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    Wizards of Dalal Street: Watch S Naren of ICICI Prudential AMC and Ramesh Damani in coversation

    Wizards of Dalal Street: Watch S Naren of ICICI Prudential AMC and Ramesh Damani in coversation

    Wizards of Dalal Street: Watch S Naren of ICICI Prudential AMC and Ramesh Damani in coversation
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    By Ramesh Damani   IST (Updated)


    Below is the verbatim transcript of the conversation between S Naren and Ramesh Damani.

    Below is the unedited transcript of the conversation between S Naren and Ramesh Damani.
    Damani: I have heard investors, I have heard fund managers use words like apocalyptic, cataclysmic, unprecedented, what is the adjective that you favour to describe what we are going through?
    Naren: I would say as a contrarion I have seen it as a great opportunity. The beauty is that you thought that you had one opportunity and we saw that there were two opportunities.
    So in the month of March, we went to town saying that there is a massive opportunity to buy equity because as such, we thought that when there is panic on the streets, it is a time to buy an asset class and panic and valuations being cheap is the time to buy the asset class.
    However, I never realized 30 days later, you will get an even better opportunity in a much safer asset class: debt. So one month later we were doing similar sessions telling people to invest in debt mutual funds at a time when there was panic.
    The beauty is that in debt, it was even more interesting. People started saying debt is an unsafe asset class compared to equity. And it is so interesting that the entire last week, people were redeeming or were thinking of redeeming from debt last week. Today, the losses that they have suffered in equity is unbelievable compared to what they would have lost.
    That is the beauty of contrarian investing. Last week, there was filing in debt but the losses that have happened today is in equity. I don’t think we are going to have a year like this year where you get an opportunity to panic first in equity and therefore a big investing opportunity in equity then there is a panic in debt and then there is a big investment opportunity in debt – where are you going to get such years.
    In my investing career of being in a fund management, this is possibly the first year after – and this year has turned out to be even more challenging than 2008 because all this has happened in a very short span of time.
    Even in 2008, it happened in slow motion and we did not understand various mistakes, today we understand that we have something called global macro and consequently it has been an amazing year for people who want to buy in panic.
    Damani: You sound optimistic to me but I know you are cyclical investor, you are a contrarion investor and you use a checklist to see whether there is value or not. Can you tell me first of all where do you think we are in the cycle of investment, are we in a boring zone, are we in a boom zone – clearly not – but what zone are we in right now?
    Naren: Basically you have to look at it from both the asset classes. If you look at debt as an asset class, we are in an absolutely phenomenal phase because what happens in debt is you are having a deflationary period in India, you have had seven years of no returns in real estate, you have had no returns in equity for five years, no returns in oil for six years. So you have a massive deflationary period. Then you have had the situation where many companies have not survived. So in debt you are possibly in one of the best periods to invest in debt and in a deflationary period what I learn from watching Japan, Germany, Europe and US is that in deflation debt turns out to be - debt followed by credit turns out to be the best asset classes to invest in because when people are paying up – first job when people have to pay upon debt and credit is the best asset class at this point of time. So I would say we are in a phenomenally attractive period from a debt point of view.
    From an equity point of view, it is very mixed at this point of time because first I would think that debt has to play out then credit has to play out. After debt and credit has to play out then there has to be a leveraging cycle. In that leveraging cycle, you will make very good money in equity and you are first dealing with another problem – you are dealing with a problem called coronavirus which is outside the zone of core competence of anyone like Mr Naren then you have legends like Warren Buffet and Charlie Hoover talking that they don’t understand the problem – who are we to understand the problem.
    So I would say that for people in equity – you are in a confused zone for the short run – obviously after debt and credit works, clearly equity is going to be a great asset class. So if you have the patience to sit through that asset class, it is great which is why what happens is, as long as you are willing to practice asset allocation in these periods of time and you are willing to handle a situation, you will sell debt as it goes up and buy equities on the way down because the kind of volatility you see in these periods, you make a lot of money out of asset allocation then asset allocation becomes interesting.
    So on the whole I would say we are in a phenomenally attractive period in debt and you are in an average period in equity but you are in a very good period for equity provided you are genuinely long-term and you are not bothered about what happens in the short-run at all in the equity, which many of us are but not everyone knows because I believe that many of the people want to see returns on a day-to-day basis and for that this kind of an environment doesn’t suit itself because can anyone predict earnings for 2021? I have told to all my research colleagues don’t focus on predicting earnings for 2021, focus on which is the company that you think will be the best in 2021, which will be the second best but don’t predict the EPS because what is the logic in predicting EPS when you cannot predict it.
    Damani: I am genuinely surprised that you are so bullish on debt because the issue as I see it is that it is not a liquidity issue, it is a solvency issue. A lot of industries will go bust, a lot of commercial estates will be under a problem, a lot of businesses will not be able to survive another lockdown if it happens in next six months, so what makes you so bullish on the debt profile because actually there will be a lot of defaults in the next six months to one year?
    Naren: All the holdings that we have are for April 30th. In our credit risk fund, they have already displayed it in our website.
    So what happens is suppose if you have perpetual bonds of a bank- are the perpetual bonds of a bank less risky than equity or more risky than equity? Clearly they are less risky than equity. The reality is when you talk about all these cases, how much of the money is – if you look at any funds of ours, look at where the money has been given to, you will find that those companies are going to go belly up then there is no India left. That is the beauty of what has been invested by the debt mutual funds of ICICI Prudential - we don’t believe that a prominent industrial groups of India are going to have a problem and we believe that what we have are all the survival industrial groups of India and therefore we believe that they are going to have a problem and people believe that we are the investors in all the most unsafe companies.
    If you look at the kind of credits that we have in our portfolio, you will realize that and compare it with what others have in the rest of the financial services system, you will find that mutual funds have cherry-picked the most safe ones and what happens interestingly is in 2008-2010 maybe we were taking more riskier credits at that point of time but most of them had been given us lower units of credits and many of the credits that we had given were so low duration that the riskier part of the credits have all come back to us long back then what we are left with is almost most of it, I think 98 percent or a very large percentage is in the AA- and above and if AA- are all going to go bankrupt then there is no future for equities in India. That is how I look at it at this point of time.
    People have this belief that equities will recover and debt will not recover – that is not true because if you look at the 1995-2003 cycle, debt went through a downturn but equities also went through a downturn. So I believe that equities is an asset class, it is priced for everything at this point of time and it comes as a fabulous asset class in a deflationary period. Look at what happened in Japan, Europe and US – you will find that in deflation, there is no better asset class than debt but there is no choice for the government and the Reserve Bank of India (RBI) but to cut interest rates and keep supporting the system because it is only through lower interest rates, people will slowly solve the problem in the economy, there is nothing else that the government and the RBI can do at this point of time to solve the problem of the system.
    I am sure that the government and the RBI will do it slowly, they have been cutting rates, they will do other things like TLTRO and LTRO and various other things because they need to bring the economy back and that has been a long drawn process but at the heart of it will be lower interest rates and support to the entire system.
    Damani: You talked earlier about asset allocation, so someone who is in about 30-40 age group, what is the asset allocation between debt and equity or debt, equity and some other asset class that you propose for someone who is 30 years old right now?
    Naren: The point is that when an asset class becomes very attractive, what happens is you have to overweight an asset class. So the way we look at it at this point of time is massively overweight in all debt - asset allocation as a category and are positive on equity through asset allocation as a category and are we neutral on equity otherwise? That is how they have been recommending the system. If you had asked me in March, it was different but from March – 7,500 to 9,200 maybe today it has come down but I would say there was a clear 20-25 percent move after that 20-25 percent move this was clearly the view that we have to be massively overweight debt, massively overweight asset allocation category and through that we have to be optimistic on equity and be neutral on equity within the asset allocations space.
    Damani: I get that point, massively overweight debt but let me bring you back to equity. You are not only a contrarion, cyclical investor but also a checklist investor – you used the checklist, price to earnings, price to book, marketcap to GDP are few of the criteria to determine how cheap equity valuations are. Given the signals that you used for many years in the past, where do you think equity valuations are in the spectrum?
    Naren: I think clearly there are two types of stocks – one is a set of stocks with the quality, high ROE, high ROCE in balancesheet companies, they are trading in one different world then you have companies, which are trading in another world, what has happened is the global central banks have ensured that you have created a very conducive element environment for equities because there is too much debt in the system and maybe that is what has led us to these two different market valuation metrics for these two different types of companies. So the result is that you have a set of very cheap companies prior to this fall and even now you have a set of costly companies. I would say – I would bet on the cheap companies and in that for example there are sectors, which we thought were very cheap which have recovered very well in this recent correction – one was telecom and second was pharmaceuticals. On the other hand I have sectors like power, upstream oil and metals, which have shown no major improvement. So I would be clearly on the set of the cheaper stocks despite the fact that I have not made money in any of them and except telecom and pharma which have exceptionally done well in the last 3-6 months. I would say the other sectors which we had bet on from a contrarian perspective have yet not done well and I would continue to bet on them.
    On the other hand, on the quality pack the NBFCs have got destroyed, everything else has become very costly, they remain costly. But I think if you look at some of the consumer numbers and the actual valuation of those stocks compare it with the numbers that they have delivered their divergence is increasing by the day and in my contrarian view point these kind of valuation differentiation cannot continue forever. So I am a great believer in my set of stocks, but how long my patience will be required is something which I am going to see. Luckily out of this pack, two have delivered pharma and telecom otherwise I would have been in a bigger problem. But I still have a number of sectors which have yet not delivered in this pack.
    Damani: I know one method which I have always admired the way you use it because you are a contrarian, as you crunch the market caps of the favoured sector as oppose to the unfavoured sector and see relatively how cheap they are. Historically, you use that – can you share with us a historical example and then a contemporary example to see where you are finding value?
    Naren: Clearly, if you look at it what worked for us very recently if you ask me telecom market cap was absurdly cheap relative to any other sector in the economy and the telecom as a percentage of GDP was very cheap, and unrelated to the importance that telecom had to each of us. So we made our telecom one of the largest weightages in almost all our portfolios and it kind of worked like magic in the last six months.
    The second was – you had a situation where India’s largest consumer sector company was comparable to the pharma sector in terms of market cap. Now ideally which happened in this whole thing is that India’s largest consumer sector company also went up and the entire pharma sector also went up. So while we did not gain on a relative basis, we gained a lot on the pharma sector because the pharma sector got massively re-rated in the recent past. So today if you look at it the aggregate power sector today the market cap us is so low compared today to any of the consumer sector and today what I look at it in lockdown which is a period where you are at your lowest consumption, what are the things that you cannot do without in this period, we have clearly seen.
    We cannot do without telecom, we cannot do without power, we cannot do without medicines and we cannot do without consumer staples and if you look at it in these four, we looked at and found that which is the sector which has the lowest market cap between these four, we found that power is the sector which have the lowest market cap in these four. Today, frankly we are looking at power because the aggregate of all the power companies is lower than the single market cap of one consumer company in India and that is a comparison.
    We have seen that overall these strategies work and it takes some time to work and you will have to be a bit patient because we are in this entire possibly in this divergence and possibly at the end of this divergence and I think some amount of patience is required. Just like telecom instantly worked and pharma instantly worked, we have to be a bit patient on this because this corona was something which hit us out of the blue.
    Today for example aggregate of market cap of energy stocks in the world is lower than the market cap of the leading technology companies. So can that market cap continue, I don’t think it can, but at this point of time corona has created such a lockdown that oil prices crashed all over the world and led us to this. So I think that something it will divert in the next few years but on the other hand we are all taking a call that corona is a transient issue which is what I am also taking a call when I am giving a very good long term call on equities. So that is how things are and it works, but it does cause its own pain as we have seen from the past.
    Damani: Another sector that shows up in this contrarian screen according to a presentation you gave a few months ago was the top company in India is perhaps worth more than all the public sector units listed. Would the public sector stocks also represent a contrarian bet at this point?
    Naren: Certainly, actually we have strongly believed it and we believe that if the companies – there have been a lot of dilution of government holdings in many of the public sector entities, I think if they were to just focus on dividends and buybacks over a year or two I think there is going to be a massive re-rating in many of them. If you look at that the aggregate dividend yield of many of these stocks given that dividend distribution tax has also gone and the kind of dividend yields which are there compare it with FD rates which are being offered by many of the banks – many of these stocks have become extremely attractive at this point of time. Consequently, it has become one of the most attractive themes at this point of time to invest in.
    I actually believe one of the best themes to invest in at this point of time is the deflationary theme. Outside the debt side, would be the sustainable dividend yield simply because of the fact that everywhere in the world you have no choice, but to come out of this world by reducing interest rates. If you are going to reduce interest rates what is the best way to invest is identify all the stocks which can give you sustainable dividend yield and invest in through a sustainable dividend yield fund because that would be the kind of strategy which I believe can actually lead to a very good investor experience at this point of time because in a low interest rate environment that we think is one-way to actually lock-in lower interest rates. Because at some point of time if global yields were to also go up they can actually lead to bond losses in the other parts of the world. But dividend yields turns out to be a much safer way to invest on the equity side. So I think sustainable dividend yield as a theme is going to work in most parts of the world including in India at this point of time.”
    Damani: As a contrarian investor, you have not been afraid to invest overseas. I know you have invested in American markets when India was too costly. At this time you think it is better to put money into the S&P 500 or the Sensex?
    Naren: Since this public information and thanks to SEBI we have to mention our portfolio on a monthly basis, we launched an interesting product called Global Advantage Fund of Fund which can invest in other products listed in India. So that product is invested for example in Japan and from a contrarian perspective I have not found an area which is cheaper than Japan because there interest rates are excepted to be Zero indefinitely and you got dividend yields which are 3, 4, 5- 6 percent and unbelievably cheap equity market relative to debt markets. It is a country which as huge current account surplus. It is a country with a huge net international investment position unlike West, so it is a currency which you can safely believe in any market will finally appreciate.
    So I am much bigger believer from a contrarian perspective in Japan over US, because US is a current account deficit country and it has the best companies in the world. But it requires growth investing because you have to effectively believe in the technology majors of the US to actually bet in US because finally at the end of the day it is the current account deficit country and the currency has massively appreciated.
    So I believe very strongly in Japan as a contrarian way at this point of time over US. In our Global Fund of Fund, we have the ability to invest in US, Japan, India, Asia, China etc. and we have taken a position in Japan this is a public information.
    Damani: Has your investing style changed or after this Coronavirus, do you think the world will be different once we return back to some sort of normalcy? Will you look at stocks differently or different industries would be winners?
    Naren: I think working from home itself has been a revelation. Sometime you don’t know that you have been working on Saturday from morning to night and you don’t realise it. I think a lot of things are going to change but we have to put our thoughts together and see how we have to look at things differently. I think there is a lot of activity we have to do and analyse on how to think about various things differently from what we did in the pre-Corona period. What has taught me is at the end of the day you will have euphoria, you will have panic, in panic people behave in a particular way, in euphoria people will behave in a particular way. At the end of the day we are managing public money, we have a responsibility to manage public money in a responsible way, all these challenges will remain and will continue to remain. The ability to communicate to everybody that they are managing money responsibly, we can also make mistakes but at the same time we are still managing money responsibly, all these are going to be continuous challenges which will remain. Whether Corona comes or goes and what happens due to Corona all those things will continue to be.
    Damani: You said about managing public money and it is a huge burden, you are one of the largest asset managers in the country, do you feel the pressure in times like this when the markets are down, negative returns are there across all mutual funds, does the pressure get to you sometimes?
    Naren: After 2007-2009 we came to a conclusion that we have to launch and recommend funds which are more defensive. So we came up with this entire category which is focused on asset allocation, as the category which can be sold throughout the country. That model Nimesh managed to get the entire sales team to market and this category has actually given investors a much better experience than the market in all market declines. Given that most of the investors want safer market experience and we believe that, that is the only way forward. You cannot sell the most aggressive products both in equity and in debt to everybody because it is not working. You have to sell intermediate risk products to everybody because that is the only model which can actually make investors stay with you through cycles and live with you in the long run. Once they stay with you through cycles, they are going to make huge money in Indian asset markets both in equity and debt. That is the lesson we learnt and that is how we created categories like balanced advantage, all seasons bond like dynamic bond categories and those kind of categories is what we think will lead investors to stay with us through cycles and make moderate returns in up markets but deliver huge returns over the long term and give investors a happy framework for long term investing through mutual funds and that is the only way in which we can manage public money of a very large order.  Choosing the high risk, high return products won’t work.
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