Rapid growth for a year won't justify present valuations: Mrinal Singh

Image: Mexy Xavier

Mrinal Singh, deputy chief investment officer (equity) at ICICI Prudential AMC, finds large-caps more attractive

Mrinal Singh, 38, deputy chief investment officer (equity) at ICICI Prudential AMC, tells Forbes India that looking for reasonably priced businesses with a long growth runway is still the best way to build a portfolio. And it doesn’t matter if you miss some richly valued companies in the process. Excerpts:

Q. How sustainable is the present mid-cap rally?
For businesses to justify these elevated valuations, it will require them to deliver on a sustained basis. If they grow rapidly for a year or two, they will not be able to justify them. If we look broadly at mid-caps, they are richly valued—the mid-cap index is close to 25 times. So the question is whether we find large-caps more attractive, and the answer is yes.

Q. Do you think the fall in interest rates and an improvement in India’s macroeconomic environment have a disproportionate impact on mid-cap stocks?
The expectation of an improvement in macroeconomic indicators is more relevant than the event itself. If the expectation is that interest rates will come down, and that becomes a firm belief, then it is priced in. A further bump can only come if the fall in interest rates is more than what the belief is. For the next year, the market is saying rates can fall by 50-100 bps. If we see rates falling much more, there would be a positive surprise for the market. So expectation is more important than the reality.

Q. Is the market already pricing the 4 percent (plus/minus 2 percent) RBI inflation target for 2018?
No. If you expect 4 percent, interest rates would be much lower. There is a government bond yield, but triple A-rated businesses are able to borrow at very competitive rates. Interest rates are raw material, like crude oil. This is already priced into the valuations of highly leveraged businesses.

Q. We keep expecting economic growth to pick up, but if that doesn’t happen, how would you value mid-caps?
The Nifty earnings per share growth in FY16 versus FY15 was minus 2 percent. So, if that continues, the valuations are in trouble. In mid-caps, there was also a decline in profits. The question is whether the government has done enough and the answer is yes. We would have liked it to be faster, but the world has worsened. GST was a Herculean task and there is a lot of investment happening in infrastructure. The government is not a great capital allocator and it has not been trying to set up businesses. So the direction is correct. So growth might be delayed, but the right things are being done.

Q. Let’s take two segments where consensus has been bullish over the last decade—consumer goods and banks and financial companies. There is this belief that these are buy-and-hold investments that outperform. Would you agree?
I’ll contest that belief. In our Discovery Fund, for the last eight years we have not had consumer goods companies because of the high valuations. We have consistently tried to pick up stocks that are cheap or fairly valued. Over a ten-year period, the Discovery Fund has outperformed the FMCG fund. So buying FMCG and holding it till retirement is not a good strategy.

Q. But if you look at FMCG for a longer period, say, the last two decades…
FMCG is a very well-managed set of businesses and there are elongated periods when it has done well. In the last eight years, there have been periods when we have had a zero interest rate regime.

Bond yields globally are not a free market as central banks have kept them low. In such a situation, FMCG seems a good place as you make a certain 2 percent return. So it is more a kind of fixed income allocation the world has done. Indian fund houses have not bought so much FMCG. The buyers are mainly foreigners. Funds in Tokyo are up against making a negative rate and so they are fine with making zero percent. That is the struggle the world has with returns and that is the elevated valuation you are seeing in the pink of macroeconomic conditions in India. Things can change, both from our interest rates coming down as well as interest rates normalising in the West.