Aniruddha Sarkar of Quest Investment Advisors
“Given the global macro headwinds, interest rate hikes, and overall demand slowdown (especially in rural India), overall profitability in Q3FY23 may continue to remain volatile and under pressure in the near term,” Aniruddha Sarkar of Quest Investment Advisors said in an interview to Moneycontrol.
Overall, he feels that companies with a domestic focus and relatively lower linkages with the external environment would outperform. For banks, as the impact of rate hikes flows through, along with the possibility of further hikes, NIMs (net interest margins) should remain strong in the near term.
With over 15 years of experience in the capital markets, this Chief Investment Officer and Portfolio Manager is responsible for managing all the PMS (portfolio management service) and AIF (alternative investment fund) strategies at Quest.
He says that going by the FOMC (Federal Open Market Committee) minutes, the US Federal Reserve (the Fed) may pause at 5.25 percent interest rate, i.e., 100 bps (basis points) higher than current levels. However, that may not mean that the Fed would start reversing the rate cycle in 2023 itself.
Do you think one should maintain high exposure in banking considering the expected growth going ahead? Also, among them, what do you prefer the most — PSU or private?
We turned bullish on the banking sector around three quarters back after being underweight on it for the previous six quarters. We continue to maintain a positive view on them given the largely benign credit environment, strong and consistent credit growth driven by increased traction in the retail and SME segment, and expected recovery in the corporate segment.
Though many fear that NIMs will contract, we believe most banks will continue to benefit from upward repricing in EBLR (external benchmark lending rate) and MCLR (marginal cost of lending rate)-linked loans, till deposit pricing catches up (due to the utilisation of liquidity and excess SLR —statutory liquidity ratio). This will offset deposit cost pressures and support a gradual rise in NIMs in the near term.
While selecting the banks for our portfolios, we base our selection on the ability of the investee banks to manage the growth momentum, the earnings trajectory, and valuation. We have exposure to both private and PSU banks and in fact, we’ve been early investors in PSU banks and continue to have them as one of our top three holdings.
Do you expect more NIM pressure in the smaller banks and NBFCs compared to larger ones?
Increase in funding cost and relatively low transmission due to a competitive environment will likely lead to moderation in NIMs, especially for NBFCs. While smaller banks will also get impacted by higher funding costs, the impact would be different for each bank depending on their CASA (current account, savings account) levels.
For large banks too deposit rates would move up as they would compete for a larger share of deposits to mitigate the softness in CASA accretion. However, we believe most large banks will be able to manage NIMs by controlling operating expenses, and ensuring good asset quality.
Do you think December quarter earnings will be better than September numbers? What could be the hits and misses?
A key highlight this quarter would be margin improvements from the levels seen in Q2FY23, given that we have seen reduced input costs across various sectors. Commodity consumers would get the lagged benefit of commodity prices that have fallen over the last six months. As for commodity producers, we expect stable prices, though margins for both should improve sequentially.
The December quarter might not surprise with respect to volume growth due to the higher base of this quarter last year, but we could see some sequential improvement.
However, given the global macro headwinds, interest rate hikes, and overall demand slowdown (especially in rural India), overall profitability may continue to remain volatile and under pressure in the near term. As the impact of rate hikes flows through, along with the possibility of further hikes, NIMs should remain strong in the near term for banks. Overall, companies with a domestic focus and relatively lower linkages with the external environment should outperform.
Do you think the December quarter earnings will be good for the life insurance space? Is it a good space to be in now?
We believe the insurance sector, both life as well non-life, is a structural story given the low-level of penetration. The underperformance of insurance sector stocks in the last few quarters due to the external macro environment and also due to some company-specific, non-operating issues have made valuations attractive.
In the near term, we expect premium growth to remain modest on an aggregate basis, though segments like annuity, non-participating, and credit life insurance policies are likely to fare better. Protection plans and ULIP would continue to be dismal and have a delayed recovery, and we would be watchful of the commentary around the revival of these products. In the near term, VNB (value of new business) margins are expected to improve for life insurers.
In the general insurance space, we expect strong year-on-year (YoY) growth in premiums, and stable combined ratios (premiums vs. payouts), leading to an overall improvement in profitability.
Do you think the Fed will continue raising interest rates in 2023. Is there no possibility of a rate cut in the second half of 2023?
I think that’s one of the most pertinent macro questions for 2023. To answer this question, we should go back in time. The Fed commenced increasing interest rates in a bid to rein in inflation. The idea was to raise rates rapidly to move away from the ultra-accommodative stance followed since Covid. As a result, the Fed went for an accelerated pace of tightening.
In our view, the Fed may pause at 5.25 percent, i.e., 100 bps higher from current levels. However, that would not mean that the Fed will start reversing the rate cycle in 2023 itself. We believe the Fed will be wary of premature easing and would wait for at least two quarters to see that the fall in inflation is sustained even if that would mean overtightening.
Any themes that you have missed and regret in your career?
We are value investors, but value conscious, which means that while we are happy to pay a premium for quality, we avoid overpaying for businesses.
Following this strategy has led us to miss out on some sharp up-moves in few growth-oriented companies which we believe are good businesses, but very expensive in terms of valuations. However, over time, the market has realised these companies were mis-priced and their performance has also been lacklustre in the last few quarters. We continue to study these companies and keep them on our watchlist for the right valuations to make an entry.
What is your investment strategy? Also, what is the strategy behind the launch of Quest Smart Alpha – Sector Rotation AIF Fund?
As part of our portfolio strategy, we believe in sector rotation and company rotation. We believe that being overweight in the right sector which is at the cusp of an earnings upcycle can make a significant difference in alpha creation in the long run. We take concentrated positions in the top four-five sectors.
We are either significantly underweight or avoid sectors where we do not see earnings growth. We do not try to align with benchmark index sectoral allocations, and focus on earnings rather than index-hugging. Even within the same sector, we switch between companies depending on their relative risk-reward ratio.
We seek mispriced investment opportunities in both the value and growth part of the market, hence you would find a balance of value and growth in our portfolios.
Our portfolio could be skewed towards value or growth depending on the market and earnings cycle. Global markets, including India, have gone through these cycles time and again and it is imperative to be flexible with this way of looking at companies.
Also, we believe that the easiest part of investment is making an entry into the company, and the most difficult part is booking profits. We do not hesitate to book profits in our portfolio companies from time to time, and avoid the pitfalls of investment bias by exiting the companies when their valuations become stretched. Cutting our losses when the investment scenario could change due to external headwinds is also something we do not shy away from.
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