Swati Kulkarni, Executive Vice President and Fund Manager Equity at UTI AMC talks to Renu Yadav about the current market valuations and the strategy she follows across the funds she manages.
BT: Markets have rallied ever since the exit polls came and predicted the return of the Modi Government. How far will this rally go?
Kulkarni: There is a kind of euphoria in the market with a stable government coming to power and expectation of policy continuity. But we need to be aware of the valuations of the market. NIFTY has gone up 10 per cent in the last three months with top five stocks contributing almost 50 per cent of the rise. Therefore, there are a few stocks taking the market up. The trailing price-to-earnings (P/E) multiple is elevated at 25 times at the current levels of NIFTY on account of lacklustre earnings growth, largely due to banking and finance sector reporting high credit costs and hence meagre profits.
The optimistic consensus earnings growth estimate of 25 per cent, puts the forward P/E multiple, for FY20, at the upper end of the fair valuation zone. Over the last 19 years since 1999, the one year forward P/E multiple band has been 13-21 times with average multiple at 16.5 times and currently we are at 20 times PE multiple for FY '20, at the higher end of the fair value band and one has to be cognizant of that. While the earnings growth is very important, we cannot rule out the euphoric sentiment sustaining the valuations in the near term.
BT: What is your stock selection strategy across funds?
Kulkarni: Investment philosophy across the equity funds that the UTIAMC manages gives a lot of emphasis on two factors. One, the operating cash flow generation and two, the return on capital employed. For any business, if the cash flow generation is weak, sustaining the current operation itself could be difficult, leave aside the growing operations. Such businesses may end up piling up unsustainable debt and resultant interest burden. The focus on return on capital employed (ROCE) ensures that you invest in businesses, which generate economic value by earning a higher return on invested capital than the cost of capital or where there is a possibility of improving ROCE.
Based on the reported numbers for the last 5 years we rate the companies in UTI universe on the above two parameters: C1 for the most consistent operating cash flows and C3 for the least consistent, and R1 being more than 18 per cent average ROCE for the last 5 years and R3 being less than 10 per cent. Our research process enables us to form a view on the improvements or deterioration of these ratings in future. While all the equity funds have high allocation to C1 companies, depending on the fund's mandate and individual FM's investment style, a combination of R1 and R2, R3 companies are selected.
Certain funds prefer high allocation to R1 companies while certain other funds prefer allocating some exposure to R2, R3 companies where improvement in return ratios is expected. For example, UTI Equity Fund invests mainly in R1 companies, while UTI Mastershare and UTI Value Opportunities invest largely in R1 with some exposure to R2, R3 companies. UTI Midcap Fund and UTI Core Equity Fund look mainly to capture the companies moving to higher ROCE band from R2 or R3. This ensures a good diversity of styles across growth and growth at a reasonable price and value investment approaches.
BT: How do you find growth at a reasonable price in such market conditions?
Kulkarni: I manage UTI Mastershare, which particularly follows growth at reasonable price approach along with a focus on the competitive franchise. Competitive franchise means that the companies we select; we look for durable competitive advantages the company may have. Such companies typically have either the pricing power or cost advantages.
The benefit of the competitive franchise may result in a much longer growth runway than what the market is factoring in. So when we follow growth at reasonable price approach, we are willing to look beyond the immediate 1 or 2 years as we believe that the competitive advantages will give the company sustainable earnings. Thus, the multiple, which may look expensive in the short term, may actually be reasonable considering the long growth runway.
BT: How difficult it is to find high dividend yielding stocks in a market which has run up quite a bit?
Kulkarni: We need to understand that dividend yield is a relative term. When the valuation goes up, the dividend yield of the benchmark also drops. The dividend yield is an additional part of the return, which is coming from investing in a particular company besides the potential for capital appreciation. For UTI Dividend Yield fund, we prefer companies with strong cash flows because whatever is left with the company after capex is what is distributed amongst the shareholders.
So you don't look at only what the dividend yield the company currently quotes at but also what is the free cash flow yield (that means free cash flow generated per share divided by the price of the stock). Besides, we also look at the likely earnings growth. There might be very high dividend yielding companies but if the earnings growth is unattractive or unlikely to sustain, we may not invest in such companies.
BT: What will be your advice to investors investing in the market right now?
Kulkarni: Markets in the short term are always very volatile. Valuation is at the upper end of the fair value zone, which may deter the short term investors who tend to trade frequently. However, long term investors will be better off understanding the importance of their asset allocation needs to fulfil their financial goals. Equity assets tend to give better returns than other asset classes over a long period of time barring a few instances when the returns were lower. By and large, the returns outperform the asset classes if you take a 15 year period or so.
Therefore, an adequate allocation has to be made to equity MFs for achieving long term financial objective of wealth creation. In these times, investors should look at their own asset allocation and their financial needs and make the necessary changes. For example, the one who has a lower allocation to equity may like to add exposure to equity rather than timing the market. While those with adequate equity allocation and having short term liquidity needs might like to increase allocation to liquid and short term fixed income MFs.