Buy on negative news and sell on good news’ PHILOSOPHY WHICH MAY PROBABLY WORK

Buy on negative news and sell on good news’ appears to be the simple yet difficult-to-implement philosophy of Mr Sankaran Naren, Chief Investment Officer Equities, ICICI Prudential Asset Management. In an interview with Business Line, Mr Naren talks on why the equity market is less risky now than it was in the heady bull market of 2007. He also gives his opinion on which sectors are less prone to be hurt by the slowdown.

There have been three sets of stimulus measures including excise duty and service tax. Do you see that having an impact on specific sectors?

It has helped in confidence building. The revival in the auto industry may happen as a result of the stimulus, rural consumption, Government bus orders — a combination of these three factors. So, slowly, the economy may be moving out of the ICU, except in case of export-oriented industries.

Secondly, my belief today is that capex outside power is also having a problem. When the capacity utilisation of the entire industry is lower why would they want to invest in capex?

For CY09, corporate capex will significantly come down. You will see improvement in consumption based industry, in rural based industry but not in export industries and capex industries whose user industry is in trouble.

When are the lower commodity prices and borrowing costs likely to be reflected in corporate earnings?

In the April-June quarter. I think the entire inventory cleaning up process would be by March.

What I would like people to realise is that our index benchmarks are very commodity-oriented. I am not very sure if these companies will show any dramatic improvement in the April-June phase although the users of these commodities will show improvements.

If you see, the auto sector weight is low while metals and oil and gas is high. So April-June onwards, the non-index stocks will start doing better than commodity stocks.

In the ICICI Pru Growth Fund, you have an ‘underweight’ view on realty and are overweight on banking stocks. Will you hold on to this view even now, given the stimulus given to realty sector?

The problem with the real estate sector is that there is no history backing the companies. We had some marginal positions in one or two real estate stocks. But those were companies that had clearly identified one or two parcels of land, which one can understand.

Otherwise we have to get a conviction that the de-leveraging cycle in real estate has started to happen in a big way. This means that we want land bank to go down by way of sale of land or apartments; the borrowings of real estate companies should start coming down as a result of such sales. We will not otherwise look at the sector.

Bank stocks have been de-rated sharply on worries about margin pressures. What is your view?

Banking is a very mixed bag right now. One factor is in that the sector has already turned in high profit growth in the last quarter or so. NPAs will definitely go up from here. But are these risks already factored in to the current share price? There are today public sector bank stocks that trade at a significant discount to their book value.

That suggests that some part of the losses are already recognised in the valuations. My current view on banking is neither a strong buy nor a sell. Do the corporate earnings suggest that banks are better off being cautious in their lending?

My belief is that you ought to have been cautious in 2007 – in the up cycle. Take mutual funds – if you had been aggressive in choosing stocks in 2007, you paid the penalty in 2008. Today the so-called aggressive stocks are trading at very low levels. Is the risk now as high as in 2007? The answer is no. That is true even for banks. And after the downturn, you are looking at everything such as collateral values more carefully.

I think banks received too much in deposits in October to December and they do not have a mechanism to lend that avalanche of deposits aggressively. The problem for the banks was that the big borrowers were the oil and fertiliser companies. So all long as the big borrowers were oil and fertiliser companies, it was easier for the banks.

The second point is that working capital requirements for commodity companies are down. Suppose you have one tonne of steel that you need to finance. The money required to fund steel is 30 per cent lower than six months ago because steel price has come down. So also with petrochemicals and aluminium. So to maintain the same level of stock you need 30 per cent less money from the banking system.

Two, companies aren’t holding that much inventory. If you believe that steel will go up you will keep three tonnes instead of one. Today, you believe that steel will go down or stay flat.

So you bring down your inventory from three tonnes to one tonne. So the combination of price drop and inflation expectations being down, results in lower lending. So it makes it much more difficult for banks to lend in this environment.

In quite a few of your funds you are holding stock-specific call/put options. What is the strategy behind this?

Our strategy is that we want to be invested because we do not see any risk in being fully invested at this point. But we want to be invested as defensively as possible. The defensive routes include writing puts and in some cases, writing covered calls.


The strategy is used across fund-houses. We don’t think we should be in cash at this level of the market.

For a long time it was believed that consumption-oriented sectors are more immune to a slowdown. But now there are signs of slowdown in consumption and retail sales.

We have taken a call that consumption is of two types – rural and urban. We do not see any evidence of slowdown in rural consumption. In fact there are signs of growth. So we plan to focus on rural consumption industries (consumption with low unit value) and not urban discretionary spending industries.

This is why we have cut our exposures to sectors such as hotels and airlines. 2009 could be a very bad year for companies that rely on urban discretionary consumption. Our FMCG fund has also moved out of retail stocks.

Which segments within infrastructure are likely to revive quickly from the stimulus?

Power and gas based industries do not have a problem. Remember we have three years of explosive growth 2006-08 in capital goods and infrastructure industries. 2009 will see a slowdown in these sectors despite the stimulus. But it may look up in 2010. Just after election, work doesn’t gather pace.

Which sectors are well-poised to face the slowdown?

FMCG, healthcare and, selectively, power and telecom. Automobile may be seeing a bottoming out. Then there are sectors such as banks with attractive valuations but with some concerns on the earnings front. So also with commodities. Not to forget that next year, both oil and gas production will increase in India providing a fillip to the entire economy.

If you were to take an asset allocation call today, would it be tilted towards debt or equity?

Equity by a mile. In our opinion market is very attractive for investment. The initial phase will see interest rates going down, during which time you should switch in to equities.

If you look back when steel or cement touched their all-time highs and you bought the stocks then, you would have lost 75 per cent or 35 per cent respectively.

Had you bought equities when GDP growth was at 9.6 per cent, you would have lost 60 per cent. So today, when GDP is at 5.3 per cent, the risks are actually much lower. Equity is an asset class to be bought on negative news and sold on good news. The negative news will come in the next six months and you have to use the opportunity to buy.