George Heber Joeseph of ITI Mutual on why index funds could turn risky with overvalued sectors

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ITI Mutual Fund is a new asset management company (AMC), with assets worth Rs 2,000 crore. Launched in 2019, the fund house has been trying to make its mark in the Rs 36 trillion industry. A large number of new entrants are focusing on passively-managed funds.

However, ITI MF wants to keep its focus on active fund management. George Heber Joseph, chief executive officer and chief investment officer of ITI MF, in an interaction with Moneycontrol’s Jash Kriplani, says active funds have enough room to give better-than-market or index returns to investors. He says equity investors with large exposure to passively-managed funds are taking a big risk, as indices end up with more of overvalued sectors, as index weights of sectors rise when stock prices of companies in that sector increase. Edited excerpts:

Many AMCs are launching passively managed funds. Do you have similar plans?

The reason for the recent underperformance of active funds can be attributed to performance of one index heavyweight stock. Fund managers were underweight on as it had not moved much for the past several years, but then it rose sharply. If you remove this one-off event, active fund managers have not done that badly. Also, we are now seeing earnings growth for corporate India, and we expect this earning expansion to be massive.

So, fund managers will find several opportunities in picking sectors and companies that can do well in terms of earnings growth. This is where active fund management can make a significant difference. Only when Indian markets become a lot more efficient, which will take another 10-20 years, could it become challenging for active fund management to outperform benchmark indices. We are not looking to launch a passive equity fund anytime in the future, as we don’t think it will work in the Indian stock markets. Investors looking to buy index funds today are taking a big risk as they are also taking exposure to overvalued sectors. The sectors that do well in terms of stock performance end up getting larger weights in the domestic benchmark indices.

You are planning to roll out a few sector funds. Why?

In India, 80-90 percent of investor allocation happens through distributors. Now, distributors and financial planners can guide investors on how to pull out the money from the sector and also how to invest. The need of every investor is going to be different. Sometimes, the distributor might want to optimise investor returns by betting on sectors that appear undervalued. So, sectoral funds, as well as certain theme-based schemes could give that option. We are also planning a thematic fund on the lines of a build India scheme. We also plan to launch a flexicap and a focused fund.

What is your view on the stock markets at current levels?

Markets might still be far from their peak valuations. Today, market benchmark Nifty is trading at around 3.2-3.3-times price-to-book (p/b). If earnings growth continues on expected lines, then markets can rise to six times p/b that we saw in early 2008, just before the global financial crisis. There can be sharp corrections even in bull markets, but in the past we have seen that markets not only recover, but also double from such corrections, like we saw in May 2006. If such corrections do come, which most likely is going to be due to global external factors, we will be looking for buying opportunities. The share of corporate profits to GDP is still at just 2.2 percent, which is a 20-year low. So, there is huge room for improvement even on that front.

Which sectors you are bullish on, and the ones you are bearish about?

The reason for a lower share of corporate profits to GDP is cyclical sectors not doing well for the last 10 years. A cyclical recovery will lead to a pick-up in auto and auto ancillary segments; banking will also pick up. We are already seeing improvements in in real estate. A pick-up in the domestic business cycle will benefit capital goods and engineering companies. We are already seeing this, as both public and private capex are showing signs of revival. This should also benefit the infrastructure sector. We are bearish on some of the sectors linked to the global economy such as chemicals, IT and metals. We are bearish on FMCG, but we are bullish on consumer durables, as well as pharma companies with branded generic businesses. The revival of infra sector should benefit PSUs, utility companies, as well as PSU banks as the quality of their large infra loan books may improve . We think mid and small-caps are still attractive as past earning disruptions had weighed down valuations, but we need to be more selective and careful with our stock-picking there.

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