‘The market will trend towards quality and more visibility’

Sandeep Kothari, portfolio manager at Fidelity Mutual Fund, has always been fascinated by the markets and the people who move them, diving into the field soon after he became a chartered accountant in the early 1990s. After spending nearly a decade on the sell-side, he joined Fidelity in 2002, and still speaks excitedly of how wonderful it is that all the people he looked up to are just an email away. He spoke to DNA about the uncertainty of global events and how a market in a flux can be used to add companies at attractive valuations. Excerpts:

The monsoons are just about starting; how important a factor is it for the markets?
Let me put it this way — one bad monsoon is not going to derail the long-term story for India. But given the nervousness globally, given inflation worries in the domestic market, a significantly less-than-normal monsoon will have negative implications for the market.

What are the factors you look at when making your investment decisions?
We have a framework of how the macros and the monsoons and the political situations could play out and what could be the implications for the sectors, stocks, etc. These things are important. We look to identify good businesses, with good quality management teams and with long-term scalable opportunities and buy with a long-term perspective. Buying good businesses at a reasonable value is really what we focus on. There are ‘n’ number of variables which really affect the overall investments and returns.

Where do we see opportunity currently?
Our portfolio is overweight currently on the healthcare sector, the financial sector and some of the media companies and consumer discretionaries.

What is the outlook for the healthcare sector?
It is again stock-specific. We are overweight on the healthcare space because, over the next two-three years, the pipeline for some of these companies looks extremely attractive from a US or international market perspective. The domestic market is also doing reasonably well. These pipelines have only the risk of execution. Whether there is inflation, deflation, whether the monsoon happens or doesn’t happen; it’s quite immune to that. We see good earnings potential for the next two-three years and we see a reasonable sort of valuation for the sector.

What are the arguments for financials?
As we are looking at the pick-up in the credit cycle, we are hopeful that things should improve from here. We do own more of the private sector banks, and some of the diversified financial institutions. It was a proxy play on economic growth and the valuations were reasonably attractive at the point in time.

Are they necessarily attractive now?
As we take medium to long-term calls, we are still happy to hold our positions in the financials sector. Of course, if there is big interest rate shock or inflation really goes up, that is a risk which one would have to watch out for, but overall as the credit cycle and the capex cycle picks up, I think the sector should continue to be reasonably strong.

What macro factors are you keeping an eye on?
How the growth in India pans out, what part of the business cycle we are in, how the credit growth picks up, how the capex cycle would pick up, what structural reforms the  government continues to make will determine how strong the growth outlook will be. And obviously what’s happening in the global economy — can that have implications for the fund flows. These are some of the factors which are secondary which we have to keep in mind. These are not the driving force to form an investment view but these do aid or this is the framework within which the investment view would be formed.

How do valuations look for the market as a whole?
We are trading at the mid range of the valuations cycle right now. They are not in bubble territory, they are not extremely cheap. A lot would depend on how the earnings growth pans out. At this point in time, it looks like the earnings growth cycle is reasonable in the Indian context.

How could the correction in commodities affect earnings… Is there a risk of earnings downgrades?
The downward commodity cycle usually tends to have an effect, since commodities play a large part in driving the earnings up. But ex-commodities also, if you look at the market on a historical basis, it would trend towards the mid-cycle valuation. If commodity earnings collapse, does it take the whole market down or does it start benefiting the auto sector or any other sector because of margin expansion? There are counterbalances, and again taking a whole market view on the basis of market P/E...it’s just an indicator. Ultimately it goes back to which stock, what value, what is the growth aspect, and that’s much more easier to try and forecast.

What are you watching on the global scenario?
There are three factors to watch; one is the US, which seems to be recovering, then the there is the Euro area with its sovereign risk and then there is China where you have the strong investment cycle and what happens with the attempts in tightening policy.

How do you deal with the kind of uncertainties that are out there currently?
We don’t have a very strong view. What we try to do is keep all of these factors in mind and see what implication they would have an investment perspective… how do you protect yourself or what do you do? And the answer is, given all these uncertainties — and there are a lot of variables which are playing — the market will trend towards quality and more visibility. Probably, if required, pay a higher price for that.

If we come back to India and we think about the domestic economy, which is not immune but to an extent protected from all of this from a medium- to long-term perspective, then if you have quality, you want to stick to those managements which have a scalable opportunity. That’s where you would focus on rather than taking much higher risk in the portfolio.

What does this do to capital flows?
Over the short-term it could be volatile. If there is huge risk aversion, will the capital flows go out or stop? I think the answer is potentially yes. Long-term if the capital has to go where the growth is, it will find its way to emerging markets such as India and China due to the demographic and other positives. This is the consensus view and hopefully that is how it would play out.