2nd February 2012

WF: Global markets have rallied very significantly in Jan, on the back of the improved liquidity and seem further cheered with the US pledge to keep the interest rates low at least until 2014. The question that obviously is top of mind is whether this is purely a liquidity driven rally or are the fundamentals from a global perspective shaping better. How sustainable is this rally?

Sunil Singhania: From the global perspective, there were few things which were obviously spoiling the sentiment last year. One of them was the events that were shapingon the European front in terms of defaults and funding the deficits. If you actually observe, the rally started not because of US but due to increasing optimism that some solution as far as Europe is concerned would be figured out. It started with those 5-6 hundred billion Euros of fresh infusion which Germany and France in particular pledged and subsequently almost every alternate day, you saw Spain and Italy and some of these other countries were able to raise money from the bond markets at decent rates. So I think, the view which is coming specifically from Europe is that the euro zone is not going to split and that they will take adequate steps to ensure that.

As far as the US pledge of not hiking rates till 2014 is concerned, if cheap liquidity is going to be available, then people would be willing to take additional risks. It's not only India but also other emerging markets which have also shot up; since India had fallen more, so the pace of increase in India to that extent was higher.

WF: The key question is whether the market rally in India is purely a high beta play on this global liquidity or can we take any comfort that maybe FII's are finding valuations in India a lot more attractive and so on. How sustainable is this rally from an Indian perspective ?

Sunil Singhania: Again we will have to look a littlebackward. In the last 15-18 months, whatever money was present in India moved from so called high risks to safe stocks and sectors. Once this risk rally comes into play and combining the fact that inflation numbers in India have started coming in positiveat around 7-7.5% and also the RBI's step of the CRR cut of 50 basis points- all of these have led to a belief that probably the days of tight liquidity in India are coming to an end. The fact that markets had underperformed massively and the presence of some technical factors in terms of huge shorts especially in the financials space - all contributed to this sharp bounce back.

WF: Most experts suggest that in a cyclical slowdown like what India is experiencing at the moment, it is prudent to stick to large caps. Yet, these are also perhaps the best times to spot undervalued gems in the mid and small caps space. You have experienced two downturns in the last decade as a fund manager - 2001 to 2003 and then the 2008-2009 phase. What is you take on this conventional wisdom - should one stick to large caps or brave it out into the mid and small cap worlds?

Sunil Singhania: Every downturn presents an opportunity to buy mid caps as well as large caps and these are clearly the best times to go stock picking. However this time, the downturn has come with a whole lot of other challenges. Firstly, we have never seen high interest rates for such a long period of time. Secondly, we have never seen liquidity being so tight. So both equity and debt raising has become very difficult. In fact, we have never witnessed such huge risk aversion. Some of the decent-quality midcaps are trading at very low P/Es which might be a buying opportunity but it is going to take a lot more than earlier times for these stocks to get re-rated. And most importantly, there are other factors like currency movements and commodity prices which have been very volatile. These factors are causing some of the smaller mid caps or the small caps to stress much longer than what they had to in the past. So, while accepting that it is definitely an opportunity because of the huge valuation gap between the so called quality large caps and the mid caps, the fact that is worth noting is that the bounce back in the recent weeks in the mid cap and the small cap space has been largely in the low quality stocks, or the so called speculative stocks. I think interest in some of the high quality mid caps and small caps is yet to come, but we definitely agree with the view that it is time to start building your portfolio in the so called 2ndtier names which can generatehigher returns. Having said that, I think it is still not the time to go too deep into very small companies.

WF: A corollary to that is the hypothesis that if small and mid cap segments are more volatile than large caps, and that they are supposed to build better wealth over a market cycle than large caps, then would it be fair to say that for investors looking at SIP's, an exposure to mid and small cap oriented funds would perhaps serve them better than large caps because they will be able to ride the volatility and capture that wealth creation?

Sunil Singhania: I think it is very logical to do that. Last year, the large caps index went down by 20%, the small cap index went down by 38%. This year, the small cap is outperforming the large cap index by 2-3%. So I think what you are saying is perfectly right, that when the markets fall the small caps will tend to fall more and when the markets rise, logically they should rise more as you are taking higher risk for higher returns, otherwise why would you take a higher risk. So from an SIP perspective, it is better to play volatility in the small cap space than in the large capspace. Its like saying that by doing an SIP in a large cap fund, you are creating sort of double hedge to volatility. Another way of looking at this is that if you are having an option of lump sum investment and SIP's, the lump sum can be in the large cap funds and the SIP should be in the mid and small cap funds.

WF: Infrastructure is a theme that has caused a lot of grief to advisors and investor alike in the last few years. Is there light at the end of this tunnel? Do you see any reason for optimism in this sector in the near term? Is on-ground activity showing any signs of improving momentum? At the margin, would you be a buyer today into this theme?

Sunil Singhania: I will give you a twofold perspective from 2003-04 to 2007-08. Sales of someof the companies in the infrastructure sector havemultiplied ten times. And their market caps went up between 50 to 100 times. So basically, P/E went up from 3-4 to 15-17 times and the profits also grewvery fast. However, India was propagating this public partnership model. On the face of it, it's a good model. But companies out bid themselves very aggressively and took up projects at very low IRR and the premise of that was that they will be able to raise equity at very cheap valuations and will be able to manage the IRR by way of selling some of their assets etc. But the downturn appeared and they were not able to do any of the financial deals which were necessary.

So one side you have companies which are good EPC (Engineering Procurement Construction) companies, but have their balance sheets blottedbecause of the huge BOT (Build Operate Transfer)projects which they have undertaken and it has hit them in multiple ways because the interest rates went up, and the IRR fell further. Also, the execution got delayed because of the government policies, land acquisitionand other issues. It is going to take some time for these companies to come out of it.

On the other hand, you have some companies which didn't take up such projects and they are usually the smaller companies which are now benefiting by getting increasing allocation of orders from NHAI in particular. The ministry seems to be a lot more efficient now in terms of placing orders. Execution has started, but it is not very visible so far on the ground. Because of the size,a lot of these projects also need local government support. So in some states like Gujarat and Bihar, there has been a lot of progress. But in some other states like Maharashtra, Andhra Pradesh and Uttar Pradesh, much more push is required.

We can say that we are probably at the bottom as far as the stock prices are concerned. But we would not be very aggressive fresh buyers in this sector rather we would be very selective. Another interesting thingis that the P/E's are now becoming little bit comfortable for investing in infrastructure sector. But, for the market to give this sector higher P/E multiples, a lot more government action should be visible - which is not yet the case.

WF: When do we see the next bull market coming and what's your market prognosis for 2012? Which are the sectors do you think will lead the next bull market?

Sunil Singhania: I think the bull market definition is a question mark. Market has already delivered 14-15% returns in the first month of this year itself. So if you consider 20% annual returns as the bull market, we are probably in one already.

But I will give you a very honest answer : though we do agree that the downside is limited, I think from here on for the markets to have more legs, we require a lot of baby steps on the policy front. We are still in a situation where companies are facing issues. Quarterly results are a mixed bag with a fair share of disappointments. The only positive thing as a whole is that the earnings would be slightly better or in line with the estimates. So for the first time in let's say 4 to 6 quarters, we won't have earnings downgrades for the index as a whole. But for a significant rise from here, we will need some luck as far as the elections are concerned. We would also need some strong policy decisions over the next couple of months leading to the budget.

Ultimately, we know that low interest rates are the need of the markets right now.Even today, banks are issuing 1 year CDs at 10%. I think at the grass root level, interest rates have to be cut for this rally to sustain. Right now, there are too many moving parts to give you a straight answer.

WF: Which are the sectors that you are most optimistic about ?

Sunil Singhania: Our fundamental premise is that when you invest in Indian equities, you do this with an intention to make money - not with an intention to lose less money. So, if in the last year you had lost 15% and someone else had lost 11% by investing in stocks like Hindustan Unilever, that is not what we look at. I think in India, consumption theme is good but you will have to take care of the valuations. Rate sensitives will logically benefit from a lower interest rate environment. But these are all well known to all.

The themes that can well pay off this year could however be sectors where we might see some regulatory changes. So whether it is oil marketing, insurance sector or to some extent the retail sector or media sector - wherever regulatory changes seem possible - that can cause some rerating.

WF: What are the key risks to Indian market that you would be watchful for?

Sunil Singhania: Very frankly, India's P&L at least for now is in bad shape. There is a thought process that at least the balance sheet is manageable but unless something is done urgently, the balance sheet also has a potential of getting messed up. So I think from our perspective, the key risk or challenge would be as to how the P&L and the balance sheet of the country is managed and there again we need some luck.

If oil falls to 90 dollars, the balance sheet will automatically sort itself out. On the other hand, if oil becomes 130 or 140 dollars, it is the biggest risk which India faces because then irrespective of the policy changes, India's balance sheet and P&L both are going to get blemished. So, the biggest risk is oil and a consequential impactful risk is depreciation of currency.A depreciating currency dissuades investors to come in a big way. So, the fate of our economy right now is likely to be decided by the movement of oil prices and how the fiscal position of the country is managed.

Common Source:

www.bseindia.com, www.rbi.org.in Bloomberg & RCAM Internal Estimates

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