Financial Space A Good Bet Despite Challenges, Says WhiteOak Capital CIO

Ramesh Mantri: Yes, so first, I would say the world is always uncertain, so I wouldn't ever give the confidence that there is no uncertainty. The uncertainty is, the degree changes and by the way, expected uncertainties don't impact the market. You know, it is unexpected events that really move the market. So I would say the election is now less of an unexpected event and the (U.S.)  Federal Reserve has been around for a long time. So it's always Federal Reserve actions that will happen. So I don't think these are big deals. I think what has happened in India, you know, post the Covid-19 is the economy has seen broad-based momentum, you know, earlier a few sectors were doing well. 

You know, in fact, the economy was quite weak going into Covid-19, you know, the only sectors like I.T. Pharma, Consumers were doing well. Now, I would say a few engines were running and now the whole economy is doing well, whether it is cyclicals like capital goods, metals, commodities, infrastructure, real estate, tremendous economic momentum in real estate. So it's a broad-based recovery and that's why the set of opportunities have expanded in the market and, of course, after a long period, after ‘17 a lot of companies got the opportunity to go public. So companies or entrepreneurs are already raising capital. So we've seen a huge amount of companies go public in the last three years. So that expands the opportunity set and you know, every trillion dollars of GDP you need to create new companies, new business models, you know, new industries. 

So if that cycle of new companies stop coming into the market, the market loses the economic vibrancy, you know, so you know, for example, something like electronics manufacturing is a sort of something that's happened the last five years, a number of companies have gone public, you didn't have scale electronics manufacturing companies going public. For example, now you started seeing interesting consumer tech companies also started going public. Many of them were loss-making but they made very interesting pivots, many of them and some of the very successful pivots to profitable business models. So you need to constantly churn new companies to come into the market. 

For example, the healthcare services sector, hardly a few companies listed a few years ago and now you have a large number of healthcare companies available. So the opportunity set has become a lot more interesting. It's a better market to be an active manager.

Ramesh Mantri: Yes, I think clearly valuing the ask rate in small caps is higher than it has been for the last three, four years now. So I wouldn't say there's not a challenge in small-cap space. At the same time for AMC which is extremely well resourced and researched. For us, you know, a small cap, by the way, small cap, mid cap has a higher alpha pool for everyone. If you have a lot of your own research then you have a lot more ability to generate alpha. So it’s like our ability, our confidence in our team's ability to generate alpha even when valuations today are less attractive in the small cap space than they have been.

There is also constant churn happening in the small cap with new companies coming into the markets, new IPOs and all and I would say the new emerging India, you participate actually through small and mid caps. It is only when companies become large and mature they they transition into large caps. So a lot of those, you know, emerging themes in India, whether you talk about you know, growth in, you know, defence capex or for that matter electronics, manufacturing, healthcare services, number of sectors that have been doing exceedingly well. They typically tend to be in small and mid cap. 

Ramesh Mantri: Yes. So you know, in small cap and mid cap space you know, managers can have portfolios that can behave very differently from the benchmarks, because it's a very bottom driven, you know, risk investment. Macro things matter less than micro themes like what the individual company does matters a lot. So clearly a lot of confidence that, you know, you can do substantially different. In fact, a very strong small-cap and mid-cap rally, which we've seen in the last 12 months, is actually difficult for active managers because in a very strong market rally, highest risk taking gets rewarded, not balanced risk taking. But as market transition and volatility now emerges or has emerged clearly in the last few days. You start seeing very clearly that active managers start doing well.

Ramesh Mantri: Yes, so one, you know, the valuations, the smaller the market cap, you know, we'll start from SMEs and micro cap, then the small cap, you know, the valuation curve is reverse. Today the mega caps are the most attractive, then large caps then mid cap and then you can go down the market cap gets keep getting worse. So the quality clearly, and secondly, markets haven’t, in the last 12 months, differentiated between quality businesses and poor quality businesses and managements. 

So, enough capital has been made available to even poor quality companies or management. By the way supply also keeps turning up because a lot of companies are constantly raising (funds). You have practically capital raising every day today, you know, apart from IPOs and talking of either a large, you know, big investor exit or companies raising primary money. So I think the supply is really the issue, the quality of supply that is really the issue.

Ramesh Mantri: So if you ask me, where the value lies in the  market, fundamentals are good and value and prices are right, I think clearly the BFSI sector is where, you know, the fundamentals are still very good. You're still not seeing a credit cycle, you know, which is what damages BFSI on the lending side. So that part of the market, I think, where valuations are actually below average, particularly for very high quality financials. So that's really, I would say on a three-year basis, that is really the pocket that looks very attractive to us. 

Then, on the other (hand), reasonably large sector where valuations are very normal and fundamentals continue to improve is the pharma sector. This is again that sector that did well during COVID and then went out of favour. Again, fundamentals have improved both on U.S. generic and clearly there's a very large opportunity on the CDMO CRO side, which is I would say,  another Indian version of the I.T. industry. There's a large potential there and of course, even on healthcare while some regulatory challenges have emerged on healthcare, the opportunity in medical tourism still remains very large and again, the sector again, has seen a lot of discipline. So these are the two real sectors where valuations are reasonable or attractive, and fundamentals remain good. Unfortunately, a number of other sectors either are seeing much above average valuations or too much just poor quality of companies and you know, just too much stretch valuations. So I'm slightly cautious about them. But otherwise these are the real two pockets for me on my sector basis.

Ramesh Mantri: Yes. So let's understand this, you know, a large part of FIIs (foreign institutional investors) selling, you know, in the last two years in India have happened in financials, that number is 60 to 70% of which selling has happened. So they've gone from being significantly overweight and they've cut that portion and it was very difficult for domestic capital to absorb that kind of selling and, by the way, the market has also become much broader today, there are opportunities in all sectors so people don't have to allocate only to financials and number two, particularly on couple of large banks, or you'll see management transitions and or you know, in the sense and one in a management transition, one in a merger and of course, we are going through a very difficult liquidity cycle. 

There's a massive fight for deposits, which is causing a lot of pain in the banking side on the cost of funding side, but I would believe these are intermediate challenges and as the liquidity situation improves. The biggest risk in banking is always a credit cycle and we don't see any signs of a credit cycle. Yes, there are pockets in below Rs 50,000 loans where these narrow pockets where generally banks don't participate. We've seen some spikes in credit quality, poor quality, but otherwise there is no signs of a credit cycle as yet. So banking typically struggles when there's a credit cycle, deposits eventually they will figure it out to price it to the customers

Ramesh Mantri: Yes. So one, you know, the valuation differential between private banks and PSU banks have not narrowed significantly, you know, when you adjust for the quality of franchises. We do own public PSU banks within the pack, but I would say clearly when you look at very long term, even long term averages, you know, clearly today private banks are more attractive than PSUs even on a relative basis.

Ramesh Mantri: So you know, if the business is short gestation, then actually you can see a lot of competition. You know, because if someone starts doing well, other people will jump in. If a business has a very long gestation business, let's just think of another very different example of life insurance. Then it becomes very difficult, you know, the pot of gold is much later in the cycle. So actually, it creates large entry barriers. The fact of the business is a long gestation and the terrain is in favour of incumbents. 

You know, it's like people who are there and it favours them. So competition becomes harder actually, over long, longer term, the competition in the competitive space is much simpler if it's a longer term gestation period. 

Number two, the same if you're talking of CDMO CRO, the same capabilities that India has in I.T., which is basically one highly qualified talent, you know, which isn't, you know, chemical engineers, you know, BSc Chemistry was, tech engineers, low cost highly talented and number two, the fact that India has a great reputation for you know, history of protection of IP, that's why the IT industry scaled up, those two dimensions remain and number three is I think, the US, you know, pharma companies are under significant pressure to cut costs because the cost of drug discovery is going up a lot. 

So India is number three because of the geopolitics today, even in this industry. India is better position today than it was so well longer term, but it's a harder industry and it's also it's harder, it also means competition is going to be less. Coming to healthcare, we’re clearly overweight there. I like to say that you know, among all the industries you can think of healthcare is probably one of the most non discretionary spending. In fact, I would say you know, when you're sick, you don't even like eating food. So medicine comes ahead of food. 

So it's a sector with very low longer term correlation with markets. Long-term returns are very good and it's a sector which requires very specialised knowledge. So if you can do bottom-up research, you can add a lot more alpha in pharma and healthcare. So that's the reason we're already not because we think the sector will do very well. It's simply we (have) a lot more confidence in our ability to, you know, generate alpha in that sector.

Ramesh Mantri: So we’re participating in nearly all pockets but I would say it is more balanced towards this bucket than domestic branded generics and also healthcare in India.

Ramesh Mantri: If you look globally, while real estate happens to be the largest industry in just about every country, yet very rarely, you see very large index rates of real estate stocks. The two reasons for this is, one it is a sector that tends to fragment. 

You know, a fairly fragmented real estate tends to be very local, often, you know, the Delhi developers don't do well in Bombay and the Bombay developers don't do well in Delhi. So even in the U.S.  it's a very localised business, you know, so it's a very local dimension, so you can't scale profitably. People do try to go to other markets and when they will come they’re very ambitious, but actually success stories are far and and people believe in an upcycle that will go everywhere and will sell and actually, real estate being highly cyclical. 

In the upcycle anyone can set up a project itself, but then invariably, the cycle turns down. You see a lot of euphoria in the last two-odd years now in both volumes and prices, prices more in select markets volume across the country. So I believe markets where pricing has stayed reasonable and price hikes surrounding I think the market will stay firm and continue to absorb. 

One of the things we are hearing from a lot of developers is this time, the demand is more on users than investors, So that makes the market more sustainable. You know, of course, there'll be parts of the market in real estate India particularly in NCR and all which will have a lot more investor demand. But particularly southern India is more user driven. You know generally the construct of the market and generally you don't see very large spikes in Bangalore, Hyderabad, all these markets. 

They tend to be less speculative markets. So we live in markets, which are no less speculative, you know, prices are reasonable and secondly, clearly there is a shift in markets, where people are less confident of buying under construction property and buying, you know, delivered property and the market has consolidated in favour of large brands, trusted brands. 

But I'll tell you again, there'll be a cycle on this consolidation. So again, new plays are jumping in real estate. Is it always that cyclical? Everybody jumps in and upcycle. So it will play out in a few years the same way. But I would say there are players who have been there in the last cycle and survived and done reasonably okay. You're looking at them because they have a DNA of prospering across cycles and not just being, you know, flash in the pan.

Ramesh Mantri: You know, so you participate both ways. You know, there are, you invest through real estate developers. There is another asset class that's been created in the last five, seven years called REIT, but REIT has a very different dimension because there's no developmental element there, generally. So that is another way but you also participate through mortgage financials through the whole ecosystem of building materials. So you participate across the board.

Ramesh Mantri: We are more or less sort of not more or less neutral to the market but it's very when you look into the portfolio construct, it is significantly overweight, small and mid versus large. So when the mid-cap index tends to be very skewed towards large caps, while our portfolio has a very large skew towards small and mid caps, you know, one of our… something that we believed for seven years in India is that the small and mid caps will do well in I.T. and they've done well. 

There are a number of reasons on your show I've talked about earlier why, you know, mid cap and small cap will do well. I am seeing, I'm particularly invested in a very interesting space now in I.T. services, which we generally don't talk much about in India is called the Enterprise Software Space. So India has largely been IT services to Western world, to the Americas and Europe. That's typically like the services model and whatever we say AI is an emerging disruption and the pace at which things are changing. You can be sure what happens in a year but it's very hard to predict what happens even on a three-year basis. So let's be very clear, this space is fast evolving. So I'm an optimist, but you know, but I would be cautious and optimistic. you know, things may be a lot more difficult in the middle for IT services large companies. 

I like enterprise software because earlier it was always used in the Western world. Now we have created a number of enterprise software companies in India, which are catering to the Indian market. We're also doing exceedingly well in emerging markets, particularly the Middle East and Middle East is doing very well. So for example, your number of banking software companies in India, another number of them in public markets in India, and they are focused on the capex which the private and the PSU banks are doing, the Middle East banks are doing, emerging markets banks are doing and they are doing very well, growing well. Margins are very fantastic. They are not subject to a lot of these disruptions and the cyclicality of the Western economies and valuations are very reasonable there. Normally, if you look at the best tech companies in the world, think of Microsoft. Microsoft is an enterprise tech company. So ultimately the highest valuations go to enterprise tech companies.