An intrinsic characteristic of equity markets is that they are driven by sentiments in the short term and fundamentals in the long term. Over the past 10 months or so, the overwhelming sentiment in global equity markets has been that of fear. When fear or risk aversion takes over, asset prices fall, valuations become attractive and risk reward trade off is favourable for the long term investor. Warren Buffet made a profit of $3.7 Billion in less than three years by investing in $5 Billion in Goldman Sachs in the depths of the financial crisis in 2008. The mantra of getting extraordinary returns in equity market, as per most investment gurus, is to invest when there is fear. From March 2015 to January 2016 the Sensex has corrected nearly 20%. Is this the right time to invest in lump sum in Indian equity? The timing is certainly right now, as per ICICI Prudential Mutual Fund. ICICI Prudential has launched a new close ended mutual fund scheme ICICI Prudential India Recovery - Series 4, aimed at capturing low valuations in select large cap companies with the objective of creating wealth over the investment horizon of the scheme.
There are compelling reasons for investing in the Indian equities at this point of time:-
- India’s macros are among the strongest in the world. As per estimates by external agencies, India’s GDP will grow at 7.5 to 8% in FY 2015 – 2016. As per a World Bank report, India will be the fastest growing economy in 2016 as China slows.
- Over the last three years the macros of our economy is steadily improving. The improvement has been across almost all important macro parameters like Fiscal Deficit, Current Account, CPI Inflation, Government Bond yields and RBI policy rates.
- However, our equity market valuations do not reflect the economic strength. The overall market cap to GDP ratio is lower than the historic average. As discussed earlier, equity market valuations in short term prices in sentiment rather the fundamentals, but in the long term they inevitably revert back to fundamentals.
- One of the pain points, as far as our equity market is concerned is that, corporate profits have not yet picked up.In fact, corporate profit as a percentage of GDP is at its lowest level in the past one decade. The aggregate Q3 corporate profit growthon a year on year basis was weak, as per CRISIL. Corporate profit growth is seen as key to the recovery in our stock market performance.
- FII flows to India slowed down in this fiscal year and over the past few months FIIs have been net sellers. The FII sell-off, however, was triggered largely by external factors like fall in crude prices and concerns regarding China. Risk aversion impacted flows to the entire emerging market basket, not just India.
- FII flows are expected to resume again once crude price stabilizes.
- If we look at Sensex returns over the past 15 years, every major correction has been a great wealth creation opportunity. Whenever the Sensex corrected by 15% or more, the returns from the lows have ranged between 90% to over 300%.
Large Cap as a theme
As per ICICI Prudential Mutual Fund, large caps are currently undervalued and therefore present an attractive opportunity. FII ownership of large cap companies has been increasing over the last 7 to 8 years and these companies have come under some stress due to selling by foreign investors over the past few months.
Large cap stocks, in fact, are now available at cheaper valuations compared to midcap stocks. As per ICICI Prudential Mutual Fund, large cap stocks are now trading at a discount of 28% relative to midcap stocks, compared to a premium of 7% seen in February 15.
Source: ICICI Prudential Mutual Fund
As such some well known large cap companies, leaders in their respective industry sectors are trading near their 52 week lows and their valuation (P/E multiple) is lower than their 5 year average. Large cap companies have proven business models and established track record of management teams. The current situation in the large cap segment is certainly not normal and therefore investing in cheap good quality stocks in large cap segment has the potential to generate exceptional returns when the market returns to normal.
Cyclical Sectors as theme
While there has been reversal of valuation gap between large cap and mid cap market segments in the past one year or so, there has also been polarization of valuations between cyclical and defensive sectors. The valuation gap between cyclical and defensive stocks have widened over the past several years.
Source: ICICI Prudential Mutual Fund
We can see that the valuation gap between cyclical and defensive stocks is now at its widest extent. We can also see in the chart above the valuation gap between cyclical and defensive stocks have converged in the past. Once we see recovery in earnings, good companies in cyclical sectors are likely to give great returns.
Key Features of ICICI Prudential India Recovery - Series 4
- 3 year (1099 days) close ended equity scheme
- The scheme will aim to invest in 15 to 20 high conviction large cap stocks
- The scheme will aim to capture profits by selling or by using derivatives. However, this is no assurance that the objectives of the scheme will be realized
- Minimum Investment:
- Fund Managers: Manish Gunwani and RajatChandak
- Benchmark Index: S&P BSE 500
Investors should consult with their financial advisors, if ICICI Prudential India Recovery - Series 4 is suitable for their investment needs.