For good governance, boards need to vouch for shareholders not management: Vetri Subramaniam

The reason it is limited is because there are founding families, which have dominant stakes in the company, hence it is impossible for the outside shareholders to put pressure on the board. But even in companies where promoter stakes are low, there is sometimes a problem in terms of getting the board to represent views of the shareholders. This is a classic agency problem with capital markets.

It exists in India and other parts of the world as well. In the US, too, companies are mismanaged. The boards are supposed to represent the legal shareholders, but, more often than not, they end up representing the views of management. So, agency problem exists. You can't wish away the agency problem. You have to continuously find new regulations, try and make sure that you are able to make boards more accountable.

Q. How does one hold these agencies accountable?

We are interested in companies which largely show that, when they take decisions, they are keeping in mind the interests of minority shareholders and not doing things only to address the interests of the main family or the management. There are large number of companies in India which have exhibited that ability.

That is why the Indian market is doing so well as compared to elsewhere.  Doesn't mean that because it is doing well, we should ignore some of the problems. Of course, we should try and address those problems, but I am saying there is no magic bullet to that. The agency problem is a well-researched issue in capital markets all over the world.

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Q. Fundamentally, does India look strong to you, in terms of corporate earnings? Does it give you confidence?

The economy is doing well, valuations right now are pricing fantastic implementation of that. If I am an investor saying I want some margin of comfort, that margin of comfort is greatly eroded.

Q. You find this comfort even in smaller tier II or tier III companies like in the smallcap or midcap segments?

The small and midcap space is more challenging. The valuations of largecap space look expensive but they are not bleeding. It's a small and midcap where actually the valuations are more of a concern.

Q. You mentioned the economy is doing well. But, at the same time, large spends by the government have not been able to stimulate private capex. When do you see a recovery, given now even cost of capital is high?

It is unclear because the animal spirits are not yet visible with entrepreneurs in terms of their intention to invest. But just to what you said, look, right now maybe the cost of capital and the real interest rate are slightly higher than normal, but there was also a period where inflation was much higher than what we wanted it to be. This cost of capital argument is completely overstated. Eventually, what matters to companies is the growth interest rate rather than just the absolute interest rate. I think we just make too much noise about it.

The US policy rate is at 5.5 percent and India at 6.5 percent, I would actually submit debt is not, significantly, having to pay higher rates.

Capex is happening but you would like the private sector to do more. Compared to pre-pandemic, the economy is still digesting some after-effects of the pandemic. Per capita income from the pre-pandemic year to today is only about 3.5 percent. It's not particularly great. In 2019 and 2020, companies had likely factored in for the economy to grow at 6-7 percent annually over next five years.

The reality is that the size of current economy is slightly smaller than what they had budgeted it to be. That means companies are saying that they have not reached a point where growth expectation is higher than their ability to produce and deliver.

Companies are taking it slightly more cautious. A lot of companies have learnt the hard way through the last decade. They got very aggressive in the 2000s and then spent a whole decade cleaning up balance sheets. Nobody wants to go down that path again. There is a reluctance to take debt.

Secondly, some companies had a massive profit boom. But they are all now a lot more cautious about the fact that they don't want to take debt because they don't want to go back to that situation… of what it was a decade ago. The risk-taking ability has been compromised both by their own experience and by the fact that due to IBC (Insolvency and Bankruptcy Code), companies are a lot more careful about debt.

We just have to be patient. There is no way for entrepreneurs to wake up and suddenly over-invest. The equity market will not like it if they over-invest. However, the good thing is enabling conditions for a pickup in investment exists. Between 2020 and 2023, corporate profits went up almost 70 percent of Nifty companies.  So their balance sheets are the strongest that we have seen, but way disproportionate to the economy. Part of the steep rise in profitability is also due to corporate tax rates cuts announced by government earlier.

Q. What about rural consumption which continues to lag despite the government’s push through various schemes and incentives?

It is a bit of a challenge and is going to take time.

Q. How soon are you expecting recovery in rural consumption?

It may take one or two years of steady continued recovery. The good thing is the government is holding up the allocations to MGNREGA, to keep it running to another five years. Remember, that covers 80 crore people, which is more than half of population. Again, we just have to be patient. There is no magic formula to this.

Q. The agri-economy recovery is also dependent on weather, especially monsoon that was very scanty and uneven last year. Are you aggressive in the consumption rural sector theme in terms of picking up any stocks?

The linkage between monsoon and the agriculture sector has only been going down over the last 10 to 20 years because a large part of agri output is not directly linked to the monsoon. That is because either there is a better irrigation system now or some of them have moved on to other forms of agri-farming, which is not directly related to rains.  For example, shrimp farming, which has nothing to do with the rains.

Q. What about staples like rice, pulses, onion, tomato, etc?

That's a smaller and smaller portion of the total agri output. You look at the value of agri output in India and the contribution of rice and wheat. The contribution related to the larger pile is only declining.

The challenge is also that there hasn’t been a very strong cycle of pricing, farm incomes have not really kept pace at that level. The government has done what it could but farmers have not seen that price increase. Every policy decision will have some beneficiary and some who suffers. In the last two years, as wheat prices have increased, the government capped prices to control inflation.  Had wheat exports not been banned, farmers would have had bumper gains.

Most important, people in that segment have become more reliant on farm income because maybe some of the urban incomes of those households have not returned. This was partly a Covid-related phenomenon. Some data show that people have not left those farms and returned to urban areas. So, it is not that there is no farm income but actually the same income is now supporting a larger number of people.

We just have to wait for some of these factors to rebalance. What we know, and historically this has been true, is that whenever you see construction activity pick up, that means people leaving the farm sector—it is the first job that they take because it does not require trained skills.

So, as government and real estate construction continue to pick up, this may possibly get sorted not because of a raise in agricultural prices, but because those people move to these sorts of jobs and therefore family income goes up.

Overall, the consumption trend has been disappointing. We still like some of the companies. But, at this point, it's not something that we feel usually excited about that we want to increase our exposure. They are all facing challenges of subdued demand.

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Q. A few months later, the general elections in India will make markets volatile. Any strategic changes in your portfolio to weather it?

I haven't seen a format which has ever helped me figure out how to position companies for a US election or an Indian election. Where or what is the template that tells you how to position for elections. If you are an investor in equity and you are investing for 20/30 years, then you have got to believe that eventually, you are investing in good companies.  There are going to be some nasty shocks along the way. Every 10 years, the market will find some reason to fall 30 percent. Every three to four years, there will be some reason to fall 20 percent. But, if you are staying invested over 10, 20, 30 years, which is your investing lifetime, hopefully, you should be able to make money with a good, diversified portfolio.

Q. What factors or events are going to keep the market challenged now?

The biggest risk factor is uncertainty or unpredictability. Besides, there are some traditional risks that we worry about. Investors are discounting multiple rate hikes, but what happens if inflation actually doesn't come down and starts to accelerate again. That would be a rude shock to all risk assets because widespread expectations are of a interest rates declining.

Exactly at the opposite end of that spectrum, there is still a non-zero risk that, the biggest surprise of 2023 was that the recession didn't happen in the US. What if it does eventually show up? If that happens, that will be in an environment where China is also not pulling along the global economy. Then we will have two large economies not being able to pull along the global economy. It is certainly not good for growth, not good for anything around the world.

The US elections are very tight and if there is a legal battle relating to the election outcome, it just raises the level of uncertainty about how that country will be governed. The US elections are more challenging than in India. I think, more sort of India-specific, the K-shaped recovery is just holding back the economy on a platform which is very strong but it hasn’t been able to due to post-pandemic issues.