Indian equities have bounced back but equity fund managers may not be in a mood to celebrate. Market polarisation, the uncertainty created by the pandemic and a liquidity-driven rally have made managers' task difficult.
Analysts and fund managers seem to have discounted Financial Year (FY) 2020-21 and they are betting on stocks based on projected FY22 and FY23 numbers. Consensus estimates peg Nifty EPS growth of 10 per cent and 39 per cent for FY2021 and FY2022, respectively, according to Credit Suisse Wealth Management, India. A nationwide surge in Covid-19 cases, states going under lockdown and limited fiscal support, however, could pose significant downside risks to these estimates.
"There's a bit of disconnect between market and macro reality. The former is driven by excess liquidity, hopes of economic activity returning to normal together with a Robinhood effect in the form of huge retail participation," said Navneet Munot, chief investment officer at SBI Mutual Fund.
Getting clarity about earnings estimates will be challenging for fund managers this year. Price-to earnings-multiples for FY21 are almost irrelevant because profits dropping across sectors. Managers believe companies should be assessed by looking at their earnings two or three years down the line.
“Taking FY19 as the base, one can arrive at a normal growth trajectory for a particular sector over the next three to four years. Based on that, predict what the earnings will be in FY22-23 and try to value the company on that basis, ignoring FY21 numbers. Also, look at price to book value and see where it is compared to historical averages," said Mahesh Patil, co-Chief Investment Officer at Aditya Birla Sun Life MF.
Indeed, metrics like P/B value, market cap to GDP and solvency ratios have gained currency in the current environment.
Market observers believe that companies with high debt and/or leverage may not be able to withstand the pressure on their balance sheets. Companies that innovate, have liquidity and robust risk management will emerge winners.
"It's not market cap or size of physical assets that will determine a companys resilience but how nimble and agile its management is," said Munot, adding that high frequency data from various agencies, alternative data from search or social media and mobility trends have become important during the pandemic.
Feroze Azeez, deputy CEO of Anand Rathi Private Wealth Management, said analysing the Altman Z-score of companies may be a better way to predict impending defaults and bankruptcies rather than credit ratings given by ratings agencies. Another way to gauge resilience would be to go far back into history, say 10 or 20 years, to assess how companies have fared in recessions, political uncertainty, or catastrophes, said Siddhartha Rastogi, Chief Operating Officer & head of sales at Ambit Asset Management. Historical data, however, may not be relevant for sectors or businesses that will see a new normal and are significantly impacted by the pandemic.
Taking cash calls wont be easy. Setting aside 5-10 per cent of cash would seem prudent given the limited upside for the markets in the short term. But large cash calls could backfire if the liquidity-driven rally continues.
Aditya Birla Sun Life MF, for instance, has decreased its equity exposure in asset allocation funds to 65 per cent levels from about 75 per cent before the pandemic. SBI MF's Munot says the fund house does not take large cash calls in equity funds, where the focus continues to be bottom-up stock picking. The fund, however, may take tactical calls to hold more cash in hybrid and asset allocation funds.
And while valuations are not as cheap as they were in March or April, fund managers insist there are enough opportunities for stock picking. "Stock selection was much easier two or three months ago; we have to be much more discerning now," says Patil. "But we don't mind holding on to companies with a clear visibility of recovery and steady growth in the coming years, even if they are slightly expensive.”
Large cap funds or strategies, however, may find it difficult to beat the benchmarks given the polarization and weak earnings growth seen in the past three to five years. Experts say investors should temper their returns expectations given the sharp run-up since May and spread out their investments to tide over market volatility.