Getting the CAD call right

With the macroeconomic concerns holding sway over the last year, fund managers Sankaran Naren and Mittul Kalawadia put their fai th on a top-down approach to investing in the markets. The schemes managed by the duo handsomely beat the CNX Nifty Index. While the benchmark index returned just 0.56 per cent for the year ended September 30, the Dynamic Plan and the Top 100 Fund gave absolute returns of over 5 per cent each. The two fund managers combined well to get their investment strategies right. While Naren, who is the CIO of ICICI Prudential Mutual Fund, looks at the big picture, his co-fund manager Kalawadia zeroes in on specific stocks within the chosen sectors that are available at attractive valuations.

The view adopted by the fund managers over the last year was on account of an expanding current account deficit (CAD) and huge trade deficit. Moreover, till August 2012, oil subsidies too were going up. "The call given in this scenario was to be overweight on export-oriented sectors such as pharmaceuticals and IT," says Naren. A key differentiator which helped outperform was the call to be careful with investments in the financials space. "Our past experience shows (global examples such as Spain), as the CAD expands, financials tend to underperform. We had been underweight in financials for the last couple of years because of this worry," he adds.

Another area that helped them score over competition was the energy and materials space. The fund managers saw it as import substitute sectors rather than one controlled by China. Stocks like NMDC and Cairn India were earning in dollars and weak rupee helped them get better returns. The thrust thus was on dollar earners as well as dollar savers. Continuing on the theme of higher CAD and a weak rupee, they looked at midcap names in the textiles and shipping space. The company took exposure to GE Shipping given that it had dollar assets and dollar was growing stronger. The focus thus was more on global companies such as Tata Communications, Standard Chartered and Motherson Sumi. While the top-down analysis gives the overall picture, given the tough economic situation, the fund house avoided companies which were not financially strong especially the leveraged infrastructure plays. "You look at companies which have robust balance sheets and are cash rich," says Kalawadia.

In addition to the sectors impacted by the economy, the fund managers also picked up sectors which were at the bottom of the cycle. Between April and September 2012, they saw value in telecom which a number of people had given up on. "We don't worry when somebody says that the sector is in big trouble. For us it is an opportunity to invest in the sector," says Naren. Stocks such as Bharti Airtel, Tata Communications and Bharti Infratel are part of their portfolios. The basic stock picking principle for the fund managers is to see whether it is available at cheap valuations. The valuation call comes through given the huge differential in market cap of telecom companies in India and countries such as China and Malaysia. Further the potential given the explosion of smart phones and data usage was another factor which helped dispel the notion that the sector was in distress.

In equities, while some of the above names gave good returns, where the duo went wrong is investment in the consumer sector. "While we thought that the consumer stocks were expensive at 30 times price to earnings ratio, they went up to 35 times," says Naren. Consumer stocks had outperformed last year and the fund house avoided them thinking that they were expensive. While the fund managers have been averse to consumer stocks because of valuations, going ahead they will however look at them if the underperformance (over the last three months) continues. While the fund has high weightages for financials and IT, the relatively higher weightage for pharma (with respect to the broader indices) was in lieu of consumer stocks. While pharma and IT sectors were safer bets to be invested in, Naren believes that they are fully valued as of now. However, they will continue to do well till growth comes back to the Indian economy. On the financials sector, they are less underweight given that CAD worry is not as severe as it once was.

What about the rest of the market? Naren believes that returns are dependent on the election outcome and the perception of investors to the same. "For the stocks to give a return you need a catalyst. Once a critical indicator such as the IIP for example moves from 2 per cent to 5 per cent all the cyclical sectors will move up," he says. There is value with some sectors trading at low price to book value, some of which are below the 2008 crisis levels. The fact that they are available at low capacity utilisation levels will translate to higher operating profit margins once the situation improves, say the fund managers.