14 months of keeping it at an over two-decade high, and forecast another 50 bps rate cut in the ongoing calendar year. End

Edited by Tanima Banerjee

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