ASK's Prateek Agrawal Picks Top Two Sectoral Themes As Economy Rebounds
ASK Investment Managers has moved from defensive bets to sectors likely to benefit from India's economic rebound.
As the pandemic wanes, ASK Investment Managers Pvt. has moved away from defensive bets and is choosing sectors expected to benefit from India's economic rebound.
Before Covid-19 struck, the asset and wealth manager included consumption, and staples stocks in particular, Prateek Agrawal, business head and chief investment officer at the firm, told BQ Prime’s Niraj Shah on Alpha Moguls series.
“Now as the recovery has started and the faith in the recovery has gotten stronger, we have moved consumption down a tad; more importantly, reduced staples and increased discretionary space spending categories,” he said.
The investment manager has added chemicals, beneficiaries of production-linked incentives, and new-age manufacturing to their portfolios.
Top Two Sectors
According to Agrawal, the top two sectors in ASK's portfolio are cement and defence.
Defence has emerged strongly on the backdrop of current geopolitical tensions, he said. It's a space that can deliver over 15% CAGR growth for a period of time, Agrawal said.
"We used to be the largest importer of arms globally and indigenisation of the same over time does provide an extra leg of growth," he said.
Private defence suppliers, who provide to large platforms, integrators and systems companies in the sector are the ones benefitting from import substitution, Agrawal said.
His other key bet is chemicals. The sector is growing more than 3% globally, prompting companies in India to double capacities as soon as possible, he said.
If cement producers double their capacity in the two-and-a-half years, and further double it in a similar period after that, the industry can see a "very strong growth" over four to five years, he said. At the end of it, that should take India's share in the global cement market to 10%, he said. The country currently accounts for 3.5-3.7% of the global output.
Rising wage costs and pollution control in China will help domestic businesses exporting to that country, he said.
While ASK is underweight on banks, Agrawal said the firm owns "most of the names which are doing well". "If with 25-26%, I am getting as much bang for the buck as for putting in 35%, I think we are very well off.”
The investment manager, according to Agrawal, has shown more conviction on smaller lenders than bigger peers and "that is something we have retained".
Watch the video here:
Edited excerpts from the interview:
What has been your approach to portfolio construction over the years? Is the current thesis of your portfolio construction different from the past?
Prateek Agrawal: We stick to our investing philosophy, we don't change it. We may tune it a bit for the time being, but we don't change it. We seek to deliver preservation and growth to our investors. Towards that goal, we invest in high-quality free cash flow generating businesses, which will grow over a three-to-five-year timeframe.
All businesses have an element of cyclicity in them. It is not that any business is in a perpetual growth phase, but there are businesses which have longer-term, secular growth phase that they may experience during a period of time. We wish to be associated with those kinds of businesses, some of the best businesses in those spaces.
You have never invested in cyclical businesses as the valuation remain limited for a period of six to nine to 12 odd months, like how metals were in 2020. Can you select other cyclical spaces?
Prateek Agrawal: Yes, they were enticing but the valuations were limited. How we address such issue is that we tell our investors clearly in the beginning that we do not invest in businesses where longevity is low. This also clears the path for our investment team and we stick to the path that we have communicated, which is something that our investors value. This method also results in lower volatility in the portfolio.
That is what helped you make money and therefore you don't see much reason to change even in a post-pandemic world? You still believe that is a winning formula?
Prateek Agrawal: Yes, that's a winning formula. But because of the changes that may be happening globally and in India, there may be new themes emerging. The earlier themes may also be running their course. But, we include only those newer themes that has longevity of growth and richness of businesses, then we ride it.
We have today 20 equity-based portfolios with the largest portfolio holding 23 stocks. Nine out of these have been there with us for over five years. All these stocks multiplied and continue to do well. Our investors base too have remained similar. People come and stick with us for a long, long time. There are very few changes may be three to four in a year. Rebalancing that is all we do and the newer themes get included. The earlier themes that have run their course, may either get trimmed or excluded because we want a tintype portfolio.
The overarching view is that the market is slightly ahead of its long-term valuation metrics. India is much more expensive compared to the world, but markets that are doing well mostly look a bit more expensive when interest rates are moving up, quantitative tightening is happening, and there is geopolitical stress. Are you currently fully invested? How do you align your thoughts to stay fully invested in light of all of these uncertainties that we currently have?
Prateek Agrawal: We are always fully invested except for the period when we are selling something to buy something else. In our system, you need to raise cash before you can deploy, and this happens simultaneously. Except for some days when you may see some cash, we remain fully invested.
One big reason for taking cash calls is to dampen the portfolio. In a high beta portfolio, if you take a cash call on the way down, it will dampen performance, meaning it won't fall as much as to tempt the fund managers.
Our portfolios are low beta historically. Now, if we buy pretty strongly growing businesses with less variation in profits, that element which causes volatility itself is less. Over the last 11-12 years, there have been just three instances when we may have fallen more than the market. So, the need to raise cash to dampen the move down does not rise.
I tend to see cash as a source of risk.
There has to be a thesis behind raising cash. Most managers, individuals, or investors who raise cash end up deploying it at levels higher than where they have been, not just in one instance but over multiple instances. Hence, taking cash flows is to be seen as a source of risk. It looks good for a period of time, and it almost always hurts performance.
Global geopolitical stress is very good for India. This is due to the fact that if one country is flexing its muscles against the US and the US wants to diversify its business to other countries. We are down one on the line. We all benefit. Or if two countries fight with each other, suddenly 'Make In India' benefits. Also, post-Covid, giving protection to your own business is not frowned upon. So that gives a lot of strength to Indian businesses, and that is why there is a lot of optimism about moving capex in the country because businessmen see profit, they see the government's ability to defend the business, and they see margin sustaining for longer. A lot of things happening globally are a huge positive for us. I think it helps that we are also learning to not dabble too much in geopolitics and do business.
In terms of the business outlook, in many ways, we are better off than where we have been over the last 10 odd years. If you segment the last 10 plus years into two halves, in the first half you will see margins of corporate India falling, and that was the period when bank backbones were getting recognised. That was the period when globalisation was at its peak, and we had to drop import duties. Chinese competition was so high. There was a decimation of several Indian businesses just because China thought that they wanted to manufacture it.
Now that's changing very, very sharply. Bank profits are up. Margins are picking up. Bank and market margins are picking up. There is this change that one is seeing plus the outlook. After 2003-04, we are looking at capex no longer being a drag on the economy but being the engine of growth. The government was always doing it; the private sector has started to do it. Even households have started to buy houses. All three segments coming together really helps. It's not something that starts and stops quickly. If it happens, it gives some tailwinds to consumption as well. I think there's lots to look positive at and be overall positive.
If somebody is a global investor, there are not too many places to invest because large geographies like the U.S., Russia, and Europe are not growing. China is slowing, while Japan is also not growing. Our subcontinent, apart from India, is not growing. The Middle East continues to expand. So also commodity countries because of the commodity tailwind, but it is a very shallow, with few companies’ kind of market. If you are a global investor and you want growth, your choices are limited.
On the valuation front, because of this, we may be looking better than other emerging markets. We are on solid ground on our historical valuation metrics such as PE. If you look at the last 10-year kind of PE averages, we have some periods when we were low and some when we were a tad higher... Currently, we are at sustainable levels in PE as far as our own history is concerned.
If you look at bonds' yields to earning yields, it is clearly pointing to some amount of discomfort on equity valuations. With bonds being where they are, we expect the period of consolidation in the market to go forward. But, we do expect a large correction at this juncture. This is the time to keep faith. What is also happening is unique to India. If people start to buy more cars or buy more air conditioning, it is the reason why people also buy more stocks. The reason is that they have more money, so as you grow up in per capita, the quality of life starts to improve and you start to spend. Thus, sales improve and the ability to invest, causing money to flow into equity, increases.
We are seeing a very secular trend there. Yes, it won't be without hiccups for sure. but a very secular trend. This means we have a very good buy on dips kind of a market. So, as the globe normalises, countries which may not have done so well will do better or hope to do better. But that doesn't mean we fall; we may just do slightly less, and hence the evaluation differentials may reduce.
Is it a prudent time to be a growth investor, or is it time to be a slightly defensive investor?
Prateek Agrawal: If you look at the eight months of successive selling that we experienced, it was that kind of period when there was the prospect of liquidity tightening, there were prospects of interest rates moving up, and if you look at other geographies, they were getting outflows as well. Many commodity-producing countries and value-added markets brought inflows. However, the growth market experienced massive outflows on a never-before-seen scale—eight months of consecutive outflows.
The track, if you look at it, has changed. Trade changed in July when commodity prices also dropped. The oil became a tad less. Commodities like steel and copper, agri-commodities, all started to drop. Oil has fallen from its peak for a variety of reasons, as have bond yields. In the U.S., 10-year treasury yields peaked not at the last rate increase but before that. It fell from 3.4% to 2.7%, but with the rate increasing and tightening, it has come back to 3.3-3.4%. So, the rate hike is not having the kind of impact that it used to have before. The thought is that unless the rate of movement is not far from the expected line, the tenure is discounting. If it exceeds those levels, then we shouldn't be expecting another round of selling, as they will also coincide with dollar tightening etc. However, if oil shoots up, we will get hurt very badly. The combination that caused a lot of outflows from India will be commodities moving up and interest rates again going up, so those are things one needs to be thoughtful about.
Chances are also that this thing does not occur because, all said and done, the driving season is behind us. We may see Venezuela and Iran coming back to the market with greater force, and the much-wanted barrels will pull oil prices down. So, everything is possible. That's the market which hurts us the most. That is something we need to watch very closely. We need to watch very closely because we are losing forex at the rate of $2 billion a week. Simply because even if a dollar is not lost in the defence of the currency, the trade deficit, the surplus on the services side, remittances etc., all put together, the balance is $2 billion a week. That we bleed.
Today we are comfortable. We have one of the largest reserves of foreign exchange globally. We do not have too much short-term debt to repay. All is good, but if this thing continues, and we drop $650 million more in over a year, Then we need to keep an eye on it as it would cause tightness in money supply in India. It might also cause an increase in interest rates and even lending rates, even if inflation has been conquered globally. That is something to be aware off.
In light of all of these hypotheses as well as the uncertainties, what is the current portfolio? Where are you most overweight or where have you changed your stance? Are there any things that you have removed from the portfolio?
Prateek Agrawal: During the Covid period, we were busy with stables. We were positioned there, and it helped us. Pre-Covid growth was slowing, and it was thought that smaller ticket consumption items, mostly of the essential variety, would be the most sustainable.
So, our portfolios had consumption, and within consumption, also more stables, with 15% into stables. As the recovery has started and the faith in the recovery has gotten stronger, we have moved consumption down a tad, but more importantly, we have reduced stables and increased discretionary spending space categories. So that's one change that has happened. We have also introduced themes that we are very positive about, such as chemicals, more into the portfolio, such as PLI beneficiaries, such as new-age manufacturing in the country, in greater force.
For example, manufacturing, for example, in our portfolio used to be close to zero for a long, long time. But now, it is close to 15% to 20%, along with cement. I include cement in manufacturing. That's a big change that has happened. Defence has been a small part of our portfolio and has done very well, but it is not a part of our major portfolio because most of the businesses there are not large. That's another theme that we are very positive about. If you look at our portfolio, we have lowered consumption a bit lower in line with overall consumption change—from stables to discretionary spending. Then the financials have been moved up a tad.
We are "underweight" the financial sources index by a larger margin. The index is 35, we are 25-26%, consumption is 25-26%. We are 20% in chemicals, pharmaceuticals, agrichemicals, and that kind of space. This is the space, primarily the specialty chemicals space, that we see long before drugs and is heavily represented in all of our portfolios. 20%, like I said, is manufacturing. Previously, it was 5–6%. Now that's expanded. Again, we are severely underserved in terms of services. We just have 4-5% here and we have commodities from the platform at 5-6%. So that kind of makes up our portfolio. So, these are the places where we have increased.
There is a consensus view that banking results over the next three quarters will stay very strong. If valuations were not astronomical, why would you have an underweight stance?
Prateek Agrawal: Banks are a great place to be. We are very positive about banks. We invest with an eye on the index, but we have not indexed others. So, if I have 25–26% in financials, it means we are very positive, but we don't want all the names. We believe in smaller-ticket lenders more than larger-ticket lenders, and we will continue to do so.
We had our good times in between when the corporate lenders did very well and we struggled a bit. Given the evaluation, both have an equal chance of doing well. Our financials are doing quite well. In fact, if we look at the attribution analysis, you will find that while on financials, we are less weighted. We have most of the names that are doing well. So overall, if with 25–26%, I am getting as much bang for the buck as putting in 35%, I think we are very well off because if I need to put money into chemicals, which is simply not there in the index, I simply cannot. I need to find it somewhere.
Similarly, IT accounts for 15% of the index, whereas we have 5%, which has been a simpler task. We see long periods of stronger growth. So IT is sustained growth, but it is now a more mature industry, where sales growth should be around 10% or a tad lower, with profit growth of a similar amount. This year will be stronger. Next year is expected to do well. So, the growth outcomes are lower and stay lower.
What is your take on non-lending financials because I heard you mentioned banks being the large and dominant part of the 25% allocation in financials?
Prateek Agrawal: We have reduced our non-lending financials a tad. We still have a lot of insurance, both life and general. But we almost never had a brokerage, though they did well. We did have mutual fund exposure. We made money there. We got out in good time because, you know, they also experienced some sort of volatility on margin reductions etc. But we continue to be positive in this space. The service providers to the equity market, which is again a space that we are positive about. We are tracking them, but they are not finding space in the portfolio.
Do you believe in the theory that more than $2,000 or a particular level per capita, people start investing in equities? How are you playing the equities theme? What is there in the ancillaries?
Prateek Agrawal: We are not into ancillaries.
How are you playing?
Prateek Agrawal: As of now, it is not represented in portfolios aside from, say, life insurance, where a lot of business happens for actually investing in it. We are, without a doubt, glued to the space. We also like mutual funds.
Yes, because of the 10% annual appreciation.
Prateek Agrawal: We have invested. We were invested there. But then you know, a theme can deliver not only growth but valuations if they catch up and go ahead of it. You need to look elsewhere, which is what we did, and it's worked out. Again, it is on the radar, something that we focus very closely on.
I want to talk about manufacturing because there seems to be a consensus and some people go as far as saying that if 2010 to 20 was a decade of B2C, maybe 2020 to 30 will be a decade of B2B. The SKF MD says that if I was a manufacturing CEO, I would be very happy. How are you approaching this bucket because some of the valuations of well-known companies that will do well are very high. So, how do you go about doing this?
Prateek Agrawal: We believe that this space is definitely good. It does very well when the economy comes back and vice versa, but then you won't be able to defend the current valuation, and it is high.
They were already high, and when you compare it with themes like chemicals or defence or financials, you will realise it is not the only thing that has worked during this period. This is not something that alone has worked in this period. That is why we consider the theme, even though it is not represented in our portfolio.
The other big challenge is that lots of industrial activities in the country are very closely associated with coal-based power. Renewable energy was something that was less represented in the marketplace. People would also need power supply lines. So that segment of companies will do well, but then, once again, the cyclical nature of the sector will not justify these valuations that we saw there. However, it may prove to be less cyclical. Still, one will have to debate if the cyclicity of the sector is of the same order as before. Since we are talking about the capex cycle, it can do well for longer because a lot of the good names here are MNC subsidiaries.
However, valuations were a little higher than our comfort zone, so we did not participate, except in cement, PLI beneficiaries, and new age steel equipment makers, but not in construction equipment makers. So, it is 15% to 20% weightage in our portfolio, but we are not in the names like ABB, Cummins, Siemens, etc.
I think defence seems to be a theme that has finally come of age. The conversations are very promising. How have you approached investing in this space?
Prateek Agrawal: Yes, but not so because of something that is happening strongly. The geopolitics of the day further support this sector. We used to be the largest importer of arms globally, and indigenisation of the same over time does provide an extra layer of growth.
Assume that the budget will grow by 8-9%. And if a significant portion of the forces grows even slightly less, you may notice a slight increase in capex, which will be amplified if you indigenise. So, you are looking at 11% real growth in the budget, not counting inflation. So, this is a space that can deliver you 15% plus annualised growth for a period of time if you engage with any large platform guys like BEL, BTL, and MDL, among others. The long period of sustained growth of this order, coupled with civilian order, would be a tad more successful. So, the outlook is very strong.
Then there are the guys who supply stuff to these platforms. While the integrators and the system and platform guys will go up to 15%, the guys who are supplying stuff to these guys are also getting developed. They are the ones who are really benefiting from import substitution, with many growing at very high rates, very, very high rates. And this is in the private sector.
We have some exposure in this private sector. We would have been happier with more, but the movement has been sharp. I think if the space consolidates a bit, managers may just get a breathing space to have more of it in their portfolios. But it's a very interesting space to look at now, with a very long, long period of growth for many, many vendors in many spaces.
In many spaces, especially in radars, it is really exciting. If you look at what we are proposing to export to other countries in terms of aircraft having Indian radars, Even newer versions of aircraft, again, Indian radars. It seems they are proving themselves to be as good, if not better, in some ways than the imported ones. So, this is really helping in some ways, and for example, the prints that are there for Periscope, which used to be an imported item, are now manufactured here. So, these stories are nice to hear because they make you feel good and, in the long run, will lead to growth. I think we need to understand what will happen with more certainty. This is a space that should keep finding legs, is what my belief is.
What about chemicals? It is a pocket that a lot of people are present in. It's gone through a peak and a bit of a flux. I heard you mentioned that that's one of the two top themes that you have. Why do you like it so much currently?
Prateek Agrawal: Simply put, India contributes to around 3.5–3.7% of global production. This is a space that is growing at over 3% globally, and for various reasons, not too many people want to make more of it. So, every company that you speak to in India is trying to double their capacity as soon as possible.
Today, you know, they are taking, let's say, two and a half years to double capacity, and I dare say, after two and a half years, we will again see a similar doubling of capacity. So, four to five years of very strong growth is ahead of us, which at the end of it should take Indian market shares closer to 10% versus closer to 5% as of now.
The government now has the ability to provide protection, and with rising wage costs in China and a higher focus on pollution control in China, it is a good thing for Indian businesses as they are now able to export to China. We export 10% of our production to China, 30% of companies said.
We are cost-competitive; the government is able to provide a helping hand; and this is the space that does not have alternatives. If you don't want to do it in China, we are the next best ecosystem.
Malaysia is starting to come up, but I think they are way behind us, so unless we really do something wrong, we have a great outlook for our guys here. Yes, they were discovered. They did very well. Then there is an element of commodities in the books. They have margins which move up and down with higher oil prices, leading to higher input costs. Various people have benefited or lost out over the past year. But for a long-term investor, this is something that will keep happening, and if you identify these spaces well, I think this should prove to be, even at these levels, a very strong return generator into the future.