Investing in US stocks? Investment guru says India will generate higher alpha

NEW DELHI: Investment guru Prashant Khemka, who managed developed money market for eight years, spent four years managing emerging markets like Korea and Mexico, and lived for 11 years in the US, says his personal net worth has been entirely invested in India.

Khemka said this is not because he believes Indian markets are going to outperform the US or any other markets, but the fact that the opportunity to earn higher alpha is much larger in India than any developed markets like the US or even other emerging markets around the world.

Why? The founder of White Oak Capital Management said Indian markets are inefficient.

India an alpha generator
"India is one of the few countries where there's a very large mid and small cap segment of the market. A very few markets come to my mind in comparison. The US market is one, then we have China in Asia. In case of the US, it is an extremely efficient market. Institutional investing there is a centuries-old profession. But in India, it only started in the 1990s or mid-90s," he said at Morningstar Investment Conference.

In India, it was a monopoly of UTI and maybe one or two other government institutions, he said, while suggesting that we are lagging many markets in terms of institutionalising our investor base in India.

Besides, the cost of transaction in India is very high and that contributes to lower liquidity.

"The impact cost is also high and it's partly because the cost of transacting either due to taxes or duties, and all those add up. Speculators and arbitrageurs don't find it worthwhile to trade in India. They play a very crucial role in supplying liquidity. If you don't have liquidity supply from these participants, you are not going to attract institutional investors," Khemka said.

"They are not going to find it attractive to research because they're never going to be able to deploy any meaningful money in those companies, whose trading volumes are extremely low, not only on absolute terms, but also as a proportion of market cap of India," he said.

Khemka pointed out a research, based on empirical data, which suggested how India provided the highest alpha and the most persistent alpha compared with most developed and emerging markets of a material size.

At present, Khemka said, there is a risk of overestimating the longevity of the impact of pandemic.

Three to five years from now, we might see travel tourism coming back with bang, he said.

"If you see some of the other major events in the world like September 2001 (World Trade Centre attack) was supposed to change the way we live. (Covid was) indeed as gripping back in February this year. That's the reason why markets fell off the cliff. Since March 23, markets have been recovering fairly strongly and rightly, well ahead of everyone else realizing that the situation isn't going to be as bad," Khemka said.

Markets always ahead of themselves
Khemka said that the pandemic is a very unfortunate crisis and more than a million lives have been lost. But it is not going to cause as much damage to the economy, equities, companies and their cash flows, as was feared in February and March.

"We no longer worry about companies going bust. Some companies would have filed for bankruptcy but are a fraction of what would have been the feared earlier. The market recovered strongly as the impact on long-term cash flows was not big. Yes, this year's and next year's cash flows might be under pressure, but if market values are reflecting present value of future cash flows, then this year's cash flows at the market wide level are basically two to three percent of the value of the market," he said.

"If anything investors are still living in the six-month old world and they're still very worried. If you listen to the earnings pulse of companies, they are talking about very sharp recovery. That's what the market is reflecting. What you read in newspapers or see on TV would continue for a lot longer, just as was the case with the global financial crisis. But in 2009 markets bottomed around March globally and started a sharp rally. People in the media or investor community kept scratching their heads," Khemka said.

Khemka said it's just the tip of the iceberg and that the markets are way ahead of themselves.

"What markets rightly looked at was one of the longest bull markets in the US, which was the epicenter of the global financial crisis. So markets are looking ahead and properly reflecting at most times. On an aggregate level, they are efficient," he said.

Earnings acceleration, at last
Khemka said he was wrong at predicting the timing of earnings recovery. The only consolation, he said, is that he was not alone in being wrong for a dozen years since 2008.

"Corporate earnings recovery is alluded awfully. There is a general tendency for all of us to believe that markets are going to get back to their mid-teens earnings growth. Over time, I've mellowed down my expectations. Often on something, you have to rethink and you do lose conviction in something like this. At this point in time, we may finally get a strong acceleration in earnings, but for the wrong reason," he said.

The analyst said that 2021 is likely to see a sharp fall in earnings, followed by 20 per cent plus growth in FY22 due to a lower base.

"It's a reasonable expectation despite the half or mid-single digits growth in corporate earnings over the last 12 years. It's reasonable that corporates can at least grow in low double digits, which is in line with nominal GDP growth rate going forward. Let's assume 5-6 per cent real GDP growth rate and about mid-single digits inflation, a nominal GDP growth rate of low double digits, India earnings would be in line with that rate over time," he said.