Equities have outperformed all asset classes over five-10-year period: Manish Chokhani, Flame University

THE ECONOMIC TIMES - ETMarkets | November 01, 2016

ET Now at Home with Manish Chokhani, Director, member of governing body at FLAME University, discusses why it is necessary to have a multidisciplinary approach in education to succeed as leaders of industry.

Edited excerpts

Last time when we were here, we were talking about the importance of how liberal arts and finance which technically is maths and science, can co-exist. A lot has changed and recognition of that kind of education now seems to be getting more Indian in nature also.
That is right. Education in India typically was very much the way the British left it and they really wanted to produce an army of clerks that read, memorised and reproduced. I grew up in the old SSE system and once you graduated from school, you had to choose at that tender young age whether I wanted to go into commerce, arts or science and life does not come neatly packaged like that.

As investors over the years we realised that there is a lot of behavioural psychology involved when you are dealing with managements. There is lot of technology involved when you are dealing with disruptive change. There is lot of obviously finance and accounting is the language of business you need to know. So unless you have a multidisciplinary approach to life and you are aware of everything which is happening around you, you will not end up as a good investor. That came about in education as well as the world changed.

In school, you are seeing this now in IB education where they are a lot more focussed smaller classrooms, on practical based learning. Similarly over here, you could come here and in theory be doing a major in economics and doing a minor in theatre and it is absolutely something which a CEO is effectively as a person who is going to articulate to his employees, to his clients and all of that. So if you can really do it like you do now in the US where you can learn computers, theatre, you can learn psychology and can learn business in the same place. Why should one be so narrow cast?

Which is what I was trying to understand? This is a format which is more seen overseas. You are kind of bringing it in and giving this opportunity to students in India because a lot of them do not want to go abroad.
If you think of even the leaders of India today, they have benefitted from that. Anand Mahindra studied film making at Harvard and Ratan Tata himself studied architecture at Cornell and, of course, he is running the largest conglomerate in the Tata Group. That that is what one is trying to provide to students and it is by his complete philanthropic give back to society that all of us who are part of the Enam family have got involved. All of us are at what we call at vanaprastha stage in our life when you give back to society.

You are not that old. Are you?
Well I turned 50 so almost getting there.

But it is much needed. I have to say.
Yes very much. You need 50 institutions like this.

ET Now: Absolutely and I was very intrigued by the fact that having these tie-ups with foreign universities, you are trying to get the best of both worlds in India, which is so incredible.
: That is right and we are very happy because what we are finding here is a lot of parents who for some reason, do not want to send their daughters abroad. So, we are ending up with a 55% female students ratio over here. We are getting students from all over India, of course, and then through these tie-ups which we are now building out very rapidly, we are able to give them at least one exchange term overseas.

We have a tie-up now with Nuffield College at University of Oxford which is where Dr Manmohan Singh did his PhD. So very reputed place for social sciences and you can get your behavioural finance and all of that embedded into your course over here. We have a tie-up now in place with Babson in the US. If you want to do education, entrepreneurship, it is very cool for a lot of Indian kids going there, like you could do it from here as well. The best ladies college in US is Wellesley. Hillary Clinton went to Wellesley. So that is like the Harvard for young ladies to go and learn.

The young should invest in equities

So this Diwali those who are not planning to invest in equities, are they making a mistake?
Well equities in India is something which as a young country where the average age is 24-25 years ought to invest in. The index we started in 1980, after 35 years is closer to 30,000. You do not get that kind of wealth appreciation in any other asset class. So while our memory is stuck to the price of the flat we bought or the piece of gold we bought, the fact is equities have outperformed all these asset classes over any five-year, ten-year period that you want to pick up.

Dumb assets which does not actually produce cash flows, will probably never ever keep pace with that. And India is the last really big growth market in the world. The OECD countries have governments that are bankrupt as are the central banks and the consumers are overleveraged. So there is no growth. This is the last big country of a billion people with growth available to them. And if you are not participating in that growth which is really possibly only through equities, what are we really doing?

When you talk about growth and we look at quarterly earnings every three months, how are you mapping the trend on that growth which will fuel equities further from here?
There are two-three structural issues there and you have got my sore spot because in India we have had this tendency of aping the west and following old economic theory.

The heart of the problem in India is that unless per capita income levels go up, consumption will not go up and hence the investment cycle will not revive. In 1998, China and India both sold about a million cars each. Now, 17 years later, China has gone from one million cars to 22 million cars. India is stuck at 2.6 million cars for the last four years. You can say this is because per capita income has stagnated.

Also, it is not just that their market size is 8x. The average price point of the car in India is let us say a Maruti Alto, and in China, it is Toyota Corolla. So even the price point is probably 3x to 4x. You have the possibility of a 20x expansion in our markets which is being held back because we want to keep depreciating our rupee. We follow this great interest and inflation differential argument. I find it strange in post 2007 world. If the whole world has collapsed and gone into deflation, these guys will never get inflation and they will constantly be fighting against recession by printing money. Ordinarily if you print $20-30 trillion, your currency should have collapsed.

But what has happened is our rupee has gone from 40 to close to 70 and we are going to keep depreciating and yet our exports are not going to pick up because you do not have the capacity and the productivity gains happening over here. So some structural changes are required and you are right that is what holding back earnings over here because you just are not getting the demand.

If I look at how this Samvat year gone by, we are using the word zero interest rates now. We have seen a strong recovery rally in emerging markets especially commodity based emerging markets and you got big slowdown which is now visible in global sectors, at least Indian IT and pharma. So is the market leadership changing now? Is there something which we need to be watchful? India was always gaining ground because of IT and pharma, that wheel now seems to be reversing.
I will take you back quickly to 1972 when we broke the gold standard and Bretton Woods came about and dollar became the peg. Ever since that, the US dollar has actually been printing without the world realising the game which is going on and that led to bubbles in every decade.

In the ‘70s, you got this bull market in gold, silver and oil which culminated in the peak of 1980, then they had a 20-year bear market in those asset classes.

In the 1990s, it went to what was then emerging markets of Japan and Taiwan and they were between 12x to 20x in that decade. Then, as you know Japan has been suffering for the last 25 years.

In the 1990s, we got the tail end of that through the Harshad Mehta scam but it promptly collapsed. For the 1990s, then became the era of TMT which culminated in the NASDAQ of 2000-2001 peaking out and the NASDAQ only now started surpassing the previous high. So 2000-2010 period was the era of commodities and BRICS and much as I hate to say, the fact is it is a bear market for commodities and emerging markets.

What we are seeing are counter trend rallies in beaten down asset classes. Last year, Diwali to Diwali, Brazil, steel, were the best performing markets and sectors. But it is not like they are in bull markets. They are counter trends because they were so beaten down and you are not getting a bull market there.

Similarly Indian IT, which in the 1990s was a sunrise sector as was generic pharma, are facing their own disruptions. In 2000-2001, Infosys was at $20-25 billion peak market cap, at which point basically Apple was not a mainstream company at under $15 billion. Well Steve Jobs had just come back but they had not yet made anything. Amazon was just a gleam in the eye and Google was not yet born. Today these three companies alone have a market cap of $1.5 trillion. Just these three, which is more than our combined market cap. So there are changes in technology and it is like how IBM has now got deflated and IBM is $150 billion market cap.

So also is the case with Indian IT who have to re-invent themselves. The leaders -- TCS and Infosys -- are very much what I call in the mould of people who can remake their companies. The price points are interesting. So while there are structural issues, I think it is a bit like how metals and materials were last year. They are beaten down a bit too much and you might well get a counter trend rally.

IT could be outperforming this time next year

So next year if we come to FLAMEs, we could be discussing outperformance in IT like right now we are discussing outperformance in metal?
Possible because I do not think last Diwali anyone was taking a bet on steel and aluminium and Vedanta and Hindalco and stuff like that but they have been the best stocks.

You say metal stocks are adjusting to having come out of really oversold zones. So you are not buying into the commodities revival?
The big counter rally is over. You got the 100% gain. I do not think from here you are going to make 100% any more. They are still great businessesIn terms of profit pools, if I take the material sector, the big listed ones, there is a $18 billion profit after tax in that space. After all the hype and hoopla about IT and pharma, the IT profit pool is about $9 or $10 billion. The entire pharma sector profit pool in India is largely Sun, Lupin, Aurobindo at about $3-3.5 billion. So the globalised, knowledge India is at about 12-12.5 whereas the old India which is metal and oil and stuff like that has Reliance alone putting in $4.5 billion just to put in context. Our entire banking industry, BFSI, listed market cap has a PAT of some $11 billion.

You have always made a point that every market cycle will create new sectors and new league of entrepreneurs. Now there is a bit of a shake-up which is happening in the e-commerce space. It is not easy to raise money and create market caps now. So what is going on there? What do you think will be the sunrise sector in this leg of the market and where do you think big wealth will be created?
I will separate the two from stock market perspective. Obviously, leadership will stay with financials and consumer discretionaries like autos and durables. From private equity perspective, I think there are two challenges. In the world because it has gone X growth, everyone and his uncle has been pouring money behind technological innovation and the zero to one companies which have gone from a concept to creation of something new in the west. You are seeing this play out in companies like Uber and Airbnb which are conceptually new ideas.

And they are adding to productivity.
And they add to productivity but they do not yet make money. They still lose in excess of a billion dollars a year. So it is entirely PE funded and it is a bit like 2000 when you could not explain valuations. It is happening in the private equity world. The issue in India is that we are not doing zero to one companies. We are doing one to N which is take the proven model and try and repeat it and scale it here. So you will copy an Amazon with a Filpkart or a Snapdeal, you will copy Uber with an Ola, you will copy an Airbnb with Oyo rooms and therefore you are not getting those kind of dramatic multiples in a market where as the consumer in terms of profit pool is very small.The whole FMCG durables, retail, all of it together has a profit pool of $5 billion.

If somebody puts in HUL, Colgate, ITC….
All of it together, the total PAT of the whole sector is $5 billion while Reliance alone is $4.5 billion.

Every three or four weeks, we discover a new sector. Sometimes, it is chemical, sometimes it is agrochemicals. Right now, we are talking about ancillary companies. What is going on? I mean these sectors they always existed. Somehow markets are recognising them right now. Do you think there is a mania in smallcap stocks?
If you got the big structural bull market in the 2000 which was commodities and EMs and you are going through a bear market structurally for commodities and EMs and you are getting a countertrend bounce over there, that money basically rotates because you are not creating a big bull market where currency, stock, all asset classes are moving in the same direction. You do not really get a bull market till the currency starts appreciating. In that context, you rotate from sector to sector. So while the theme two years ago was quality and consumers, last year due to the countertrend, consumers got overdone. It went back to the cyclicals and commodities.

What could be the next countertrend?
The countertrend can be found in consumer discretionaries as the Seventh Pay Commission payout, falling interest rates, the GST coming in – all make the organised sector look cheaper.

And from a sectoral perspective, things which are beaten up and ignored tend to perform. So it may be IT, it may be PSUs because for the first time, the magic word of privatisation has been uttered. Oil marketing companies are large companies getting very low valuations. We all hate PSUs. They may end up privatising BEML or NCC. We just did the repeat follow on and there are interesting companies. So there is no dearth of bottom up opportunities in India. So while we keep waiting for this big glorious bull market on all asset classes and the currency, in the mean time there is enough to construct a portfolio of 20-30 stocks for any reasonable investor.

The Manish Chokhani I know, historically has taken cash calls. When you have not liked market cycles, you have gone on 90% to 100% cash. In terms of positioning, as a commitment, as a private investor, what are your commitment levels?
Actually it is a not a market where you get out today, it is driven by liquidity. The earnings are not there. It has been driven a lot by multiple expansion but then you have to go sector to sector hunting for relatively cheap stocks.

While the money tap may get turned off overseas, domestic investors have discovered equity. You are getting $6 billion coming into domestic equities this year whereas the net inflow from FIIs this year has been of the order of some $7 billion, finding a strange dichotomy in the market where money comes into mainly midcap mutual funds whereas the insurance companies are selling what they have which is largely the large caps. So the largecaps not performing, the index optically not going up and so called midcaps mania taking place. But it is rotating from sector to sector and stock to stock. So it is not the same thing going up year after year 100% and I do not see that trend changing in a rush right now.

The other thing I would like to say is that in a country where the average age is 25-26 and which has a $2 trillion GDP, $4-5 trillion of GDP lies ahead of us. As youngsters while it is great we should be investing in equities, we should also be going and building our own businesses and if I had to advice my son today who is 22, it is go out and build a business, investing I can take care of for the next 10 or 15 years.

There is a business I would like to talk to you about where I am deeply involved as one of the three partners. We think we will make big social impact, big consumer impact not just in India but across the world and it is things like that which our youngsters should be doing as well.