market: How should one approach investing in a market dominated by liquidity? S Naren answers

“So, on one hand, you have fantastic liquidity in equity. On another hand, you have a fantastic macro. And on the other hand, you have valuations which are out of what you have seen in your career,” says S Naren, ED & CIO, ICICI Prudential AMC.

In last 10 days, we have seen perhaps all shades of market emotion. There was excitement. There was fear. There was denial. There was acceptance. There was short covering. So, what is coming next? What is happening in the market? Ten days we have seen a bull and a bear market, have not we?
I think one thing common is retail investor have bull interest in the market. I do not think that has changed. So, I think that is one commonality which I think we have seen all the way from three-six months after COVID till 2024 June. So, I do not think whatever you may talk about other things, I do not think that has changed. Where are we headed next? One side is this brute force of liquidity, whether it is retail or DII, whether it is FIIs coming back. How does one approach in this market when you are getting about 20,000 crore of SIP every month and a lot of retail participation which is coming via direct equities? How should one invest in this kind of a liquidity dominated market?
Very tough task because see, over the years and thanks to too much experience I would call it, we are trained to be fundamentalists. We are not trained to think so much in terms of liquidity. We are trained to think in terms of fundamentals and valuations. And we have seen this phase. In my investing career, I have seen one such phase, particularly in this 94-95 phase, where you had too much liquidity in the market and we have again this phase.

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So, what happens is, when you have too much liquidity and valuations are high and there does not seem to be any threat to the liquidity, there is no margin of safety. And the other positive at this point of time is that the macro, the macroeconomic environment of India is fantastic. So, whether you look at fiscal deficit, you look at RBI dividend, you look at current account deficit, you look at inflation, you look at economic growth, look at economic growth differentials, all these things are also fantastic. So, on one hand, you have fantastic liquidity in equity. On another hand, you have a fantastic macro. And on the other hand, you have valuations which are out of what you have seen in your career. So, it puts you in a very confusing situation, which forced us to recommend asset allocation and recommend hybrid products and that is what we have been doing with no scope to ever move to recommending aggressive investing over the last six to nine months, it never gave us a chance. And it continues at this point.

What is your view on PSUs because that is where we have seen maximum amount of excitement and re-rating? Given that now we can talk about continuity, at least on the policy front, how do you see PSU as a basket moving?
I think basically we were the first bulls in PSU along with a few other domestic investors. And, at that point of time PSU valuations were mouthwatering. And I could not understand why other than a few of us in the industry, others did not find them mouthwatering.

Today, we have a situation that there are a few PSUs which are trading reasonable, which is that they are trading in line as though they are private sector companies and they are some of the best PSUs in India.

And some of the others are trading as though they are in some other country because they are trading not in line with private sector counterparts, they are trading ahead of private sector counterparts.

And so there we do not know how to apply our investment theories. So, surprisingly, the better PSUs are trading more reasonably. And I would not use the word better, I would say the PSUs that we are looking at are trading more reasonably.

But the PSUs we did not look at are trading much-much more costlier. So, this is the challenge of investing. And see, one of the biggest problems about equity investing is if too much profits are made in a stock and due to which the stock has gone to very high levels, some point of time somebody is going to make losses and the losses made are never pleasant and this is something which is very worrying to me and that is a problem.

I do not know how that can be resolved because if a stock has a fair value of let us say Rs 5 and it trades at Rs 10, the process of that fair value coming down from Rs 10 to Rs 5 is never pleasant. On the other hand, if a stock has a fair value of Rs 5 and the share trades at Rs 2, the process of the share going from Rs 2 to Rs 5 is pleasant even if it takes three to five years, like what happened in PSUs. In fact, it gave us more time to buy, it gave us more amount of time to buy and it may have allowed us to buy in more number of schemes.

So, this is the challenge and that is why when you are managing other people’s money, it is very useful to have fairly valued markets and not overvalued markets because overvalued markets leads to market losses and you never feel happy losing money for other people and that is a challenge. Whereas fairly valued markets or slightly undervalued markets are much more pleasant when you are in the mutual fund system.

Markets are not cheap, markets are fairly valued, but markets are not terribly valued. And markets when they peak out, it is a cycle. They will move to two extreme ends. So, it is not like the COVID positioning, which I completely endorse that markets are not cheap. There are no bargains in the market, but markets are not terribly expensive also. So, when markets are fairly valued and when markets not terribly valued, what should one do?
Markets are not terribly valued across the board, but markets were not terribly valued, particularly in mega cap and large cap. But slowly, markets are not fairly valued, they are slightly above fair value everywhere and that is why the only approach which seems rational and which may be deemed too conservative is asset allocation, that you allocate money to equity, you allocate money to debt, you allocate money to commodities, and you allocate money to cash that is the right approach at a time when almost all segments of the market are no longer fairly valued, they can be at least slightly above marginal value.

There was a time maybe six months down the line in the past where mega caps appeared fairly valued. But as we speak at 23,400, it does appear that even mega caps are not fairly valued, they are slightly above fair value. But still, mega caps are much more comfortable.

Mega caps are more comfortable than large caps, over midcaps, over small caps, over micro caps. So, the only approach that can work at this point of time is asset allocation and that approach involves investing in all asset classes at this point of time and that is the only approach possible and an approach which allows you to participate in case that there are corrections, it gives you the opportunity to invest and that is the only way forward at this point of time. And having said that there are things people ask us, does it mean that India is not a structural story? That is not true. India is a very good structural story.

I do not think there are structural stories like India today where the banking system is in good shape, central government finances are in good shape, the central government stability is in good shape, you have continuity and you have growth potential for the next 10 years, 20 years, 30 years. So, it is not as if that the long-term outlook is bad. It is just that, the valuation has gone above what we would want to see for new money. At the same time, we spent quite a lot of time trying to tell people, all the sensible people who have invested over the years till 2021 or 22, we told them, try to ensure that do not take out your money, instead enjoy the money, profits that you have made and do not make the mistake of taking out money because the market is in such a shape that it does not look like markets are going to crash.

So that is what we told people. It is that new money that you have to be more careful about rather than the old money on which you have huge profits at this point of time.

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