?We?re bullish on domestic consumption and investment driven themes?

The economic environment has clearly changed between the first half of the year and second. Earlier it was inflation,but now slowdown in economic growth has emerged as the dominant threat to corporate performance and the markets. Puneet Nanda, executive vice president and chief investment officer, ICICI Prudential Life Insurance spoke to Sanjay Kr Singh about how the new dynamics alter the prospects of different sectors.

What do you see as the major risks to the Indian equity markets in the near to medium term?
Our long-term view is very positive at current valuations, given India?s macro-economic fundamentals. The biggest risk is further deterioration in the global situation that could lead to continued FII outflows. The second major risk is negative surprises on the extent of slowdown in India, which will have a bearing on FY10 earnings forecasts. However, policymakers are already acting and have taken both monetary and fiscal steps to boost domestic demand and reverse the slowdown.

And what are the positives for the Indian economy and markets over the medium to long term that patient equity investors could profit from?
The most significant positive from a long-term investor?s perspective is the valuation of Indian equities. With a single-digit price to earnings ratio, the benchmark is almost at an all-time low. Moreover, commodity prices, inflation and interest rates are all coming off. This will boost corporate fundamentals and make equities more attractive in the long run.

In a falling market a lot of fund managers shifted into cash. What was your approach?
Before discussing the pros and cons of making a cash call, let me enumerate our investment approach. Basically we are a long-term savings management company. Savings are invested according to a customer?s goals and life situation. Each customer has an optimal asset mix based on his or her risk appetite and investment horizon. If one has done proper risk management at the overall savings level, the need to take cash calls at the asset level is lower. As such we do not usually take significant cash calls.

Nonetheless, in your view what are the pros and cons of raising the level of cash in the portfolio?
Sitting on high cash levels at the current depressed valuations is both irrational and risky. Taking cash calls may occasionally work tactically over the short term. But for an investor focused on long-term returns based on appropriate asset allocation, it is not prudent.

A widely preached strategy during the market downturn was: get into defensive sectors like FMCG and pharma. But if all fund managers are stampeding to get into these sectors, it pushes the PE of these stocks high vis-?-vis the market PE. Then where would you get value in these stocks?
People derive comfort from the belief that earnings volatility is likely to be lower for defensive companies compared to the rest of the market. A lot of stocks, including FMCG bellwethers, have outperformed the benchmarks by anywhere between 30-50 per cent and their earnings multiples today are two times the broader market multiples. As such, one needs to take a call on the extent of value left.

The economic environment has changed: commodity prices have fallen and inflation is no longer a threat. Slowdown in growth is now perceived as more of a threat than inflation. How does that change the prospects of different sectors?
Sectors that have strong demand, but whose profitability got hit, or was expected to get hit, because of rising commodity prices will now be seen in a different light. Similarly, there are many bellwethers that were prime beneficiaries of the strong commodity cycle. Their financial performance will weaken. Having said that, ultimately it is all about valuation, meaning how much of the incremental news or direction is already factored into the price.

Which are the sectors that you are bullish on?
At the moment we are bullish on domestic consumption and domestic investment themes in areas where funding is not likely to be an issue. We are relatively more cautious on global cyclicals as the price outlook there is a function of when and how the global economic cycle will recover.

More specifically, we are bullish on capital goods, power, telecom and banking.

What do you find attractive about these sectors?
Companies in the capital goods sector have strong order books. Earlier, their valuations were very high but now valuations have turned attractive.

Within the power sector, the margins of power suppliers remain protected because of the long-term nature of their contracts with buyers. Moreover, in this country the demand-supply balance is heavily tilted in favour of suppliers, so a slowdown will not have much of an impact on them.

In the telecom sector, most service providers are now heavily selling their value-added services. This will improve the margins of these companies. On a relative basis, I find telecom a better bet than many other sectors.

Banking has been among the worst hit in the recent market meltdown. Today, whatever measure of valuation you use ? P/E or P/BV ? stocks in this sector look attractive. Moreover, the interest-rate cycle has clearly turned. How low interest rates will fall is an open question, but there is no doubt that rates are headed downward. This will improve the prospects of banking. Concerns about non-performing assets (NPAs) remain, but these are adequately factored into the price.

Among all these sectors, capital goods and banking, according to me, have the best prospects.

And which are the sectors whose prospects have clearly worsened?
All commodity-dependent stocks will clearly be affected by the global slowdown. Real estate sector has also been hit hard, one, due to the high price of the end-product, and two, due to the high leverage of players within the sector.

Indian companies borrowed abroad to enjoy the lower interest rates. But the depreciating rupee has turned these loans burdensome. And due to the global liquidity crunch lenders are unwilling to roll over debt. Has this become a major problem for Indian corporates?
No, this issue only impacts a few companies that have a high level of foreign debt. The number of such companies is limited, and the issue is not a very significant one.

Besides foreign loans turning more burdensome, how else is the depreciating rupee impacting corporates?
The depreciating rupee is clearly good news for export oriented companies. However, the cost advantage this gives them is getting neutralised by weakening demand abroad as recession in major markets takes its toll.

Finally, what would your advice to equity investors be?
The 15-year average PE for the Sensex is 13-14X. Today, at a PE of 9-10X, the Sensex is at an all-time low. Remember also that earlier when the Sensex hit such a low, GDP growth would have been around 3.5 per cent. Today even pessimistic estimates put the growth rate at 7 per cent. So it?s clearly a great time to invest in equities for the long term.

Assess your risk appetite, do proper asset allocation, and invest in a diversified portfolio. Invest regularly and in a disciplined manner. Invest only to the extent that you can, so that any decline in price doesn?t perturb you but becomes an occasion to purchase more.