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00:00Thanks for tuning into Profit Insights, we heard a lot about how expensive equity markets
00:15may have become and we also heard sporadically from people who look at various asset classes
00:20about how asset classes move in cycles and if there is a particular asset class which
00:26might be in the wrong quadrant on the valuation front, there will always be options available.
00:31Now usually we talk to equity investors, I thought it's very good at a time like this
00:37to try and talk to somebody whose brain according to me is probably wired to think of different
00:43asset classes at different point of time and investing based on how he believes the cycle
00:49is going to move and therefore choosing the asset class accordingly and he will tell you
00:53that equity is not the only game in town.
00:56Our guest today is Manish Dangri of Mosaic Investing.
01:00Manish, so good having you, thanks so much for taking the time out and being with us.
01:03My pleasure.
01:04Now Manish, we talk about equities all the time but every time I read your LinkedIn post
01:10or occasionally see a social media post from you, I realize that you are trying to think
01:15of asset classes and how they behave in different cycles.
01:20Can you tell us why do you do that?
01:24Cyclicality is the nature of being, everything, not just markets but any system moves in a
01:30cycle and the way it operates of course is that there are booms, there are stagnations
01:37and there are busts and it's just not as I said assets, even economies, they accelerate
01:43as we have seen in India let's say for last 3-4 years, this sort of signs of moderation
01:48right now, very likely, almost, you know, it's a truth that there will be some slow
01:53down in next 6-12 months' time.
01:56So if economies and corporate performance move in cycles, of course asset classes also
02:01must move in cycles.
02:03Got it.
02:04So if that is the case and if that is the hypothesis, then you are, I am presuming saying
02:09that let's say equities as an asset class may not necessarily have, be best or prime
02:18position for the risk adjusted returns that they usually give because that's the nature
02:23of equities versus some of the other asset classes.
02:26That is true.
02:27So if let's say if we were to divide a cycle into early, mid and late cycle and cycle essentially
02:35means economy accelerating or business cycle accelerating, stagnating and sort of slowing
02:42afterwards.
02:43It's best bet to buy equities if you know for sure that it's an early cycle, right.
02:50Meaning if you are entering in a regime where more cars are getting sold at a faster rate,
02:57so acceleration or imports are growing faster or other discretionary stuff that we all buy
03:04are growing faster, it sort of makes sense to be into equities, you know, purely from
03:09a cyclical standpoint.
03:11And then of course if you are a mid cycle, then it makes sense to be in credit because
03:16balance sheets are clean then and even though the profits slow, it won't hurt credit much.
03:22And in the late cycle it kind of makes sense to buy bonds because very likely bonds are
03:27already elevated and at some point in time for the fear of slowdown, RBI or Fed would
03:33cut rates.
03:34So therefore there will be benefit from bonds because the bonds will rally.
03:39So early cycle, mid cycle, late cycle, think of it like that.
03:43Early cycle if you know for sure that you must be overweight equities, mid cycles you
03:47should be overweight credit and late cycle you should be overweight bonds.
03:51Where are we in the cycle right now according to you?
03:55So we show now again we are sure that we are not in early cycle, you know, and the way
03:59to look at it is a little bit of a dipstick, right, that have we had good times in last
04:03two, three years, four years?
04:05Yes.
04:06After COVID bust, you know, there has been a significant acceleration in economy.
04:09Is economy at margin accelerating anymore?
04:12I mean are we getting surprises on the higher side in terms of growth numbers of PV sales
04:17or GDP growth or import growth or GST?
04:24Answer is no.
04:25So we are certainly not early cycle.
04:27Okay.
04:28Now you could, there is a bet between are we a mid cycle or a late cycle.
04:32It seems in US they are late cycle, okay, and India, you know, somewhere between mid
04:36or late cycle you could call in terms of economic state of affairs.
04:42Okay.
04:43Manish, just a tangential question.
04:44But if the, I'm calling US the main mother economy because it's still the largest economy
04:50and what the Fed does, others take notice.
04:53I'm just trying to understand, just tangential to the conversation that I'm in, I'll come
04:56back to that.
04:57But if the US is in a late cycle, if the Fed were to embark upon a series of rate cuts,
05:03etc., what kind of an impact does it have on other economies, let's say for India, which
05:08may not necessarily be in the late cycle, but is in the mid cycle?
05:12How does India therefore follow suit or otherwise, can the central bank do something different
05:18than what the US central bank is doing because we are in a different stage of the cycle than
05:22what the US might be in?
05:23So, because you call US mothership, the way to think of it is that it's, every other economy,
05:31maybe outside of China, is super levered on US.
05:34So, the impact that you see in US, it's sort of, is significantly more that you see in
05:41India, Indonesia or any other country.
05:43Okay, that's one basic framework.
05:44So, if the US is going to slow, it will certainly hurt India or rest of the world, even though
05:51every time you call it that we are now different, it never is because US is a marginal buyer
05:57of goods.
05:58So, if your question is that if US is going to slow, would India too will slow, the answer
06:03is yes, it will.
06:04If Fed cut rates, would India cut rates, answer again is yes, because that is the main thing
06:11that the RBI is looking for, not necessarily local growth inflation conditions, but enabling
06:16conditions should be in place to, for emerging market or India to cut rates.
06:21If Fed or ECB actually move along in cutting or dropping rates, it's likely that India
06:27would also find an opportunity to cut rates.
06:30So, remember that India inflation is already at 3% core, so you already have a lot of space
06:36and yet RBI is still relatively very hawkish.
06:39Only reason is not local economy is very strong, the only reason is that Fed hasn't yet sort
06:44of blessed us with a rate cutting environment.
06:47Got it.
06:48So, then the follow up is and I would love for you to distinguish for some of the people
06:53who might not know this very clearly, the difference between credit and bonds per se,
06:57but you mentioned that mid cycle is credit, late cycle is bond and late cycle is when
07:01the rate cuts start.
07:02Now, we may not be in the late cycle, but if the Fed cuts and if the RBI is forced to
07:06cut let's say, then does it make bonds as an asset class more favorable versus credit
07:13or that it's not a correlation like that.
07:16Also, just explain how do people invest in credit versus bond because bond investing
07:21now has been made relatively easier by virtue of the platforms that exist as well.
07:26So, equity you understand, you know, it's mostly a bet on P&L, right, of a profit of
07:33a firm.
07:35So, in some sense it's a bet on the residual, as I call P&L.
07:43So, credit is actually a bet on balance sheet of a firm.
07:45Now, balance sheet essentially means that whether the balance sheet has enough assets
07:50that can absorb shocks and has ability to repay, you know, even if let's say overall
07:59revenues were to drop and then bonds are actually bet on inflation, you know.
08:04So, inflation is certainly down and therefore, you can bet on inflation right now, thereby
08:10you can actually bet on bonds.
08:12Bonds will drop.
08:14I am calling out that it's likely that the profits will not do well over next couple
08:19of years, 1 or 2 or 3 years versus market expectation.
08:23But because Indian balance sheets are squeaky clean for good 15 years, you know, there has
08:29been sort of some form of deleveraging sort of playing out in India, okay.
08:34So, you know, it is amazing, even if it is late cycle, then also the markers of a late
08:42cycle in balance sheet or let's say rating downgrade standpoint has not yet kicked in.
08:48The leverage ratios in Indian corporate that we track, the leverage is debt equity, is
08:54at one of the lowest level in last 40 years.
08:59The margins are at 15-year high, the coverage which is, you know, how much interest is there
09:05for you to pay, to repay the debt payment or DSCR are at very, very high level.
09:12So, basically the balance sheets are super strong and their ability to absorb what you
09:17call shock is very high.
09:18So, kind of think of it like this that if a AAA company, okay, you were to face a recession,
09:25it would still very likely remain AAA because its leverage was very low.
09:29You know what has happened in India is that today a AA company, A rated company is, the
09:36financial specs of the balance sheet of it is actually closer to what it was for a AA
09:41company 5 years ago.
09:43So, A is mimicking the performance of AA.
09:46So, in some sense the entire landscape of what you call balance sheets in India, mid
09:53or large balance sheets has been lifted quite dramatically and which is why I say that it
09:58is a safe call to take even if we are in late cycle, though I think we are a little bit
10:03of a mid to late, you know, to actually bet on balance sheets from a credit standpoint.
10:08Okay.
10:09Okay.
10:10Now, just tell us, so therefore are you choosing to do that, I mean, because you firmly seem
10:17of the view that we are definitely not in the early cycle as data would suggest, mid
10:21or late cycle and therefore as an asset manager and congratulations on mosaic asset management
10:26by the way, but as an asset manager, are you choosing to bet on credit or bonds or other
10:34forms of fixed income or non-equity asset classes at the current point of time?
10:40So, there are two things.
10:41One, I am asset neutral in a sense wherever, as you said, you know, wherever is the juiciest
10:47part of the market is where I will bet on and I think the juiciest part of market today
10:51is credit.
10:52So, the answer to your question is yes, you know, that is what investors should do and
10:58I am doing that.
10:59Why so?
11:00Look, why the juiciest, that's my point.
11:03You have given us some preamble, but why is it the juiciest part?
11:07See, let's compare equity and credit, you know, and then sort of figure out where, what
11:14kind of risk premiums or extra returns that you can earn from credit.
11:20Equity over long periods of time, if you are invested for 20 years or thereabouts, earns
11:25about 5% over bonds, okay.
11:28Now even if you are, let's say, invested in US for 100 years, in India for very long,
11:33you will get that much only and I am assuming equity is fairly priced, right.
11:39Now if you were to invest in a decent credit fund, let's say, call it performing credit,
11:43you know, fund, one of the fund that we will be launching soon, you know, you would also
11:47get about 5% extra over bonds, okay.
11:51So, in a sense, there is a return parity between a credit risk fund and return of equity over
11:59a long period of time, okay.
12:01But there is a catch here.
12:02The catch is that if you are an investor for 20-25 years, it is true, but if you are an
12:09investor for 3-3.5 years, which a typical investor is, then the equity risk premia is
12:16only 50-60% of what is available for a long-term investor.
12:20You get my point?
12:21That because equity is very volatile, on average, if you are a 3-year investor, in last 20-25
12:29years, you would have earned only 3-4% over bonds.
12:33So that risk premia for a short duration investor is actually very low.
12:38Whereas, credit in itself is a 3-4-year duration product.
12:42So therefore, whatever risk premia is available to it is available for a 3-4-year investor.
12:46Got it.
12:47Third thing is that as of today, as I made an argument, the balance sheets are super
12:52clean.
12:53So therefore, you can easily bet on them for the kind of 4-5% risk premia that you seek.
12:57But equities are, one, expensive and perhaps we are entering in mid or late cycle and therefore,
13:04the possibility that the earning growth will not be very high is there.
13:08So it is likely that equity risk premia, the risk, the premium or the excess return
13:12that you earned over bonds, remember that ERP we call it, is more likely 3% over long-term
13:18investor as well, which is 10-15-year long investor as well.
13:24So for next 3 years, I think the equity risk premia can be terribly low versus because
13:29balance sheets are squeaky clean, you will earn 4-5% easily in credit.
13:33So which is why put all of these together and then look at the balance sheets of corporate,
13:39the upgrade and downgrade ratios of corporate, I kind of think that, you know, it makes sense
13:42for investors to bet on credit right now to bet on the balance sheets of the company instead
13:48of bet on equity to bet on the balance sheet.
13:51So you are actually, see in sovereign bond, you are betting on sovereign.
13:56But you say, no, no, I want to earn that extra return.
13:59The way to do it is either by a bond of firms or by equity of firms.
14:05I think it's a time to buy a bond of firms instead of equity.
14:09And within that, I think because balance sheets are so clean, as I said, remember that the
14:13A-rated company right now, the financial specs of it are equivalent to AA.
14:19So therefore, you can go down the reading curve, earn that extra 4-5% instead of actually
14:25buying only AAA.
14:26Got it.
14:27So I just want to simplify this, viewers, and Manish, correct me if I'm wrong, but I
14:32think the point is that in the regular lingo, the risk-adjusted returns, I mean, you invest
14:40in equities because you expect a higher return, but you take a higher risk as well.
14:45But presumably in the current cycle, and Manish, correct me if I'm wrong, the quantum of risk
14:50that you have to account for, for earning an X amount of return is much higher because
14:55of all the factors spoken about and the cycle that we may be in relative to credit.
14:59That is true.
15:00So basically, as can be observed through the price action, every day, up and down,
15:05so standard deviation of 18-20%.
15:08So if you are a 3-year investor, you will experience a 13-14% standard deviation.
15:14Call it volatility.
15:15Yeah.
15:16But if you are, let's say if you had invested in my credit fund when I used to manage or
15:20any credit fund, the standard deviation for a 3-year rolling return would be more like
15:243%.
15:26In a close-ended fund, of course, there will be no volatility at all.
15:29So the walls are very different in two asset classes, whereas there is a risk parity.
15:36There is still a catch there because if you are a very long-run investor, and plus you
15:40have a tax shield in equity, it makes sense for a 15-20-year investor if the pricing or
15:47the valuations are at fair level.
15:49Right now, I think everything is a little bit up and down as far as equity is concerned.
15:55And why, and you mentioned the balance sheets are squeaky clean, right?
15:59Why is it, therefore, that a credit fund product might be able to get the best bang
16:06for the buck because a lot of corporates that we speak to, for example, are either, because
16:11the balance sheets are squeaky clean, able to raise money from traditional sources of
16:16financing that banks are hungry to lend, but their corporate is not taking money.
16:20So where would the opportunity be for a credit fund vis-a-vis, you know, considering the
16:27fact that a lot of options are available for the squeaky balance sheet to borrow from?
16:32So basically, if it's a business as usual borrowing, the very balance sheet will borrow
16:36from bank at 10%.
16:39But in credit, you sort of make returns from two or three things incrementally.
16:47One is excess, that there are certain kind of trades which are not available, you know,
16:53to public at large, or regulatory arbitrage, that trades that, you know, banks are not
16:59allowed to do, or mutual funds aren't allowed to do, or even NBFCs now are somewhat disallowed,
17:04at least discouraged to do.
17:06So those are regulatory arbitrage assets.
17:11So through these two mechanisms, you know, excess and regulatory arbitrage, there is
17:17small opportunity and it's not very large, it's 40, 50,000 crore, 60,000 crore perhaps
17:22annually.
17:23So for the size of economy, it's a very small opportunity, but available to only a few people,
17:28only to certain professionals who have access to such trades, relatively short tenure opportunity,
17:332, 3, 4 years, and they are available at equity-like returns.
17:38Why promoters are borrowing there?
17:40Because in some, in their mind, they are substituting equity.
17:44In their mind, they are doing this because they are getting tax shields, while investors
17:51experience that the equity is a superior asset class from the vis-a-vis bond, because they
17:56have to pay lower tax on capital gain.
17:59But if some company has to raise money, it works the reverse, because they get the tax
18:05shield, because it's a tax-adjusted, you know, the net expense, even if you borrow at 15%,
18:12it's actually 11% to the company, net of taxes.
18:16So therefore, it sort of makes sense for a short tenure, something instead of raising
18:21equity, promoters actually end up borrowing money at 14, 15%.
18:27So in a sense, the trick is to have access to certain trades, exploit regulatory arbitrage,
18:36and on top of it, actually, you know, since promoter also see value in it, so it kind
18:40of becomes a win-win-win trade for everyone.
18:43Everyone.
18:44Okay.
18:45And you reckon that, I heard you say somewhere in the interview before that, it's a five,
18:49six, seven-year window, if I'm not wrong for this.
18:51So you reckon that we are at the start of that cycle right on the credit side, and this
18:55could therefore last for maybe another next three, four years or five years?
18:58So see, balance sheets take time to decay.
19:03In a sense, think of it like this, if a firm's revenue fall by, you know, 4-5%, the EBITDA,
19:12the operating profit will fall by 20-25%, and the PAT will fall by 35-40%.
19:18So there is a significant leverage, the profit's leverage on revenue or cost of goods sold
19:26is very, very high.
19:29So because balance sheets are very clean right now, even if let's say bad things were to
19:35happen to economy over next couple of years, they'll take time to decay.
19:40Similarly as we began, that everything is a cycle, a good credit market four, five years
19:46out will likely give in to a bad credit market, when there would have been exuberance, mispricing
19:51of assets, and corporate would have again levered up significantly in the pursuit of
19:56more capex, more capacity.
19:58Maybe that would have a time, you know, we will be talking to each other and I'll be
20:02arguing against it.
20:03It's just that despite such high margins, if corporate capex is not kicking in a significant
20:09manner, it is a bad news for equity, but it's likely a good news for credit.
20:15Got it, okay.
20:18What about when will the turn of bonds come?
20:20Because I remember you telling me maybe a year, year-and-a-half ago, that it might be
20:24a good idea to start exploring global bond structures, because at some point of time
20:30the Fed will correct.
20:31The Fed is on the cusp of correcting.
20:32Some of those ETFs may have done really well.
20:35I'm just trying to understand from an Indian context, when do you think that turn will
20:38come?
20:39Well, I think India, for a treasury investor or a risk, the one who does not want to take
20:44any risk, balance sheet risk or P&L risk, it sort of makes sense for him to be long
20:49bonds.
20:50I have made this argument currently also.
20:54Indian inflation is super depressed and given that you've already discussed about Fed's
21:01potential reaction function over next 6 to 12 months, I guess, you know, we are headed
21:07to super low interest rates in India in next 2 to 3 years.
21:12So I wouldn't be surprised if we get to 5-handle on 10-year bond, maybe 5, 5-and-a-half percent
21:18or thereabouts.
21:20There is a lack of growth in India that I see and the biggest marker of growth, you
21:29know, perversely, is actually inflation.
21:33So if core inflation is 3, you know, they should be asking where is growth.
21:38So you know what, we seem to believe that we are accelerating in terms of growth, but
21:45then question that one must be asking that why are we behaving like China in terms of
21:49inflation?
21:50Certainly, U.S. and Europe overheated and they had massive inflation.
21:57Why don't we have it if we've also accelerated?
22:01So in a sense, a lot of growth that we made in argument has happened to the creamy layer
22:05and then underlying economic momentum actually has slowed quite considerably.
22:11So my sense is that this would pay way for significant amount of rate easing, Neeraj,
22:17on next 6 to 12 months or 18 months.
22:20One macro question before we wrap up or maybe a couple of questions.
22:23Could we get into a scenario, Manish, wherein CPI, because the CPI is a focus of the political
22:31powers because they don't want to hurt the World Bank with inflation, that CPI is under
22:36control but economic growth and WPI tend to move higher and corporate profits move alongside.
22:47Could something like that happen over the, say, next 2, 3, 5 years?
22:52Because hitherto we have this hawkish, an eye of a hawk on inflation and therefore all
23:00that's happening plus the fact that you said the Fed hasn't blessed us.
23:03Could we move to a scenario like this?
23:05So I kind of would take this question with this basic premise that I have that the biggest
23:10elephant in the room today is China and China deflation.
23:14China is, the kind of overcapacity China has today, even though everyone talks about it
23:21always been so, I don't think it's ever been in the past, is that kind of overcapacity.
23:27So if you are an investor in anything, what should shudder you and what should keep you
23:33awake is that what if a re-run of 2014-15 plays out in China again.
23:40China is slowing but China's overall capital block, its CAPEX, its total output is actually
23:48still growing.
23:49It is dumping across all industries, you know, high tech, low tech, mid tech.
23:55So my sense is that the bigger fear that one should have in mind is the fear of deflation
24:02instead of inflation.
24:04And please remember that as far as equity is concerned, its biggest enemy is deflation.
24:11No, inflation is not an enemy.
24:13The bond's enemy is inflation.
24:17Credit does all right in both, relatively all right.
24:22Deflation, of course, not good, but a good balance sheet can absorb deflation.
24:26Inflation is very good for credit, it's not bad at all.
24:29But my fear is that in next one to two years, it's not going to be Russia, Ukraine or oil.
24:37It's about how China deflation actually works its way into our economy or any economy.
24:45And that could be a very bad news.
24:46So I think I would caution, you know, this exuberance that exists in manufacturing.
24:51You know, I think I'm taking a detour now, but we should be extremely cautious manufacturing
24:57India right now because the risk, especially the ones which are adjacent to areas where
25:02China has built large capacity.
25:04So even though you may have a large amount of custom duty and stuff like that, you know,
25:08we will have a way to, you know, get goods in.
25:11And the prices at least enter, you know, easily.
25:15If you know your neighborhood in Malaysia and Singapore, you know, or Indonesia, things
25:19are selling super cheap, you know, will some way it'll it'll actually enter India as well.
25:25So I wouldn't be worried of inflation right now.
25:28I think I think a bigger fear I would have in my mind is deflation.
25:33On that note, Manish Dangi, Mosaic Asset Management, thank you so much for joining in today and
25:39giving us your thoughts.
25:40Really appreciate your time on Profit Insights.
25:43And of course, thanks for tuning in this very, very informative episode of Profit Insights.