Globally funds are moving back to riskier assets: Swati Kulkarni of UTI MF

There is a dichotomy between strong rally in the stock market and how economy is doing. However, Swati Kulkarni, EVP & Fund Manager - Equity at UTI Mutual Fund says economic recovery may be patchy going forward, the good businesses will recover to generate economic value for long-term investors. In an interview with Aprajita Sharma of Money Today, Kulkarni further says the UTI MF strives to evaluate businesses where it feels the market is being pessimistic about the recovery. Edited excerpts:

1) How do you estimate India Inc. earnings in such an uncertain business environment? What are your earnings estimate for FY21?

The downward earnings revision trends in consensus earnings estimates for the last 4-5 years depicts the fallacy of predictions for the market earnings. FY21 began with nationwide lockdown for the first 2 months, with only partial and gradual opening from June. Uncertainty is here to linger about when the infections peak out, will there be the second wave induced lockdown as economy opens up, customer behaviour post covid - will they save more or spend, borrowers behaviour - Moral hazard, SME, MSME stress impact, Timeliness and quantum of fiscal support, Labour situation, wage inflation and so on. So, it may be wise to focus on the companies that could handle these challenging times and benefit from the recovery whenever the economy and businesses normalise.

2) There is a dichotomy between economic situation and the stock market? You think markets are rising only because of liquidity and the endgame could be risky or the rally will sustain?

Worldwide central banks have responded quickly with monetary measures to increase liquidity. Also, governments have responded with fiscal expansion through cash transfers and loan guarantees. For example, balance sheet expansion in March was $3 trillion by US Fed, $1 trillion by ECB, $490 billion by BOJ. This concerted intervention may have led to globally funds moving back to riskier assets, reflected in crude moving up 50% after falling 60%, most equity markets rallying 35% - 40% including Indian Equity Market. So, the panic that followed post global economic shutdown may have recovered with the interventions that gave confidence to investors about the extended support to tackle the adverse effects of pandemic. The situation is evolving, economic recovery could be patchy, and volatility is likely to persist. But remember the good businesses do recover from such economic shocks time and again and generate economic value for their long-term investors.

3) What is your outlook on midcap and small cap mutual funds?

The valuation of mid cap indices had gone to premium of 30% over the Nifty 50 in 2017, that has since normalised. The returns over the last 5 years of Large Cap indices and the Mid Cap indices are very similar around 7%, though Small Cap indices have fared poorly with (-)3%. In fact, we observed quite similar fall in March from Jan '20 levels and recovery from March till June 20 across market capitalisation.

Having said that there have been large/mid/ small cap companies that have outperformed the respective benchmarks. We continue to evaluate businesses across market capitalisation that can sustain high return ratios and cashflow generation as well as those where we think that the market is too pessimistic about recovery in return ratios. This creates pricing anomalies and opportunities to buy decent businesses below their intrinsic value.

4) Pharma and global funds have been the outperformers in the MF rally so far. Can new investors still enter into it or have they missed the bus?

Sector funds and global funds should be used as a top up to the main / core exposure which should always be to the diversified equity funds. The sector fund carries a concentrated exposure to single sector and has a higher risk profile. Through global funds investors can diversify India specific risk but they end up taking currency risk. The USD based funds have benefited from INR depreciation against USD during this pandemic. If investors have a view that INR could further weaken, they may consider investment. We do not have any view on the exchange rate movement in future.

While domestic pharma market has grown steadily, the US generic market for Indian companies has experienced challenges with pricing pressure and plant clearance issues. Certain Indian companies have increased the R&D efforts to move up the value chain into complex specialty products, injectables, bio similars. Given the low penetration levels, domestic pharma has long term growth opportunities with increasing awareness and increase in chronic ailments. We think the return ratios and free cash generation of pharma companies could improve. Investors could allocate to pharma funds about 5% of their overall equity allocation with a long-term investment horizon.

5) Have dividend-yielding mutual funds seen a jump in demand post the abolition of DDT in Feb?

Dividend option investors may lose on the compounding effect that growth option investors experience on wealth generation. Even before the DDT was introduced, we were educating our investors on this. We have observed dividend option investors shifting to growth option since then. We have seen inflows in the fund as investors find value in dividend yielding companies particularly in turbulent times.

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