Ajit Dayal is a Director of Quantum AMC, the investment manager of the Quantum Long Term Equity Fund, India's first fund that has stayed away from using the traditional distributor-led model and kept costs low to enhance the overall long-term returns to the investors. He is also the founder of www.equitymaster.com, India's first independent research website.
In an interview with Equitymaster, Ajit shares his views on the global and Indian markets, economy and interest rates. He also delves into the do’s and don’t for investors.
Eqtm: In the emerging markets, we have seen large increases for three years in a row. Now with interest rates having hardened globally, what is your view on money flows into the emerging markets?
Ajit: Emerging markets have seen record increases in investment from investors due to two concurrent phenomena: lower global interest rates in the developed world since 2001 AND the ability of short term money to quickly take advantage of the perceived and real mis-pricing of economic and monetary conditions in different parts of the world. We commonly
refer to these short-term pools of money as "hedge funds". Interest rates had been kept unusually low in the developed world due to the fears that global events - like the burst
of the technology bubble (in 2000), "9/11" (in 2001), the Iraq war (in 2003), and the risk of a paralysis in global trade due to SARS (in 2003) - would cause a severe recession and end in a monetary collapse.
Against this backdrop you have seen the birth of tens of thousands of "hedge funds" each promising a positive "absolute" return, irrespective of the global conditions and economic environment. These hedge funds have attracted an estimated US$ 1 trillion (more than 1.2x India's market cap) from traditional sources of long-term capital (pension pools
similar to our own Provident Fund in India) and new sources of money from wealthy individuals. In their search for absolute return, these investors have found in hedge funds a perfect fit as these hedge funds have aggressively invested in less traditional assets like the stock markets of
emerging economies like India, or currencies in Turkey, or metals like copper and nickel.
So low interest rates by itself have not been the catalyst for this flow, the creation of the "pipe" - the hedge funds, the private equity funds - to transport money from one part of the world to another and acted as the conduits for the money flows have been a necessary requirement that allowed this fancy for emerging markets to be realised. To reverse these flows to hedge funds and hence to emerging markets or even to see a slowdown in the pace of the flows would require some sort of combination of events.
Global interest rates may increase further and this may stop the rapid inflow of money to hedge funds. However, even a collapse of a large hedge fund as we saw in LTCM in October
1998 or Amaranth in September 2006 - or a realisation that maybe most hedge funds end up rewarding fund managers more than their investor base - could retard global flows. I cannot say if this will happen in 2007 as we are not "market timers" but, since it did not happen in 2006, statistically the probability of a hardening global interest rate cycle
and disillusionment with hedge funds has increased.
Eqtm: We recently witnessed the Thai central bank crack its whip on speculative money flows into Thailand. Do the quality of foreign inflows into India warrant such a control? How effective are such controls in restricting short-term foreign money in an economy?
Ajit: While not policy-makers ourselves, we have been advocates of seeing a broad discussion on how much money India needs to develop as an economy and then trying to figure out what are the best sources of that money to fund our development as a country. Given the character of global flows and the growth of hedge funds, we feel that India needs to be very wary of short-term capital. The proponents of "price discovery" argue that capital markets should be free and open and all money flows should be encouraged. Well, no one has explained to me what happened in our country internally to see a 12,500 Index in May 2006 then a 9,000 Index by June and now a 13,800 Index in December 2006? The only "event" was that interest rates increase in the US in May 2006, caused a panic and now that the panic has subsided, the risk-takers are back in all emerging markets again. Do we want to expose
our own economic development to what happens at a global level? Is there a way to filter out the noise of short-term money and seek long-term capital flows that stay committed
to India over decades? Those pools of money exist - we are in touch with them. But they see this 9,000 then 12,500 then 9,000 then 13,800 Index levels over a 12-month period and they wonder whether India is a meaningful destination or some hyped up casino!
Thailand was brave enough to put this filter in place on December 18. A simple filter: all it said was that if you take your money out within 12 months, there will be a penalty imposed equal to 10% of the money that was brought in. One year was the "lock-in" or commitment period required from the foreign investor. But the short-term money has little desire to stay anywhere for any committed period of time and a US$ 699 million sale by the foreign investors in
the Thai market caused a US$ 23 billion loss in market cap in one day; a decline of 15% in the market. India saw that in May-July 2006. A US$ 2 billion sale by FIIs saw a US$ 200 billion loss in market cap of Indian stocks. The Thai policy was "successful" because it proved the point: short-term punters with different nationalities had created an asset bubble that got deflated by 15% in a few hours! Yet, within 24 hours the policy was diluted and the punters can add
Thailand to their list of potential hunting grounds.
Globally, there is an entire industry of brokers and research analysts and fund managers and foreign exchange traders that live off short-term flows of capital and have reaped huge financial rewards over the past 3 years. The downside of being an advocate of such a Thailand-like policy is that I have few friends in this "industry". The potential upside is that India can get hundreds of billions of committed capital and develop into a stable, steady destination for these long-term providers of capital. I will stay on the side of what I believe is in India's long-term interest.
Eqtm: While questions have been raised with respect to the sustainability of the current stock market rally, what are the do's and don'ts you would suggest for investors?
Ajit: Do not get misled by Index levels, worry about the long-term valuations; do not get carried away by what the FIIs do or do not do - they have little idea themselves; read and understand the business of the company before you buy the stock; and if you wish to invest in mutual funds and not bother about individual stock picking, read up on Quantum
Long Term Equity Fund.
Eqtm: Which sectors are you more positive looking at 2007 and beyond?
Ajit: Well, what we like or do not like is mentioned on the fund fact-sheet on our website www.QuantumAMC.com and the fund managers have acted on this by showing you their holdings in the Quantum Long Term Equity Fund. Typically, the fund management team buys stocks with a two to three year time horizon and valuations and recognition of risk drive the decision-making process.
Eqtm: What is your interest rate outlook for 2007? How do you expect the Indian economy to perform going forward? Any significant positives/negatives that you want to mention?
Ajit: We are very optimistic on the long-term growth potential but with a few caveats. We think that interest rates will increase in India in 2007. Although I have little idea what the GDP growth rate will be in 2007, we believe that the GDP growth rate will be closer to 6.5% on a sustainable basis, unless we get power plants up and running very quickly. And we still think that the risk for India remains a lack of a "population improvement" policy, per se. While many others applaud India for its potential because of its large population, we feel there must be a concerted effort to create a sustainable living standard for many of the 300 million who are below the poverty line. At a more micro level, we have been extremely concerned about the lack of experienced people in many industries and what we term as the "execution risk" - can the jobs and projects get done on time and within budgets when there is little job-stability in most companies? Overall, we are strong believers in India's future but we also like to price risk before we make any investment decisions.