We expect the upcoming budget to continue its spending focus on rural India

What are your views on the state of the Indian economy? Can we expect to see some demand recovery in FY 2021? Please share your outlook?

We remain positive and constructive on the economy into the coming year. Short frequency indicators on the ground are seeing a mild pickup with passenger car numbers seeing some traction on the ground with some restocking underway. Airline traffic, passengers handled at airports and hotel occupancy rates are also seeing an appreciable pickup in monthly numbers. We read these as green shoots on the ground that are likely to help growth bottom out over the next few quarters.

We expect growth in FY20 to hover just above 5%, with the economy moving towards 6% growth in FY21. The underlying gradual pickup seen on the ground, we feel, is likely to translate into a bottoming out over the next two quarters. And by the end of H1FY21, with improved monetary transmission, there should be a discernible improvement in aggregate demand.

We base our expectations broadly on : 1) the bottoming out of global manufacturing growth that we notice is underway 2) improvement in the global trade narrative that greatly reduces uncertainty 3) a stable-to-strong rupee on the back of strong flows-support and continued 4) sufficient global liquidity infusion from central banks to the extent of around $100bn per month and 5) monetary and fiscal policy synergy with a clear bias towards fiscal policies.

We have seen negative IIP for the last couple months and creep in inflation. Some economists are saying that we are entering into a stage of stagflation. What are you views?

The IIP numbers generally tend to exaggerate the extent of movements on the ground. The PMI numbers would be a better reflection of direction given their low levels of volatility. The recent manufacturing PMI prints have reflected some stability in prints that we expect could translate into a gradual bottoming out over the next couple of quarters.

Inflation has been inching up over the last few months mainly on the back of a surge in vegetable prices, especially onions. This has been on the back of excess rains that led to vegetable output damage. The government has been attempting to address this on a war footing and with an expected increase in winter supply of vegetables, this is expected to cool vegetable prices and ease the trajectory of inflation into the first half of FY21. The RBI is likely to hop on to this opportunity to ease rates further. Headline inflation has been the RBI’s main concern.

Rural consumption growth historically outpaced urban consumption. But rural consumption growth has clearly slowing down (to its lowest point in the last 7 years in September quarter). Is this slowdown purely cyclical or structural, needing policy measures from the Government?

The current slowdown in growth appears largely cyclical to us, while there are some elements of structural factors that creep in as well. Rural wage growth remains to be a reliable indicator of demand in rural India. This continues to stay subdued. Moving out of this phase would need a concerted effort from the government. The impact of improve transmission of lower interest rates, increased government measures to boost disposable income through tax relief, PM-KISAN scheme and better MSP should start percolating in the coming quarters. We expect the upcoming budget to continue its spending focus on rural India, targeting the bottom of the pyramid. Towards this, we expect government spends to continue and increase in the areas of NREGA, rural roads, rural housing, irrigation, education and health. Do note here that some rural inflation could also bring about a thin layer of increase in disposable income for the farmers.

What are some things you would like to see from the Finance Minister in the February Budget?

These are unusual times and the RBI appears to have done their fair share to cut rates aggressively by 135bps. Therefore, we would like to see targeted spends at the bottom of the pyramid. Do note here that the bottom of the pyramid has a higher propensity to consume and therefore would translate into an immediate boost in consumption. We would also like to see the government not compromise on their capex spending given their large multiplier effects on the economy as a whole. Given the fiscal constraint we are in, personal income tax cuts may not be appropriate as the consumption boost that this is expected to bring about can translate only if there is wage / income growth in the economy. This can be brought about in a speedier manner through targeted schemes in rural India and specific focus to affordable housing and real estate in specific that have large backward linkages for growth.

Consumption sectors were the outperformers in the stock market for the past 5 years or so, but they are underperforming for the last 1 year or so. What is your outlook for these sectors in the medium to long term (2 – 3 years)?

The current consumption sector performance is a mixed bag where recent trends in consumer staples do indicate growth rate of companies normalizing to mediantrends, from a high base of Fy19, while discretionary companies continue to impress on growth in several pockets such as branded apparels, paints, foods and consumer durables. The short-term weakness in high-discretionary spend categories such as automobiles is expected to be transitory as companies reset operations to the new regulatory requirements and we believe improved liquidity conditions and longer-term demographic trends remain catalysts for demand to rebound in the medium term.

Landmark tax reforms such as GST have been aiding market share gains in various sub-segments while benign commodity prices continue to provide tailwinds to earnings. We remain positive and expect consumption sector to continue remain integral part of the India investment thesis as favourable demographics and rising income levels performance continue to underpin growth for these companies.

Many retail mutual fund investors and also financial advisors are of the view that, thematic or sector funds do not offer adequate risk diversification. However, in the case of Sundaram Rural and Consumption Fund, you have fairly broad-based theme which covers a number of sectors. For the benefit of investors, who have not invested in this scheme, please provide your views especially from the perspective of diversification?

A study of a broader index such as BSE500 indicates the addressable universe for this portfolio would stack up to ~60% of the index.The fund is diversified across ~52 stocks with top-10 holdings accounting for ~35% of the fund. The fund’s investments span across the consumption thematic,covering a wide gamut of sectors including consumer staples, consumer discretionary, retail finance, agri-inputs and building materials. Consumer discretionary includes white goods, brown goods, automobiles, paints, branded apparels, retailing,etc. which have varied levels of growth and multiple drivers.The fund aims to capture the domestic consumption growth story by taking measured exposures across a wide range of sub-segments of consumption, thereby diversifying the risk.Exposure to retail finance, a key enabler for growth in consumption, provides added diversification to the portfolio.

What is your investment strategy in Sundaram Rural and Consumption Fund?

Sundaram Rural and Consumption Fund is a thematic fund with ~60% invested in the consumer staples and discretionary segments, 24% in consumer finance companies, 6% in agri-inputs and8% towards building materials and allied segments.Directionally, the portfolio has been increasing allocations towards the consumer discretionary segments as we see several levers at play such as increasing mix of working-age population, changing lifestyle habits, improved access to consumer finance as structural factors aiding long-term growth. With this skew towards discretionary consumption, the fund has a slight tilt towards mid & smallcaps that construe ~54% of the portfolio.Valuations and growth continue to be our key pivots of the strategy in terms of positioning within the sectors.

You have maximum sector allocation to FMCG in your scheme portfolio. FMCG stocks usually have been quite expensive from a valuation standpoint. What are your views on FMCG stocks after the recent correction? Are there good investment opportunities at these prices?

FMCG sector in India historically has traded relatively higher compared to global peers, the key reasons being the relative attractiveness of the Indian market for the organized players, favourable demographics, lower per capital consumption in several categories and increasing affordability leading to premiumization. Globally, India remains amongst the very few markets to have a mid-to-high single digit growth in several categories within consumer staples. On a long-term basis, we remain positive on the sector as formalization of the economy provides levers for a steady uptick in performance.

In the near-term,we expect a consolidation as growth rates normalize to the long-term averages after an impressive run in the previous two years. The FMCG sector dynamics continues to bear strong linkages to income growth at the bottom of the pyramid and the impact of improved rural incomes should percolate to demand with a lag. Given current valuations of FMCG stocks, we still intend to be selective in this space, with preference towards companies with reasonable pricing power and strategies to reinvest a part of the gains from corporate tax-cuts behind growth initiatives. The portfolio has been directionally increasing its allocation towards consumer discretionary stocks where valuations have turned reasonable amidst the correction in mid and small caps.

What is your stock selection strategy? When do you sell stocks?

Stocks are selected based on framework of looking at simple businesses with scalable opportunities, sustainable competitive advantages, good promoter pedigree and strong cash flow generation. The endeavour is to invest behind such companies with where growth is available at reasonable valuations.

The stocks are constantly evaluated on a valuation framework with relative comparisons drawn to their peers. Stock exits are normally triggered when they trade in excess of their fair value as well as against their peer valuations and where challenges emerge for the basic investment thesis to play out.The decision to exit stocks typically gets triggered on a combination of macro and stock-specific factors. Macro factors such as high commodity inflation, rising interest rates, regulatory actions which could’ve a bearing on demand on a varying scale across sectors. Stock-specific factors which can impede growth include such as threat of disruption to business models, material risk of product obsolescence, heightened competitive intensity, etc. It is an ongoing process within the research team to assess growth of a company against such factors and evaluate the consequent risks to stock valuations.

Does the consumption theme now present attractive investment opportunity over 3 – 5 year investment horizon? What is your advice to existing and potential investors of Sundaram Rural and Consumption Fund?

Our firm belief is that consumption is a key part of an investor’s long-term portfolio as they add alpha to overall returns on a longer horizon. Over the last decade, the portfolio as well as consumer thematic indices have outperformed the broader markets decisively, despite bouts of intermittent volatility. We believe that the consumption sector is poised for a long-term structural uptrend given the changing lifestyle, increase in disposable income and favorable demographics with high lifestyle aspirations.Many of the stocks in the thematic viz., within mid and small caps have seen price corrections and valuations have turned reasonable. With concerted efforts to stimulate growth through monetary and fiscal measures already underway, investors with long-term investment horizon could make use of current market opportunities to add exposure to the consumption thematic.

Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.