21st February 2012

WF: All through 2011, you were very cautious on markets and your call was spot on. What's your call on the equity market this year? What are some of the changes that you are seeing in the fundamentals?

Satish Ramanathan: The market is actually witnessing a sort of a turnaround and there are a couple of things that have changed over the past two months. One perspective is on the local domestic initiatives front. We have already seen what the Prime Minister's Office has done on the coal allocation front. And prior to that, we observed freeing up of capital flows into the country and letting foreign individuals buy shares. A whole host of reforms have been taking place which had actually gone unnoticed by the markets and we have actually not seen the glimpse of these benefits transpiring in the markets.

The question that arises is whether two months can make such a change on a policy basis? The answer is yes from a policy perspective but on a corporate earnings basis, it will take a while longer to actually trickle through. We are already aware that corporate earnings are under pressure due to higher interest rates and companies do have a problem in terms of sourcing capital. So some aspects of the fundamental problem has not yet changed. We had reached a situation where even projects that were under execution had suddenly become unviable. I believe that fear has been removed to some extent now and consequently we have seen many of these companies getting back onto their growth tracks.

In respect of valuations, I suppose we are still slightly less than the long term average. There is potential for earning money in several stocks from a medium term perspective. Now, if we talk about being happy with the economic situation per se, we clearly aren't because the government has been borrowing a bit too much. Interest rates have been a bit higher than what we anticipated and there is still a large deficit which is squeezing out money of the capital market system. India's current account deficit is a natural dampener to the market. So these are three or four things which we need to bear in mind and consequently look at the entire situation in that perspective when reforms are coming in place. These structural issues need to be addressed for markets to gain more strength.

WF: So your call for the market would be a directional move upwards or broadly in a range for the rest of this year?

Satish Ramanathan: I feel we are on an upward track; there may be plunges due to issues relating to politics, monsoon, the growth momentum, interest rates or fiscal deficit. These are the key factors that one needs to be watchful for as they can cool off the market. But the bias is upward.

WF: The huge amount of global liquidity that is getting into risk assets is lifting markets across the globe. Is such a liquidity driven rally sustainable? Can markets continue to expect liquidity to support them?

Satish Ramanathan: I believe there are a couple of things which we need to bear in mind. There is huge liquidity outside which is not being really invested. Money lying in US bank deposits itself is somewhere close to a trillion dollars. People are not willing to invest and they are not prepared to take any risk on their own portfolios. That kind of risk-taking behavior has still not arrived in the retail market. So that is one part of it.

Secondly, we feel that assets are cheap on a replacement cost basis. And that can act as a natural support. The classic example would be the cement sector where we see stocks trading well below their fair valuation in terms of replacement value.

WF: The other big variable is commodity prices including oil rallying on the back of global liquidity. Do you see commodity prices remaining firm? Does that pose a challenge to Indian markets?

Satish Ramanathan: Commodity prices will be a worry and there is no two ways about it because India is short on commodities and if commodity prices rise, we do get impacted; be it steel, be it copper or for that matter oil. With one third of our trade deficit being accounted for commodities, oil prices and oil shocks that can take place in the world will be our natural concern. And that precisely reminds us the fundamental vulnerability which our Indian economy and Indian equity markets are fraught with. We cannot escape from that fact, unless we receive some domestic positive signs on oil and gas discoveries or exports start growing significantly to counter the growing import bill. My conjecture is that as we move on in the next year, we will see some curbs on oil consumption coming through by way of higher taxes because that is actually what is resulting in this large fiscal deficit and trade deficit.

WF: Moving on to some thematic preferences, what is your call on midcaps? Would you advocate the relative safety of large caps for now or do you see the valuation gap becoming attractive enough to warrant exposure in mid and small caps?

Satish Ramanathan: Firstly, we need to bear in mind that each portfolio manager is trying to select the best companies across the cap curve to hold in his portfolio. Having said that, I believe there is definitely a higher value in the mid cap space than the large cap space. Clearly of course, it depends on the individual's risk appetite but I feel that given the run up that we have seen in the large cap segment, there is definitely more merit in increasing allocation in the mid and small cap space.

WF: What is the best way to participate in the infra / cap goods space?

Satish Ramanathan: Here, we need to look at two things; one is the deeply cyclical capital goods companies and other the utility companies which are also right now categorized under infra. The power companies do not have the cyclicality which the equipment supplying companies have - and therefore must be viewed differently.

I think it is clearly the lack of equity availability that has impacted many of the infra firms and consequently they have become extremely leveraged. If these markets are to continue remaining healthy, you will see some gradual de-leveraging and we will actually see a kind of a virtuous cycle creeping in. We observed that the markets went southwards because of which these companies' ability to raise equity went down and they became more risky and kept spiraling downwards. Similarly, it is possible that the upward spiral encompasses all the asset classes.

And finally at the end of the day, the risk of an airport or risk of a port or risk of a power plant is extremely low in terms of cash flows other than the teething problems that we are facing. The minute the power plants are established and there is power linkage and PPA, it's becomes one of the safest assets.

WF: What would you enumerate as the key risks that you would be watchful for and what would be the key data points that would give you comfort that the upward trajectory is still intact?

Satish Ramanathan: The fundamental risk to the country is in terms of our ability to actually execute our projects without too much of a delay. The other macro risk is our vulnerability to oil prices. A more local level risk would be the slower corporate earnings and somewhat lower credit quality which is making people diffident in the first leg of growth.

WF: How are you positioning your portfolios in this context, in terms of sector preferences and thematic preferences?

Satish Ramanathan: We were luckily well positioned in the first week of January to capture the upside in financials and in the infrastructure space. All four of our large cap funds - Growth, Leadership, Focus and Tax Saver managed to capture the upside in the market. SMILE has done exceedingly well and so have our PSU, the Financial Services and our Capex funds. Our mid cap was slightly defensively positioned and so it has lagged the benchmark by 3-4% - but we are not changing it in a hurry and or turning it around just to capture this kind of a rally because we still like the companies that we own. The way we look at it is that SMILE is well positioned to participate in rallies such as this one while our Midcap Fund is an ideal choice for long term SIPs.