Business Cycle Is Likely Rebound On Back Of Easy Monetary Policy: Sanjay Dongre, EVP & Sr. Fund Manager – Equity, UTI AMC

Markets appear to be taking off into orbit despite us having gone well beyond all time high valuation multiple. Is this sustainable?
Barring few sectors, earnings seems to have been stabilized as reported in the Sep 2020 quarterly results. With shift of market share from unorganized to organized sectors, listed corporate India seems to be coming out pandemic stress with much stronger balance sheets. With vaccine uncertainty getting over, business cycle is likely rebound on the back of easy monetary policy followed central banks. Earnings are getting upgraded and market is expecting Nifty earnings growth to be 30% and 20% in FY22 and FY23 respectively. Valuations on forward earnings basis seems richer compared to historical valuations. Valuations based on P/B multiple are at slight premium to average valuations of last ten years. For these valuations to sustain, market needs to experience a) Continuations of strong liquidity b) Faster economic rebound to 6% growth c) Earnings growth better than market expectations.

What’s your take on banks now? Are you overweight or underweight banks in your portfolios?
Going into COVID19, larger banks had recognised large part of stress on loan portfolio and had made enough provisions for it. During COVID 19, most of the banks had reported 9-10% of their book under moratorium 2. Some banks had made covid provision of 1-1.5% of the loan book during 1HFY21. Recent trend suggests that the collection efficiency has already reached pre-covid levels which may address the concern about asset quality to a large extent. Although slippages would increase over 2HFY21 post the SC order, we may expect normalizing trends from FY22 onwards. Banks with a strong/granular liability franchise, higher liquidity, and strong capital levels would be able to tide over the current crisis efficiently and gain further market share.

What sort of changes have you made to your equity risk management framework, post COVID? Have you incorporated any structural changes to the ways in which you manage risk?
Every portfolio manager must adhere to Board approved limits in terms of single stock exposure, single sector exposure, top 10 exposures, maximum cash levels etc. Even research process mitigates the risk to a large extent by assigning high consideration to the operating cashflows and profitability in terms of RECE/ROE. In a COVID or non COVID environment, risk management remains an integral part of fund management process at UTI MF.

How do you intend to identify and avoid fragile businesses over the next couple of years – those that will struggle to adapt to the new normal, and may go through extended periods of pain to the point of capitulation, even?
Fragile businesses are exactly opposite to the quality business. Quality companies are characterized by high free cash flow generation on a sustainable basis, high ROCE and high ROE. High free cash flow means no debt on their balance sheet and hence entire the cash flows are available for distribution to shareholders. High ROCE means less reinvestment rate to sustain higher earnings growth. Hence quality companies tend to attract higher valuations in the marketplace.

Fragile business tends to have irregular operating cash flows and earn poor returns on their capital employed. In the absence of sustainable operating cash flows, fragile business tends to have leveraged balance sheet. Hence fragile business is most vulnerable to the disruptions caused by unknown events.

Lastly, what would your advice to investors be? While we all know that equities are for the long term and time in the market does beat timing the market; would it not be unwise to be passive and not take profits at these levels?
Valuations have started becoming richer when compared to historical valuations. One strategy to beat volatility would be to pay utmost importance to asset allocation. At higher market valuations, investors need to have lower exposure to equity asset class. At lower market valuations, investors should have higher allocation to equity asset class.  In order employ this strategy, investor needs to follow valuation-based discipline while investing in equity asset class. Current COVID crisis had created opportunity in Mar 2020 for the investors to increase its allocation to equity. At current high valuations, investors should be prudent enough to reduce allocation to equity class. Funds that follow a valuation-based quant model for dynamic asset allocation will be able to meet the above-mentioned investor objective.  The lower equity at higher market valuations and higher equity at lower market valuations enabled these funds to deliver higher risk adjusted return to the investors.