Manish Kumar chief investment officer at ICICI Prudential Life Insurance is betting on metal and auto shares to deliver superior returns even as the broader market is likely to remain range-bound for a while. As on February 28, 2011, his firm had a little over Rs 38,000 crore invested in equities, making it the second biggest equity investor among domestic players, next to only the Life Insurance Corporation of India.
"Market will remain range-bound for another six months, though that range may change a bit on either side," Kumar said in an interview with Moneycontrol.com.
"We had a similar view six months ago, but that was for a different set of reasons. Then the earnings momentum was strong, but valuations were expensive. Also, robust foreign funds were neutralised by too many share issuances by companies.
Right now, valuations appear fair, but there are headwinds in the economy that could eventually impact earnings growth. We are seeing a slight easing in the economic growth and the investment momentum.
In addition, inflation has remained high despite the efforts to tame it. "Because of these factors, earnings growth for FY12 (April 2011-March 2012) could be in the low- to mid-teens. We are cautious on the economic growth for the coming fiscal and expect it between 7.5-8.0%, even though the government has guided (8.75-9.25%) much higher," Kumar said.
Insurance companies are normally big buyers of shares during the January-March quarter, which is when they collect maximum premium as people invest in insurance schemes to save on tax.
But this time, inflows into insurance schemes—especially unit-linked investment plans—have fallen, with the result that insurance companies have not been very active in the stock market.
Kumar says that perception is not entirely correct.
"Domestic insurance companies have invested roughly USD 2.5 billion in shares in the current quarter, which is not a bad number in the context of the regulator changes that became effective from September 1 (2010)," he says.
After the Insurance Regulatory and Development Authority changed the rules for unit-linked insurance plans (ULIPs) from September last year, companies had to scrap most of their existing ULIP schemes and introduce plans that were compliant with the revised guidelines. The new rules included, among other things, a higher level of life cover.
ICICI Prudential Life Insurance collected Rs 40.55 crore in premium for the October-December quarter, almost the same as in the same period the previous year.
After a sharp drop in inflows into ULIP schemes in September and October, things have been gradually looking up, says Kumar.
Choosy About Bank Shares
Kumar is bullish on metals, auto, and is neutral-to-underweight on banks.
Banking shares have rallied the sharpest from their recent lows, but Kumar says analysts may have not fully factored in the pressure on net interest margins that will arise from high deposit rates. Net interest margin is the difference between the rate at which it lends money and the rate at it which borrows.
"Lending rates will start softening in a few months, but it will take some more time for deposit rates to soften. So while the net interest margins may look healthy for some a couple of quarters, the pressure due to high deposit rates will inevitably catch up," he says.
But Kumar is not bearish across the banking sector.
"Banks with a good CASA (current account, saving account) will do well because their cost of funds will be much lower," he says.
Kumar’s schemes have significant exposure to HDFC Bank and Axis Bank. Other key holdings include Oriental Bank of Commerce and Punjab National Bank.
Auto and Metal Bets
In the metals space, Kumar is betting on companies' operating efficiencies more than on a recovery in the global economy that leads to higher demand for commodities like steel and aluminium.
Key holdings in Kumar’s portfolio include Tata Steel, JSW Steel, Sterlite Industries and Steel Authority of India.
“We are focussing on companies with the lowest cost of production, because we expect good volume growth. So even if metal prices are depressed, the companies will be able to show good profit growth on higher volume sales,” Kumar said.
At the same time, Kumar is bullish on automobile companies, even as their margins are getting squeezed because of rising metal prices.
"Right now the economy and so the auto sector, is still in a growth phase. I see strong demand for passenger vehicles and two-wheelers persisting for a while. Besides, operating margins of most auto companies are below their five-year average, because of which valuations too are reasonable. We are quite comfortable buying into auto stocks at these levels," Kumar says.
Stocks in Kumar's Negative List
"We are avoiding companies with high debt/governance issues/low margin NBFCs/banks with low CASA," says Kumar.
He is cautious on capital goods/infrastructure stocks where he sees few opportunities despite share prices having fallen sharply.
"We did buy some infrastructure stocks, but not very aggressively," says Kumar, adding "…the political environment around the sector is not very good. Also many companies have ended up winning projects at unviable prices, which will soon start showing up in their earnings."
"The investment climate will take some time to change, and the government has to contribute a lot towards that. But more importantly, interest rates will have to soften. It is not possible to make good returns when you borrow money at 12-13% to execute projects," says Kumar.
Medium-Term Interest Rates May Rise
Kumar agrees with the widely-held view that the government will exceed its net borrowing target of Rs 3.43 lakh crore for FY12 announced in the Union Budget.
"Though the 10-year (government bond) yield has been steady around 8%, I expect it to rise by another 25 basis points," Kumar says, pointing to inflation that refuses to ease despite the Reserve Bank of India’s persistent efforts.
"At the very short end, there could be some softening of interest rates. But the medium-term rates could rise some more," Kumar says.
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