Bond A Valid Class In Global Investors' Portfolio: UTI Asset's Vetri Subramaniam

Vetri Subramaniam: The way I look at this, actually, I don't see volatility as being high because if you look at volatility either in terms of historical volatility, or in terms of the volatility that we can look at in the options market, both are actually very muted.

I think the definition of volatility sometimes hides the language that we should be using, which is that the markets are not going up every day, but the market is not supposed to go up every day. So I think that's the wrong definition of volatility. The market actually remains very, very low in terms of volatility and you know, the bigger point that I would make and always tell investors is this, if you're going to invest in equities, expect that the market will drop at least 10% once every year, expect to the market will drop 20-25% every two to three years and once every 10 years, it might even drop 30-40-50%. That's going to be part and parcel of your journey. When you look at it in that context, I don't think anything we've experienced in the last few months amounts to volatility.

Vetri Subramaniam: Partly true. But again, I would say look, you know, in the markets, there's always something going on. If you were to tell me that there's more news flow today as compared to 2020, when at this point of time, we were all getting locked up at home and we didn't know where the future looked like, I would say that was a lot more uncertain than it is today. So yes, these are all small things. Look, the Fed policy, MPC policy, these are all part and parcel of the discussion about markets, but these can’t be the sole determinant of what investors choose to do.

So you know, I treat this as part of the weather. You know, should you dress appropriately for the weather? The answer is yes. But you don't change your strategic objective because of what the short-term weather forecast is. So that's the way I look at it.

Vetri Subramaniam: I think that's a good question. You go back to January and I remember looking at the data. People were expecting as many as almost, you know, five to six rate cuts during this year; 140 basis points was what the Fed implied was showing. That's now obviously down to about 75. You know, to that extent, I would say the market has already sort of shifted in its expectation that growth is going to be much better than anticipated, inflation seems to be coming down, not yet near target but coming down.

But to my mind, the more interesting thing which actually emerged from the Fed messaging day before yesterday was the fact that they have actually indicated a willingness to walk back on quantitative tightening. To my mind, that was actually the most critical part of the messaging as opposed to anything else because I think one of the challenges that the US Fed in particular, and the US Treasury in particular, face is that unlike central banks all over the world, or governments all over the world who increased their average tenure of borrowings in the post -pandemic periods when rates were close to zero, the US Treasury never did that. They actually continued to borrow very, very short term. In fact, in the last one year, they have predominantly borrowed Treasury bills, which I would actually submit is a very dangerous strategy to follow, but therefore, they will sooner or later have to replace that Treasury bill borrowing with dated security borrowing.

Now, imagine a scenario in which the US government is continuing to happily run deficits of $6-7 trillion a year, they're going to have to issue long-dated bonds and now the biggest holder of bonds, which is the US Fed, is also saying I need to sell bonds into the market.

So if there was a reason to breathe a sigh of relief, it's simply that the Fed for the first time in a way sort of blinked and said, ‘Okay, you know, we might have to rethink how much and how aggressively we sell bonds’. So that messaging on QT (quantitative tightening) was, to my mind, the most significant part of what came out and maybe there is nervousness, and rightly so there should be nervousness because I think the US Treasury has played what I would say is a fairly risky game of borrowing so much in T- bills and not in dated securities.

Vetri Subramaniam: We talked about Tina (There Is No Alternative) versus Tara (There Are Reasonable Alternatives). I think in the Indian context, it certainly didn’t work. Global equities work very well.

But I think the fact of the matter remains that what we discussed last time in terms of the underlying change in not just weather, but in terms of climate is very, very pronounced. It is pronounced because we've now made it very clear, we have moved away from zero-interest rates. Japan is the last one to sort of exit that territory. Therefore, as a result, bonds have become a valid asset class in any global investor's portfolio and this is already visible in what's happened in the US. So, which asset class in the US pulled in the largest amount of money last year? It was US money market funds. They pulled in almost $6 trillion of money simply because people are saying, ‘Hey, I can actually get, you know, 4.5-5% over there. You know, I'm happy to take that because I haven't seen this kind of, you know, reasonably safe return on a safe liquid asset for a long period of time’.

So I think that will continue to remain a challenge, that bonds have once again become a valid asset class in the pools of money, which are the largest pools of money, which are trying to meet retirement obligations and you know, you want to use a balanced portfolio of bonds, equities, so on and so forth.

The mad rush to go down the risk curve to get better returns, that period is now behind us. So I think this is a change in temperature that we will have to continue to deal with—that bonds are once again a valid investment instrument in global investor portfolios. I think that will continue to pose challenges to equities and from that point of view, therefore, high equity valuations and I would be a little bit worried and circumspect because incrementally, rather than people hunting for yield by going down the risk curve, they're going to go back to the stability of what bonds are willing to offer them.

Vetri Subramaniam: So I think the critical difference here, I would submit, is that we don't see the long bond yield coming down dramatically. And equities are eventually priced relative to the long-bond yield rather than to the short-term money market rate.

So will the Fed cut? Sure, they most probably will cut. It should get cut at some point of time. Likely in India, as well at some point towards the end of the year, we will cut. But that's not the important number on which people price equities. What they price it on is where is the 10-year bond yield. The key, I think, is that that is not going to come down for the simple reason that inflation looks like it is higher for longer. The West, and particularly the US, has suddenly discovered this new toy called fiscal deficit, no signs of bringing it down, unlike India, where we are actually continuously looking to tighten fiscal deficit going into 2026.

And if you look at what the finance minister has actually now even talked and if you see recent commentary, not just the fact that we need to bring down the fiscal deficit and be disciplined, but also talking about debt to GDP. And this is happening in an environment where the US is not even talking about these things. The CBO (Congressional Budget Office) is there but the government is, you know, pretty happy to run fiscal deficit.

So I think equities will get priced off the long end and that is where we need to be cautious. I don't see the long end coming down.

Vetri Subramaniam: I think you're absolutely right. In all our conversations—and we raise money from a lot of global investors, which we manage almost $3 billion of global money—I think there's no doubt about the fact that most people say look, India is a very structural component of our portfolio and we want to continue raising our exposure to equity in India simply because we can see the long-term structural opportunity.

But that's one part of the story. The other part is what am I paying for it. And I think that's where it starts to get slightly more tricky, because valuations in India are expensive. Equities, in general, across the world are expensive at this point of time, particularly the US. In India as well you're having to pay a significant premium to that. So I think to that extent, the sort of appetite has been a little bit more muted. I would submit more muted than what perhaps people have hoped for. That's been offset by the fact that domestic demand has been very strong. But I would really interpret the setup to say that if for whatever reason Indian equities were to correct, or come down, you will start to see a lot more stronger foreign bid.

Just two points I want to make here. You know, Indian equities have reached a premium where it's interesting to just think through the mindset of global companies. We've had two or three global companies in recent times come and say, ‘You know, what, we're happy to sell down some of our stake in India’. So when you have these high valuations, it's not surprising that rather than seeing a rush of global M&A inbound into India, you're actually seeing some of these MNCs saying, hey, we can actually sell some of these rich assets in India. The other interesting thing that I want to point out is that everybody only talks about how much money is coming into the market, particularly the local money is coming into the market. Look at the amount of stock sales which are being made by PE funds, VC funds, promoters, QIPs, OFS, IPO.

If you look at that number for 2023, actually, there was $45 billion of buying by FPIs and domestic institutional investors. There was close to $38 billion of what I can count of sales of primary fundraising or secondary selldowns by these investors. So you know at these valuations, you're also attracting a lot of supply. I think it is a great decade for India as a country—capital availability, the economy grows, all of that. Equities—I argue that I want valuations, which offer more margin for comfort.

Vetri Subramaniam: If you look at the Bloomberg consensus, it's now pencilling in about 14% growth in earnings for the Nifty 50. That's the consensus number for 2025, not too different from what actually happened in 2024. It will happen, because the final quarter numbers are yet to come in, but I think that's pretty much in the bag.

I think the big difference is if you look at the 2024 number, the challenge is that top line growth was actually very weak and the entire growth and earnings was actually driven more by Ebitda expansion, because the base year actually had a lot of the impact of the post Russia-Ukraine disruption in supply chain and prices.

I think, the key for 2025 is that it will have to be more revenue led. I don't think there is scope now for Ebitda margins to expand any more. In fact given—as you rightly said—there are some pockets within the economy where for a variety of reasons, things are a little bit tighter, there is very limited scope for margin expansions. So I think it will have to be now led more by revenue growth, rather than by margins. That's point number one.

The outlook I think for revenue growth is reasonably good. The consumption side of the economy as we can see most high frequency numbers is challenged. The investment side is doing better, but I would still submit you know, it's not necessarily doing great. So that whole pick up that we have been hoping for—in terms of private capex—is still something that we are hoping for. It's not yet visible in the numbers at this point of time. It's only the government capex, which has sort of held up. But even there, if you take government capex plus PSU capex, the overall impulse is actually more or less flatline now for a few years. And remember that you're going into continued fiscal compression, 5.1% fiscal deficit this year, then again, 4.5%. So I think the backdrop has certain challenges. We cannot say zero challenges. Some of those challenges could be related to global growth, some of those challenges could be related to NIM compression, which the banks might experience this year. So there are some challenges in getting to 14%. But at least the bar is not set at 25% earnings growth. So the market is looking at a number which is perhaps slightly more in the realm of what is possible.

Vetri Subramaniam: Look, the valuations are rich. They're slightly rich in the case of the large caps, slightly above the comfort zone, but at least they are not blinking red. They're far more uncomfortable in the mid-cap and small-cap place and I would submit that, you know, at these valuations, you really need earnings growth to not only deliver but even to deliver some upside surprise. I think that's a very high bar. So I would be sceptical about earnings ability to sort of really outperform significantly on the upside.

You know, whether the markets correct by going nowhere for a period of time or whether they correct in valuation terms by, you know, coming down sharply, that's very hard to predict. But I think people should be aware that valuations are posing a challenge to, you know, the returns that you can get from economies. A lot of the potential of businesses is reflected in their multiples. And if it is reflected in their multiples, it means those earnings expectations are baked in. Now, you really need something far better than that, to give the stock price a lift.

Vetri Subramaniam: Very good question. Two ways of looking at this and I think everybody should be aware of it.

Obviously, the SIP flow gives us a lot of visibility. But when I peel back the SIP flow and I look at the rate of cancellation of SIPs, it does seem that there is some momentum seeking behavior, visible even in the SIP flow. How many SIPs are actually persisting beyond one year, two years, or three years? The numbers, I must say, are slightly disappointing. They're still good, in an absolute sense, compared to where we used to be five years ago. But if you just look at the headline number, that's a bit misleading because there is a high number of SIPs which are getting cancelled and then you know, people are opening new SIPs again.

My interpretation of that is, there is some bit of return-seeking, momentum-chasing behaviour which is there, but I still think the SIP will give stability, it will give support. You know, the Mutual Fund Sahi Hai programme, which AMFI has been running, goes back now almost seven years, since 2017.

And I do think that, in my travels across the country, when I meet people, there are a large number of investors who have started to think about this long term—they're thinking 10 years, 20 years. But on top of that, there are some people playing momentum and that's what we should be a little bit worried about.

Vetri Subramaniam: I think, certainly, there are challenges on the IT side. It's been visible for a while. Even the Indian companies have been articulating challenges over there. They've been winning big deals, but the challenge is, in many of these cases, you're losing something which was a legacy business, and now you're announcing a new deal. So the net benefit to the company you have to offset the legacy lost with the new deal wins. You can't just keep adding the new deals without recognising the fact that there is some legacy business which is going away. So I think that challenge will continue.

Everything that we hear from the US suggests that you know, tech spending is going through a difficult period. This is visible in technology, it's visible in the classic IT services and it is visible in support and it's also visible in the consulting side.

So the top end of the market discretionary consulting is badly affected, services less so. The only point that I would make is that from a domestic economy perspective, one of the strengths that we've seen in the economy in recent times, is not the growth of just the classic IT services but the rise of global capability centres in India, where you have multinationals setting up their own sort of research units here doing research, doing coding, and doing a lot of stuff which is core to their own enterprise and that I think will continue to sort of grow.

So overall IT services and related exports from India should continue to do well. But the classic listed IT services companies, particularly the ones with a lot of legacy business, I think they are going to struggle a little bit more to handle this transition.

Vetri Subramaniam: I should just add one more point on that IT bit, which is, look, these are India's most globally competitive businesses. So our view on I.T. is really that, you know, buy the dips. If they get cheaper, we're happy to buy them because we think they will eventually come out on the right side of this.

So not that despondent, in that sense. I think equities are just rich. So really what we're trying to tell people is, go back to the drawing board, look at your asset allocation framework. It's very likely that with the strong rally in stock prices, your equity allocation may have moved higher than where you were in your asset allocation framework. Go back to what your framework is telling you to do. So even in some of the schemes that we run—which sort of run our own internal asset allocation models—we used to be at 65-70% asset allocation, those have progressively kept getting cut and they are down to about 50% equity allocation and 50% in a strategy which can be as low as 30, as high as 90.

So that should give you a sense of the fact that you know, the equity allocation is somewhere more neutral at this point and these valuation metrics largely look at large cap, not mid and small cap. If I were to use that, the numbers might look worse. But I don't have 20 years of history. So we run it only on the large-cap space. But that's my simple message to investors. That's been the message from January—rebalance, rebalance, rebalance—keeping in mind your long-term goals. Rather than falling for the narrative of this is India's decade. It might be, but that's no reason for you to move away from your asset allocation framework.