India, with China, tops the list of countries with high-growth sectors and markets; hence the massive foreign capital flow

From the nursery of Nobel Laureates. Dr. Carlos Asilis, formerly with the IMF and at present MD and CEO of Vega Asset Management, speaks at the last meeting. Dr. Asilis has a doctorate from the University of Chicago whose alumni have accounted for 24 of the 61 Nobel Prizes in Economics awarded since 1969

What are the factors that determine investment returns, whether on bonds or equities?

To answer this question, Dr. Carlos Asilis, economist with a doctorate from the illustrious University of Chicago, prefers to hark back to the pre-globalisation days, particularly the early .90s, to point out that investment returns then were primarily driven by local factors.

Even the amount of capital flowing across borders was determined by local political and fiscal policy factors and was a very small percentage of their economies. This situation applied to India, Brazil, Mexico, the US, Europe and many other countries.

Today, everything had turned upside down. .Over the last four weeks or so, we have all read about the massive, not large but massive magnitude of foreign capital flowing into India. Thus, today, it is virtually impossible for an investor to be successful in his/her local market as well as in the global portfolio held by him/her without paying attention to what is happening beyond the country .s borders..

Dr. Carlos Asilis, formerly with the IMF and at present MD and CEO of Vega Asset Management, was speaking at the last meeting on .Investment strategies in a globalising world..

Having worked with Credit Suisse, the Union Bank of Switzerland and Merrill Lynch, he has been professor of economics at Georgetown University, lecturer at the University of Chicago and visiting professor at the Stockholm School of Economics.

A highly-qualified professional, he has a doctorate from the University of Chicago and an Honours B.Sc. degree in Finance and Economics from the Wharton School at the University of Pennsylvania. At present he is on the investment committee of ICICI Bank.

Addressing the question, .what should an investor pay attention to during this globalisation period and what are the mechanisms that connect investment performance, whether in the share market or the bond market in any country, to what is transpiring in the international arena?. Dr. Asilis said the first .driver. was global capital flow.

One of the basic criteria for global capital flows, whether across regions or within a region and across countries, was the quest for .the highest return..

India is the world.s favourite destination for good returns and this situation will not change in a hurry, says Dr. Carlos Asilis

This being the fundamental requirement, the questions to be asked were, what was a country.s overall ranking (in the global markets) and what was the ranking of that country.s industry (or sectors, as the case may be)?

.Normally, the ranking of returns on invested capital will dictate the pattern of capital flowing across borders,. he said.

Another crucial query was, .what.s transpiring in the core markets?. The core markets meant the US, Europe and Japan which were the older, more established capitalist countries.

Why was this so? This was so because it was in just four countries, Italy, Japan, the US and the UK, that most of the institutional savings in the financial area were held.

Further, anything that excited the capital investors in those countries would dictate the pattern of flows.

In other words, what was happening in the US economy over the last few months was the main .driver. of the magnitude of capital flowing across borders.

.It is my view that the US macroeconomic data coming out over the last few months culminating in the rates decision by the US Federal Reserve (to cut rates aggressively by half a percentage point), has been the primary driver behind the moving global capital.

.As a result of the US Bank.s action, global investors are now coming round to the view that the Bank is concerned about the pace of growth in the US economy for the next several quarters. And the US Central Bank is likely to continue easing (the interest rate). so that global liquidity will remain abundant.

.Where will this liquidity, or the flow of savings, go? It will go to highgrowth sectors and markets. In practice, what this means is that capital will flow to countries whose growth characteristics are relatively independent of the growth dynamics facing the US consumer..

China and India were at the top of the list of countries that met these criteria (of high-growth sectors and markets), Dr. Asilis declared.

Interestingly, this was also the case with reference to capital flowing within the US stock market itself. The dynamics of the US stock market over the last few weeks revealed that the best-performing sectors were those whose growth was somewhat immune from or less related to the US consumer sector.

These sectors included biotech, which was doing very well, as also certain areas of the consumer staples sector whose growth was driven by foreign markets whose stocks were traded in the US stock markets.

However, it also included the stocks of some US technology companies which earned the bulk of their revenue from overseas operations.

Thus, a pattern appeared to be emerging in terms of the movement of capital not only across borders but also within a particular market, Dr. Asilis pointed out.

The same held true in the case of India, where the sectors that were lagging and would continue to lag, would include IT outsourcing companies.

.It.s largely a function of the currency, the dollar-rupee value, and we believe that this trend will continue..

Going beyond the macro-economic factors (outlining how investment strategies had to be adjusted during the current globalisation phase of history), Dr. Asilis said he would dwell on other issues related to globalisation and certain trends visible in the global economy.

The first trend that an investor had to keep in mind was demographics, or the ageing of the population. India, Brazil and the rest of Latin America were yet to be hit by the ageing problem and would probably remain immune for another 20 to 30 years. It was already a problem in China, Japan, Italy, Spain and the US to a much lesser extent.

A second trend was the scarcity of national resources . not only crude or energy resources, but also water. With globalisation, water supply seemed to be shrinking and could become a major issue in course of time. It was already happening in China. India could also face such a problem.

The third and final trend, Dr. Asilis said, dealt with security and certain areas of space, technology and biotechnology.

Therefore, for an investor with an eye on growing his/her capital in a smart way, what were the main conclusions?

.First, when you set up your portfolio seeking a high return at a relatively low risk, you have to take into consideration the growing interdependence of markets across borders, because the correlation of returns by sectors is growing.

.Second, in order to gain diversification, you have to be a little smarter and try to look for some of the themes such as the examples that I have given this afternoon.

President Dr. Rumi Jehangir and Dr. Carlos Asilis sit down to lunch with Mr. Niranjan Bhatt, CEO of Glovista Investments. Dr. Asilis also sits on the Board of this company. In the picture at right, Mr. Bhatt and Dr. Asilis flank Tarjani Vakil, former CEO of the Exim Bank of India. While Pradeep Saxena is at left, PP Dr. Adi Dastur is seen at right

Third, and most important, also focus on the big picture, on the macro-trends unfolding over the course of time..

At the end of the day, Dr. Asilis added, one crucial factor remained local . and that was policy and politics.

Policy flippage would always be at the top of the local factors of concern to an investor, whether in India, Brazil, Mexico or even the US.

.Politicians can cause a lot of damage to an investor.s portfolio . not only in developing countries but also in developed markets,. he concluded.

Following his brief presentation, Dr. Asilis answered several pertinent questions.

Jayant Malkani recalled that in the early .90s, the price-to-earnings (P/E) ratios of emerging markets (like India) were the same as those of developed countries. A similar phenomenon was evident at present, too. .Is this euphoria, or due to the decoupling following the post sub-prime era? Your thoughts on whether this is a lunatic phase?.

Agreeing with him, Dr. Asilis said he did recall that in 1993 the P/E multiples of emerging markets were trading at a premium to developed markets. A similar phenomenon was evident at present, too.

.The question is whether this is lunacy or not. There is no doubt in my mind that there is a massive difference between the macro and corporate governance backdrop of 1993 and today.s backdrop. For most emerging market countries, the savings position, whether at the household level or the public-sector level, is many times stronger than it was in 1993.

.Secondly, the viability or solvency of the financial systems in most of emerging market countries is much better established than it was in 1993. Thirdly, the return on invested capital, or the profitability matrix, of emerging market corporates is much stronger today than it was in 1993.

.Thus, in relative terms there is no doubt in my mind that the emerging markets are in a much stronger position today than they were in 1993..

But was this sustainable? Was there a fair valuation spread (in this case premium between emerging and developed markets)?

But was this sustainable? Was there a fair valuation spread (in this case premium between emerging and developed markets)?

(1) Convergence; some countries would converge more rapidly than others; (2) policy flippages in some of the large emerging market countries; and (3) the possibility of changes in the sectoral composition of stock indices, especially in the US.

.In general, I am very optimistic and constructive on most large emerging market countries, especially Brazil and India. But I am actually pessimistic about Russia; I do not like the political backdrop of the country from a credit profile perspective..

As for the changes in the sectoral composition of stock indices, Dr. Asilis said since the composition of American stock indices was dynamic, there could be changes in the market leadership.

For example, energy sector stocks in the S&P 500, the benchmark index in the US, were close to 20%, even though they were about 6% in 1999/ 2000.

Further, Dr. Asilis said, it was possible that in the next three to four years there would be some major technological or biotechnological revolution in the developed markets; then, the developed markets would take the leadership on that front and that would be reflected in the stock indices at that time.

Subrata Mitra, himself a banker, wanted to know how best one could configure a portfolio in these tumultuous times, keeping in mind both risks and better returns.

Dr. Asilis said he would concentrate on some of the points that he had already discussed, such as geography, sectors and themes like demographics.

.In terms of geography, if you are a global investor in a developed country, I would have no less than 25% in emerging markets.

.For an investor in India. I would first like to mention from experience that there is a lot of enthusiasm towards your home country, towards India, which I have seen in Brazil and Mexico in their own times. sometimes to the exclusion of the rest of the world.

.That, obviously, is a mistake, for no matter how optimistic you are about your country, you want returns and are wary about the risks; therefore, you can.t always put all your eggs in one basket..

Thus, the best bet for an Indian investor looking for high returns from equities would be to place 40 to 60% of the portfolio in India and 20 to 30% in other high-growth countries such as Brazil, South Africa, Eastern Europe, Turkey, Thailand and Korea.

As for the fixed-income portfolio, this would depend on the age of the investor. At the moment, US highgrade corporate bonds were attractive within the developed markets, but treasury notes and sovereign instruments were not very attractive.

Vibhay Sinha asked how the speaker would rate the BRIC countries (Brazil, Russia, India and China).

Dr. Asilis said in terms of attractiveness he would rank India at No. 1 and Brazil at No. 2, followed by China and Russia. While India would remain attractive for four to five years, there appeared to be something amiss about China.

.I am concerned about a financial crisis in China, not necessarily in the next couple of years, but within the next seven years . which will have implications around the world. It.s imminent. The components are all there, the demographics, the make-up and the way society is managed.

.About Russia, I have serious concerns in the intermediate and long term; I am optimistic about Brazil, although it is not as compelling a story as India. Again, this does not mean that if you are an Indian investor you should put all your eggs in your local market, because, only God knows what risks lie ahead even in an attractive story like India..

Sitaram Shah took up cudgels on behalf of small investors, saying they were looking for returns and safety. With the advent of the free-market economy, .their protection is gone.. The markets were bumpy and returns not assured. .Whatever you have said is for the big investors, for big people. What about the smaller people?.

Dr. Asilis said first and foremost, the investor, whether big or small, had to decide the objective behind the investment programme. Was it the preservation of capital? To earn current income? Or the growth of capital?

If growth of capital was the objective, then the approach had to be long-term and in equities. Since it was also necessary to be cautious, it followed that a fixed-income component had to be included in the portfolio. But in which equities did one invest?

.My view is that you should place primary emphasis on local demand plays. Why? Because if we are correct in our prognostication and India continues to grow, especially in terms of the developed world, the rupee would continue to strengthen.

.There will be a lot of productivity growth in India as there has been in many countries. And the exporters, as a general rule, are not going to have as supportive a backdrop as they had in the 1990.s and early 2000.s. Thus, you should de-emphasise the export sector in your equity portfolio.

.You want to emphasise local plays, which means property, infrastructure and banks. But there are certain industries that are local plays, though without enough protection to the competitiveness of the industry built around it, such as telecom.

.So you simply have to do your homework to decide what might be more specific to the company or the industry..

Thus, the discipline would remain the same, whether one had a portfolio of Rs. 100,000 or a multicrore- sized portfolio, Dr. Asilis concluded.

Shailesh Haribhakti introduced the guest speaker, while Hon. Joint Secretary Nowroze Vazifdar proposed the vote of thanks.

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