India's premium valuations remain a challenge: Invesco MF's Taher Badshah

Equity valuations are unlikely to expand further unless there are surprises on the earnings front or developed economies do much better than expected, says Taher Badshah of Invesco MF

Equity valuations are unlikely to expand further unless there are surprises on the earnings front or developed economies do much better than expected, says TAHER BADSHAH, chief investment officer, Invesco Mutual Fund (MF). In conversation with Abhishek Kumar, Badshah shares that the room for MFs’ outperformance is limited in 2023 due to a predictable earnings environment. Edited excerpts:

 

In 2022, we saw companies report strong earnings growth. Do you see that continuing?

 

While 2022 was more about top-line (revenue) growth, 2023 could be better from a bottom-line (profit) perspective. The revenue growth was strong in 2022 due to a lower base but profits didn’t go up as much due to higher costs. Since a low base effect is not there in 2023, revenues might grow at a modest pace but profits may surge due to cooling commodity prices.

 

How much of a drag can India’s relatively higher valuations be on 2023 equity performance?

 

In 2022, domestic equity returns were muted but we still did better than most other markets. Hence, India’s valuations are lower compared with 2022, but the premium over the rest of the world has expanded (as they went through corrections).

 

Historically, India has been trading at a 10-20 per cent premium to developed markets and 30-50 per cent to other emerging markets. These ratios have now gone up to around 35 per cent and 80 per cent, respectively. 

 

This can emerge as a challenge for the Indian market because we cannot let premiums go beyond a certain point, even if the economy does relatively better than others.

 

How can valuations improve, considering robust domestic flows?

 

Premiums seem to be stabilising because India does not seem to be in a position to deliver any major earnings surprise. Only faster-than-expected economic growth can propel valuations further. Overall, we see less action in the equity market, considering high valuations and low prospect of earnings surprises, which was a common affair in the post-pandemic period. However, India might benefit from positive developments on a global level, with either the US and Europe seeing better economic outcomes than expected or the Russia-Ukraine crisis coming to an end.

 

As an active fund manager, do you find the predictable earnings scenario challenging?

 

Certainly. In a situation of predictability, the pockets of alpha generation shrink. You don’t get enough room to forecast and position your portfolios for outperformance. The scope was higher in the post-Covid phase due to uncertainties all around and markets not being able to fully assess the economic situation. Cut to 2023, the economy is normalised and fewer quarters can throw a surprise.

 

Will global slowdown benefit Indian companies by way of cooling commodity prices?

 

There are two ways to look at it. A slowdown in the US can cool demand for commodities but that can be offset by the opening up of China. Last year, there was almost nil incremental demand for oil from China due to the Covid situation.

 

Also, the supply of commodities hasn’t been very strong and incremental growth seems limited. This is because investments in the production of key commodities like oil and gas have not happened in a big way for some years due to environmental, social, and governance considerations.

 

What’s your strategy for managing funds in 2023?

 

At present, there seems to be consensus in the market that banking and financials will continue to do well. It looks like banks still have the momentum to go up further. Credit growth has remained strong and their balance sheets are in very good shape. There’s also a possibility of recovery in rural demand. There are signs but we still do not have any conclusive reasons. Sectors like agriculture, cement, and automotive can also benefit from softening commodity prices.