Kenneth Andrade was recently voted among the top 3 equity fund managers and his flagship fund - IDFC Premier Equity Fund was also voted among the top 3 equity funds in the recently concluded Wealth Forum AMC Awards 2010. Kenneth gives us his perspective on markets, his views on key sectors and on how he manages to outperform benchmarks and many peers in a highly competitive market.
WF: The Indian market is now underperforming developed markets - quite the reverse of the de-coupling theory that we all keep talking about ! What has led to this situation?
Kenneth: I think it is related to both the external environment and the internal environment. The internal dynamics have been affected on a couple of fronts - one, regulators of virtually every industry have opined how the industry should not cartelize their products in line with the demand. Second are corporate governance issues with various personnel of companies involved; the law has stepped in and this has caused a bit of uncertainty. All the same, the problem is not systemic and I would not expect it to have a very long term effect.
Externally we are close to the year end. Fund activity worldwide is pretty muted at this time. Also, this year India received a disproportionate amount of money amongst all emerging markets. So I would imagine that the liquidity flows will take a small break, at least for the year ending. I don't believe we will see the same thing happen in 2011.
WF: In terms of domestic growth data, some analysts are worried about the choppiness in the data and the robustness of the growth. Is there anything in the data points that are coming out which leads you to worry about the earnings for next year?
Kenneth: The domestic economy should be seen in three parts. One is the export sector where the robustness of the business comes from the advantage of cost. There is nothing very disturbing in that part of the economy, though international capex spends are going to be a significant driver on how this business evolves.
Then there is the investment economy that was the darling of the capital markets until o 2007. The 2007 peak had multiple companies investing into that entire segment and to a very large extent created reasonable amount of capacity and in some businesses, like cement, it created an overcapacity. That part of the economy is still grappling with lack of demand. Projections indicate that in 2011 and 2012 there will be a return to the investment cycle. However, the choppiness in those numbers is posing as an area of concern for the capital markets, which has garnered a significant amount of assets and had taken on significant debt.
The third leg is the consumer economy, where an incremental amount of disposable income is effectively driving the demand of that market. This part of the economy continues to grow very well.
Thus, within two of the three areas, the outlook seems reasonably robust. Admittedly, a lot of it is being supported by the government. The area for concern is the investment economy which needs significant amount of money to be injected for India to continue to grow at 8% - 9%. There is lumpiness in that part of the market. I would imagine that 2011 and 2012 are very critical for the economy as a whole and this part of the entire environment has to come back.
WF: The muted order flows in infrastructure disappointed many. With 100 thousand rupee crores raised from 3G and more, what do you think has held back the Government and therefore what is the confidence level that come January and 2011 the outlook will be more positive?
Kenneth: The Government budgetary allocations were focused on three main expenditure sectors - infrastructure being the largest, the next was defense and lastly the social environment which includes NREGA and the food subsidy. The infrastructure spend did not really happen. Social spend had a lot of money effectively transitioning into the wider population. The Government emphasis appears to be bringing more people into the earnings cycle, even it means subsidising the entire regime. Hence consumption continues unabated, not only in India but also in China. China has a 30% wage inflation rate with no Government intervention. It means that the entire emerging market basket, of which India and China are the largest, have moved towards the domestic consumer environment rather than focusing too much on exports. That's where the money is going.
At the other extreme, 2011 and 2012 will be critical for India in terms of getting investment infrastructure on the ground, because that will create an environment conducive to manufacturing which, will in turn, create a the right logistics for increase in employment. That will sustain the 8 or 9% growth. We will have to wait and watch.
WF: From your perspective, would infrastructure rate as a buy now in the midst of this bad news and uncertainity or would you stay on the sidelines for more clarity to emerge?
Kenneth: We think that valuations are coming to a price point which is becoming attractive. To us infrastructure is more about consolidation than growth. Therefore, if I had to an infrastructure product together, I would look to lead with companies with a monopoly - basically utilities - which is where the best money is. Rather than playing asset growth, reduction in liabilities would deliver stock performance. If corporate interest rates drop from today's 10% to 6 ½ % in the next three years, there will be a transfer of wealth from bond holders to equity holders. So that is the first ladder. The second leg is consolidation in an interest rate environment where you have easy money. In an environment of overcapacity and stressed assets, consolidation would come from a company with low debt on its book and is a market share leader in its field. The third leg, when the environment of growth comes in, will be the icing on the cake. We plan to build our infrastructure based on these principles in the next 2 to 4 years.
WF: The banking sector has gone from being a favourite to a perceived liability with many saying that the fundamentals have deteriorated in the last couple of months. There has been a significant sell-out of banks in recent weeks. What do you make out of the banking space and what is your stance on the same?
Kenneth: Yes banking was a favourite due to low valuations, high ROE differences and great capital efficiency - probably one of the most capital efficient banks across the world. But the challenges that banks face are high interest rates, slow increase in credit growth and slow down of deposit growth rates. While the larger banks are significantly ahead of the curve in terms of reach and getting cheap mobilization of money, the smaller banks have struggled but they will also effectively catch up. The sector is going through a cyclical downturn. One needs to factor in the fact that none of these banks are trading at a significant premium to their peer growth. Banking has 26% of the market capitalization and is attracting a significant, if not a disproportionate share of the liquidity - and will continue to do so. So I would not write it off. We are fairly neutral on this sector and have never been underweight.
WF: Recent developments have also seen a turn in sentiment towards mid and small caps with huge sell offs in the recent weeks. Do you think they represent attractive value or would you be cautious because of the current situation?
Kenneth: While the corporate governance issue will always remain, one has seen some of the best businesses come from this place. Also, there are enough ambitious entrepreneurs who do things differently and move things right. Our focus is to capture the growth cycle forward rather than capturing valuations. In our domestic driven consumer economy there are enough such growth opportunities available.
With mid caps, the last rally occurred in 2007, predominantly in the small commodity and the small capital goods space. None of them came back, but the mid cap index came back. So you basically shifted investment from one segment of the market to another which has driven the indices back up. So I think this is the way to gain exposure to the smaller end of the market.
Our focus has always been to capture the growth of an entrepreneur who starts off as number nine in the industry and ends up being in number one or two or three.
WF: Moving on to a slightly broader market issue, some technical analysts have been predicting the end of the bull market. What is your own prognosis for 2011 for the markets?
Kenneth: 2011 won't be anywhere close to 2010. You should get an absolute return - but the biggest risk is that we might actually get into an overvaluation zone.
As far as the economy is concerned, with the aid of political will, return to spending will be beneficial. We need to leave a lasting impression with assets on the ground rather than spends on the ground.
WF: Your flagship fund - the IDFC Premier Equity Fund - has caught the eye of many advisors. What are some of the factors that you believe have helped differentiate it and deliver in an extremely competitive equity funds market space? How are you currently positioning this fund?
Kenneth: We stuck to our philosophy of trying to be ahead of the curve and continue sifting through data to find opportunities which would be in line with what we believe would lead the market in the next rally. This means aligning with companies or entrepreneurs from the bottom of the pack that are cost leaders or thought leaders and who drive their business pretty high. Thus, we have aligned ourselves with some of the smartest businesses. And that's how we actually executed that product. We intend to stick with that investment approach. The challenge remains in the timing of the cycle - getting in too early is not good either.
Thematically we are still significantly consumer-oriented. Over the last month or so we are looking at consolidators in infrastructure space or the investment economy space. But it is still fairly early and were we to add infrastructure, it would be a small part of the portfolio. Overall, infrastructure would be 15% of the portfolio. Consumer driven stocks are around 55% of the portfolio. The balance is financials and export oriented companies.
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