What’s the potential upside for S&P BSE Sensex and Nifty 50 from current levels in the next one year?

I don’t want to hazard a guess on the index level—we are largely a bottom-up driven house and for an equity investor three years is anyways the minimum duration over which to evaluate an investment. That said, our analysis of earnings yields versus bond yields suggests that we are fairly valued at the headline index level currently. Given returns are a function of two variables, change in price to earnings and earnings growth, we believe earnings growth will determine returns trajectory hereon. Given the trough profitability levels currently and our expectations of a cyclical uptick in the economy, we see a case for stronger earnings over the next three years. With signs of improvement in the big loss leaders such as corporate banks and telecom, that should also aide corporate earnings.

What’s the strategy to manage the periods of downside to generate returns to investors?

Investors should follow an asset allocation based approach to investing, stick to their investing discipline without getting swayed by emotions, and rather than let volatility deter them, should use volatility judiciously to their advantage by keeping a long-term investment horizon.

It’s only a few stocks that is fuelling the market to conquer new highs, but the economy may have to grow at 7% to 8% to support a broader rally. In this backdrop, which sectors look attractive in terms of price and value in the next one year?

A new earnings cycle should lead to broad basing of profit growth which in turn should improve the breadth of market performance, in our view. This is especially relevant as stocks perceived as safe havens trade at hefty premiums to the rest of the market today. Early signs point to a change in market undercurrent—‘value’ stocks have significantly outperformed over the past two months. Similarly, along the capitalisation curve, small caps should start to perform as markets get more confident of a recovery. While our investing style is bottom-up driven, a look at our funds reveals that we are overweight on financials, industrials, and telecom. Within consumption we prefer discretionary to staples given the stretched valuations in the latter.

Stress in the banking system is far from over, the NBFC crisis is still unfolding, and liquidity crunch is a big concern. Where do you see growth potential in the banking, financial services and insurance segment in the next one year given the underlying economic challenges?

The current crisis has separated men from boys. Given the broader under-penetration of the sector in India, we believe the winners will continue to deliver strong shareholder returns. We continue to look for banks and non-banks that are strong on liability franchises, digital capabilities, risk forecast and assessment, and better asset-liability profiles.

At low valuations, medium and small caps are throwing up attractive opportunities for investors with risk appetite. Where do you see pockets of value in this space in relation to good governance, RoE, and cash flow?

Today, we find that the market cap polarisation in favour of large caps is at historical extremes. Overall, an improving economy and broad-basing of profit growth should lead to a revival in the fortune of mid and small caps. Moreover, given the large universe, especially in small caps, we believe alpha generation opportunities for active managers are significant.

What’s the potential for alpha in active large cap funds, medium and small cap funds?

In India, active fund managers have historically delivered alpha, barring the last few quarters which have been characterised by a very narrow market. We believe there are two dimensions to alpha generation—first is time arbitrage wherein keeping a long-term investment horizon and avoiding short term noise provides edge, and the second is research arbitrage wherein the ability to analyse relevant information forms the basis of edge. Finally, behavioural edge is an important supplement to these two sources of alpha. The ability for these factors to generate alpha also depends on the size of and the disparity within the underlying universe. So naturally, alpha generation potential in small caps should be more than in large caps.

In the backdrop of recent downgrades and defaults, what's the outlook for returns from debt funds in the next one year?

Duration funds have done well over the past year while credit side had challenges. However, the various policy initiatives to revive the economy along with ample local and global liquidity have led to some compression in credit spreads for the best-rated borrowers. Going forward as confidence in the economic recovery improves, we expect credit spreads to continue to shrink. Therefore, credit funds should perform well over the next year.

Passively managed assets comprise less than 4% of the industry’s total AUM, currently. But, are you seeing a marked shift in investors moving from active large cap funds towards ETF/index funds?

Globally, passive investing has taken off in a big way. However, the industry penetration is quite high globally unlike in India where penetration and awareness are still low. In India, a large part of passive investments today are by institutional investors mainly provident funds. Further, given that alpha generation opportunities continue to exist in India owing to the large and disparate investable universe, we believe there is a case for both active and passive to coexist.

Do you concur that ETF/index funds can consistently outperform the majority of actively managed funds given the low expense ratio of index funds vs active large cap funds? Why?

TERs [total expense ratios] for actively managed funds have also come down. In addition we continue to believe that managers who focus on time arbitrage and research arbitrage, and supplement these with behavioural edge, will continue to generate alpha. In fact as passive funds become larger, their compulsion to mimic their benchmarks should also open up interesting opportunities for active fund managers to exploit.

What’s SBI MF’s asset allocation outlook and key milestone targets in the coming year?

Given the severe challenges facing the economy, policy makers have taken and in our view will continue to take initiatives to revive it. We expect the economy to pick up going forward. Therefore our expectation over the coming year is for the breadth in equity markets to improve with mid and small caps outperforming along with a revival in interest in ‘value’ stocks and cyclical sectors. Within fixed income, we expect term credit spreads to narrow and therefore credit funds to do well. Investors need to have some allocation to gold as a hedge to geopolitical risks and a still fragile global economy.

On milestones, just as our parent SBI takes pride in being the ‘banker to every Indian’, we aspire to be the ‘wealth creator for every Indian’. We aspire to do this while staying extremely focussed on “sustainable investing”, by incorporating environmental, social and governance factors into investing process.

SBI Mutual Funds

SBI Mutual Fund hopeful of better earnings trajectory