Expect Stock Specific Movement In BFSI Sector, Says Demeter's Ashwini Agarwal
The sector is facing challenges like rising cost of funds and liquidity pressures, he said.
First quarter results of the banking, financial services and insurance sector have been varied, according to Ashwini Agarwal, founder and partner at Demeter Advisors.
The sector is facing challenges like rising cost of funds and liquidity pressures, he said. While banks have underperformed and their valuations seem reasonable, Agarwal is uncertain about the sources of their performance.
Movement in this sector will be more stock-specific, according to him. "From a downside protection perspective, banks and financials have significant protection, which is why they are heading upwards."
In managing risk, Agarwal recommends assessing the overall equity exposure. He suggests having a flexible range for equity investments, based on factors like age, risk profile, and risk tolerance, among others.
Investors should place themselves at the lower band of this range if they are uneasy with the market and move toward the upper band when they are more confident about valuations, he said.
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In the mutual fund industry, there is a significant amount of cash in hand, along with previously closed schemes which have been reopened, Agarwal said. "Mutual fund managers are focused on growing their assets and are collecting cash as much as possible."
Investors looking for safety should have a look at companies that have underperformed over the past three to four years. Currently, these sectors include insurance, consumer staples, and information technology, he said. "These areas could offer lower risk and more stability compared to the broader market."
Retail investment in the markets is extremely large and increasing presently. Markets are experiencing a rise in these flows, in the form of large offerings like the Hyundai and Ola IPO, he said. "Many of these inflows are becoming quite substantial."
Watch The Full Conversation Here:
Edited Excerpts From The Interview:
We are circa 25,000, Ashwini. Where do we go from here?
Ashwini Agarwal: Well, obviously, you know, for many of us who've been looking at valuations as a guidepost, will be surprised by the strength in the market and I think the part that we underestimated is the power of flows.
I mean, if you just look at the trend, and the amount of retail money that's flowing into the markets, it is simply too large and that continues.
I was doing some calculations. If you assume that Indian household savings are somewhere in the ballpark of 18–19% of GDP, and fiscal 2025, will be a year when we should cross $4 trillion in GDP numbers, you're talking about something like $750 billion, give or take of household savings.
Out of this, financial savings, which are roughly in the range between 55% and 60%, pick a number and if you include what indirectly comes into the market, via insurance, via NPS and so on and so forth, my estimate is that at least about 10% of the financial savings pool comes into the equity market incrementally each year, which is, you know, $70–80 billion.
Against this, the supply of paper in the first quarter was about $12 billion. So, if you multiply that by four, you get about $50 billion. So, you still have $20 billion of incremental inflow from domestic savers. So, unless the supply becomes significantly larger over the next three quarters or so, my sense is that the momentum that you're seeing in the market will continue.
Having said this, we are already starting to see the scale of flows increase and you have the Hyundai IPO coming up soon, which is going to be a pretty large offering. You got Ola, which is again a pretty large offering. So a lot of these flows are now getting to be of significant scale and size. So let's see, it's interesting. Let's see whether the flows will underwhelm the retail investor or it will be the other way around.
Multiple FIIs have expressed concern over the valuations in India, relative to other EMs. They are waiting for a dip. Maybe these dips get bought in, because aside from the new flows coming in, according to my math, the mutual fund community is sitting on circa lakh crores worth, which is a very large sum. So if there is a dip, that money will come into the markets.
Ashwini Agarwal: That's true Niraj. But also remember that the inflows that have come into mutual funds in last six months or so, I'm sure that mutual fund managers are also thinking about what happens when the tide turns and what happens if the inflows turn into outflows. Now, why that happens, we don't know and when it will happen, also we will not know.
So if you again look back at the two big bull markets that I've seen in my life—one is 1999-2000, the TMT bubble as we fondly used to call it back in the day or you look at the 2007-2008 cycle, which was a very strong bull run, followed by the global financial crisis. In both these times, while the flows peaked ahead of the market peaking, there were significant outflows thereafter.
So yes, you're right. The mutual fund industry is sitting on a significant amount of cash. They continue to hoover up a lot of cash. A lot of the schemes, where fund managers had actually closed the schemes for new inflows, have been reopened I'm told. So I think they kind of said, well, we are in the business of asset accumulation. So let's accumulate the assets while we can. So I think that is continuing and you're right, they're sitting on a lot of cash.
So every little bit will be bought into. But, the overall valuations are now getting to a point where I am sure everybody who has a lot of money and has been around for a while is scratching their heads to see, okay, where do I deploy this where my drawdown will be the least.
Where does somebody, who sees valuations as a bit of a discomfort, put in their money to work at the current juncture? Are you comfortably sitting on the sidelines waiting for a crash to come in?
Ashwini Agarwal: When I think about asset allocation, and when I think about stock selection, those are the two ways one manages the probability of a significant drawdown.
So let's get back to 1999-2000, 2007-2008 for some clues. If you go back to 1999-2000 and you see that at that point in time, the valuations for consumer stocks, pharmaceuticals, technology and media were very elevated. But the old economy stocks including the banks, certainly psu banks, cement stocks or manufacturing stocks, L&T, BHEL—all of these were trading at throwaway valuations, even at the peak of the bull market.
And if you just moved away from the near-term momentum and invested away from the sectors that were expensive or hot, and looked out 3–4 years out, you made a tremendous amount of money. It's not that these stocks didn't give you losses in the sell down during 2001. They did, but they didn't fall as much as the TMT stocks did.
Similarly, in 2007-2008, if you had bought a consumer stock or a pharmaceutical stock or an IT services name, they would have again fallen during the global financial crisis, but they fell by a much less order as compared to the real estate stocks or infrastructure stocks or the other names including the PSU names, that declined precipitously post the GFC.
The point that I'm making is that you can seek safety by looking at good businesses that have underperformed over the last 3–4 years. So in that context, I think, markets have been kind of looking at insurance names, consumer staples, even IT in the recent weeks and months and these are probably the areas where you will lose less as compared to a broader market. So that's one part of the puzzle.
When I think about risk management, I also looked at overall exposure to equity, which in my personal view, should be in a band, which is based on your age, your risk profile, your risk tolerance, etc, and expected returns of course from a financial pool. That for me, personally, for example, ranges from X percentage to X percent. I'll be at the lower end of the band when I'm uncomfortable, and I'll be at the upper end of the band when I'm really comfortable with valuation.
So as markets go up, you keep drifting down on the asset allocation towards equities, that's the only thing you can do. So you can't be completely out of equities and be sitting on a lot of cash.
Ashwini, you are not a mutual fund, or don't need to beat the benchmark. What are you doing currently? You can comfortably sit on cash. Are you currently buying into IT, for example?
Ashwini Agarwal: I'm not buying into IT specifically. But yes, I am invested. I don't want to go below a certain percentage in equities because I could be wrong. I could be wrong that the market will correct.
So, at the end of the day, asset allocation also has to have boundaries—a minima and a maxima. It has to apply to equity, it has to apply to fixed income and everything.
Are you saying that within that minima, you have some exposure to IT and this thing, because you believe that if the markets would correct, your portfolio might correct less, even though you have lesser exposure to equities than what you normally would have?
Ashwini Agarwal: You are absolutely right. So insurance, consumer staples, some of the places where you know I'm comfortable that I'm willing to hang on for the next 3–4 years and see a big selloff if it were to occur, especially in the small and mid space. So I'm not completely out of small and mid stocks. I think, on a bottom-up basis, one continues to see a lot of interesting opportunities.
So you know, there the only thing that you can do is you say okay, I'm going to hold this for the next five years come what may and that's how we look at it. So that's why I'm saying that there are two layers. So there is an asset allocation layer and there's a stock selection layer. That’s how you manage risk.
There seems to be a bit of a spurt in activity and performance for the BFSI sector. Shriram Finance, today Bandhan Bank, ICICI Bank, etc, all of them are revving up. Financials have been quiet for the first six months. Could the next six months belong to them?
Ashwini Agarwal: It's possible. But if you look at the results of banks reported for the June quarter thus far, they have been clearly a mixed bag, where you are starting to see pressure on liquidity, starting to see pressure on the deposit growth and at the margin, credit cost has started to turn up.
So in that environment, while banks have underperformed and valuations are quite reasonable, I don’t know where is the ammunition for the banks to fire so strongly.
So obviously, Bandhan which you mentioned is doing well, after reporting pretty solid numbers over the weekend. And because I'm naming a stock just to clarify, I don't have any position in the name. My sense is that it's going to be a very stock-specific journey.
Again, banks fall into that bucket of businesses or stocks which have massively underperformed over the last six months or one year. So, from a downside protection perspective, you probably have a lot of downside protection in the banks and financials, which is why they're revving up.
Where is it that you still have the highest conviction sectorally?
Ashwini Agarwal: I don't think it's really sector-specific when I'm looking bottom-up. I think it's very stock-specific. So there are stocks in the consumer area, healthcare, pharmaceuticals. There are stocks, as you mentioned, in real estate. I mean, I think these are very bottom-up opportunities.
See what I'm doing, just to again give you a framework rather than a name, is that I'm saying that look, is there a business out there which doesn’t have a lot of balance sheet risk, it doesn’t have a lot of business risk in the sense that there is fair amount of visibility on how the business will do over the next five years and are valuations trading broadly around a median of a long-term history? If that’s the case then I am willing to buy it and hold on to it.
It's very difficult today to find stocks which are trading below the long-term median. So it's futile even looking in that direction. So I'm looking at sort of reasonable valuations. Very cheap valuations are not possible anymore and I'm looking for businesses, which are well-managed with not too much of balance sheet risk, where I can see reasonable growth over a five-year timeframe and there I'm saying okay, fine, I'll hold on and I'll stay here for the next five years. It's possible that I lose 20-30-40%, if the market were to have a very aggressive selloff. But I'm willing to look through that.
And one essential feature is that many of these stocks have probably underperformed in the last 4–5 years.
