Mutual Funds

Is it time to bottom fish in mid, smallcaps? Find out what Navneet Munot of SBI MF says

With this fall, some of the largecaps are becoming midcaps and some of the midcaps have become smallcaps. India is a stock picker’s paradise. There has been a decent correction in the mid and smallcap space and this is time to actually do bottom fishing there, Navneet Munot, CIO, SBI Mutual Funds, tells ET Now.

Edited excerpts: 

A Nifty 50 stock like Indiabulls Finance is crashed by 30-40%. It reminds of 2008, 2013. What’s happening?

We discussed at the beginning of the year that this is not going to be a calm and peaceful year like 2017. It is going to be a lot more volatile and particularly down the capitalisation curve, there will be a lot more pain. YTD, the Sensex is up 7%, Nifty is up 4%, BSE 100 maybe 2%, BSE-500 negative, midcap minus 14%, small cap minus 20%. This is the mirror image of what has happened in last three or four years. The writing was on the wall, particularly on the sector that you talked about.

What really happened in the last few years? What led to the massive growth in NBFC sector? We have three balance sheets in the country – government, corporate and households which borrow money. The government was deleveraging because they wanted to reduce their debt to GDP. Corporates were deleveraging for a variety of reasons. The household balance sheet was in a great shape three-four years back and could take the leverage and other factors, the formalisation of the economy, digitalisation, ample liquidity held by the non-banking finance sector.

The banks had their own set of challenges, especially the PSU banks. Many had huge NPAs. There was a huge scope for the NBFC sector to grab that. But in finance, whenever the growth is much faster in a particular segment, some problems crop up. So, when some finance companies took leverage which was much higher than what they should have taken relative to the asset quality, problems arose. That happened because liquidity was ample for last few years and they were a big beneficiary. You borrow short term, you lend long term. But now suddenly liquidity has tightened because of rupee and because of a variety of other reasons, rates have moved up. You are in trouble when you have to roll over those maturities. The whole episode of AAA rated entity defaulting just complicated the situation.

Going forward, my sense is that in last few years people who could grow the asset side faster were commanding a premium. Now people will realise the value of the liability side. Some of the banks have better liability franchise. They will grab the market share back which they had lost in last few years.

In a country like India, growth is unlimited. If you are a good NBFC or a good bank you can always raise capital. It is only when the tide turns, liability can be seen and you find out who has been doing the wrong things.

When the tide turns, we will see how many people in the market were swimming naked.

The tide has just turned. Will we see more and more skeletons tumbling out of the cupboard? Will the headlines for NBFC companies get uglier going forward?

I do not think so. There are two parts to it. A few years back, we used to discuss how the formalisation of the economy, digitalisation, differential regulation and intermediation is the structural trend where savers go to mutual funds and borrowers to the non-banking sources. These are structural trends and in India, a large part of the informal lending and informal borrowing is now moving to the formal channels. Banks cannot serve all the segments and there would be a lot of space for the NBFCs who are more agile and have invested a lot more in technology.

Those who have managed their balance sheets well, who are very good in their risk management — be it credit risk assessment or recovery mechanism, companies with a stronger parent will do well. They will continue to do well because in India we are still starting from a very low base in terms of debt to GDP across all segments. So, there will be space but the boys will be separated from men.

As an AMC, how are you positioned in financials now?

We have been cautious on both debt and equity sides. The liability franchise which was not as important when there was ample liquidity, also got amplified after demonetisation. One’s ability to grow the assets faster was more important. We have diversified a lot more. Today we are focussing a lot more on NBFCs or banks with a stronger balance sheet and a stronger liability side. Of course, it goes without saying that you have to have very strong standards on under-writing and on risk management.

What happens to retail-dominated banks like HDFC BankNSE 0.81 % or Kotak Mahindra BankNSE -1.18 % or an NBFC like Bajaj Finance? CIBIL and other risk management systems are ensuring that the retail borrower has not been defaulting. 

This is a mistake that people make. If you go back in history and check three balance sheets that borrow money, you will see excessive growth has often led to trouble. In 2008, it was household balance sheets in the US, in 2011-12, it was government balance sheets in parts of Europe.

If you see the financial crisis in Asia earlier or the recent one in India, it was corporate balance sheet. In any balance sheet, regardless of the lower base, whenever growth is much faster than the income growth it will lead to some trouble. When a lot of money chases a particular sector, under-writing standards get diluted, some wrong practices come in and that leads to trouble.

That’s why I keep repeating that those who have maintained their balance sheet well and have shown extremely prudent risk management, would do well, particularly in case of banks. Some of the retail banks, the so-called corporate banks also have a massive retail franchise let. They have strong CASA on liability side. Their ability to raise liability even other than CASA is huge and they were large retail franchises. In last few years, some of these banks had their own set of challenges on the stressed asset side. As that gets resolved, they will focus on retail so I think some of the market share from the NBFCs is likely to shifted back to the banks.

Are we likely to see a reversal in demand — auto demand, consumer demand and discretionary demand because interest rates have already gone up by 150 bps?

We are yet to see the full impact. It has not really passed through completely to the consumers yet but will have impact on corporate profitability which was good last quarter. People have started extrapolating that but the higher raw material prices will also get impacted by the weaker rupee on the margin side and the higher interest cost is going to impact for consumer lending,

The rates are likely to go up. The marginal rate of borrowing of most of the NBFCs is lower than the lending rates. So, borrowing rates will go up and will impact some of those segments at the margins .

Leadership Change in 3 Years

In one of your earlier interviews, you had said that markets always follow cycles, there is a leadership, there is a boom and there is a bust. Where are we right now? Is there going to be a leadership change in next three years?

It will become more broad based as India is going through a couple of cyclical challenges, particularly on the external side. The world is getting impacted by trade war, as well as monetary tightening. Today, the Federal Reserve is likely to raise rates further. After 10 years, it will be above 2% inflation. We will be impacted by the crude oil prices. In the near term, we will remain under pressure. Plus there is a heavy political calendar.

But you look through a year and look at 2020 and 2021, once the corporate balance sheets get deleveraged, once banks are in a better shape to lend and growth comes back to the overall economy from a low base and last year’s disruptions on account of demonetisation or GST, growth will become a lot more broad based.

Structurally, the connection between the weaker rupee and exports is helping some of the sectors which were not doing well. IT, pharma and metals etc are clearly seeing the positive impact of that. If growth becomes more broad-based, we will have a lot more choices.

This year, almost 50% stocks have fallen more than 20% from where we were at a new high and 8% stocks have delivered more than 20%. Some 17-18% listed stocks have fallen 50% plus. It has been an extremely narrow rally and may continue like that for some time because of the macro challenges and some risk even at the micro level. Structurally, in three years, the market is likely to become more broad based.

So, good news and good prices do not come together.


Are prices good?

In a lot of places, there has been decent correction. The market always works like a pendulum. Given the disruptions and the technological disruptions, the consumer behaviour disruptions, the disruption caused by GST logistics, the disruption caused by the way of doing business is changing will lead to a situation where the smaller and mid companies will do better than the large guys and which played off very well for three four years.

But the valuations reached another extreme and that is why at the beginning of the year, our view was that it is going to be a year of the largecap. There has been a decent correction in the mid and smallcap space and there is a time to actually do bottom fishing there.

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