A conversation with Goldman Sachs Asset Management’s CEO of emerging markets equity, Prashant Khemka, makes one thing patently clear: he’s a big fan of cricket and Indian cricketing legend Sachin Tendulkar.
Citywire AA-rated Khemka frequently refers to investing as a sport and believes passion is a key ingredient for becoming a successful investor. ‘You need the passion,’ he says. ‘Sachin Tendulkar didn’t set out to become famous or make a lot of money. He set out to play cricket and became the best because he had a passion for the game,’ he says.
Like his cricketing idol, Khemka, who has been investing professionally for 17 years, certainly seems to have the right dose of commitment: according to Citywire data, he ranks among the top-performing managers in Indian equities over the past five years.
His India-focused fund, the $641 million Goldman Sachs India Equity Portfolio, has returned 55% against the CNX Nifty TR’s 33% in the three years to September 2014 in US dollar terms. Over five years, the Luxembourg-domiciled fund has returned 60% against the benchmark’s 29%.
Khemka, who is Mumbai-born, also manages two other funds – the Global Emerging Markets Equity and BRIC Equity Strategies. He joined Goldman Sachs in 2000 in the US. More recently, he spent seven years in Mumbai as head of the Indian equity team before relocating to Singapore.
Ready to bowl them over?
Khemka’s India Equity fund has posted strong gains despite India’s economic growth slumping to a decade-low recently.
This year, however, the stock market felt the impact of ‘Modi mania’. Expectations are running high that the new government led by Narendra Modi will introduce reforms that will galvanise the economy. ‘It feels like 2004 again in terms of where the economy and equity markets are,’ says Khemka. ‘Hopefully, we might have the same positive trend that followed 2004.
‘The Indian market and economy hit the bottom in 2003, and in terms of how that feels, it was similar in 2013.’
Between 2004 and 2007, India’s economy grew by more than 9% a year. Then following after a brief rebound following the crisis, between 2009-2010, India’s growth has consistently slipped, falling to a low of 4.5% in 2012-2013.
In such a bleak environment, companies fought a losing battle to maintain profit margins, notes Khemka. ‘In the decelerating economic environment, demand was weak, exerting downward pressure on the top line for companies,’ he says. ‘At the same time, there was upward pressure on costs because inflation was at elevated levels. Producers could not pass on those higher costs because of sliding demand, which compressed operating margins to decade-low levels last year.’
As a result, earnings growth was subdued – in the high single digits – a far cry from the mid-teen levels of earnings growth that India Inc has delivered over longer time frames.
Now, sentiment has turned full circle. A new exuberance has kicked in among investors, who are increasingly betting that economic growth will be back in the 7-8% range.
‘Demand is likely to pick up, inflation, while still higher than acceptable, is on its way down so cost pressures will abate just when the ability of producers to pass on cost pressures improves,’ Khemka points out. ‘Operating margin levels are likely to expand to normal levels and could even overshoot on the positive side in the near term.’
In fact, Khemka expects operating profit growth to beat revenue growth in the next three to five years, assuming things go according to plan with the Indian economy. ‘Interest rates could also come down, which will have a benign effect on financial expenses as well,’ he adds. ‘Overall, earnings growth could be above 20%, which was the case between 2004 and 2008.’
Valuations-wise, Indian stocks don’t seem to be in terribly expensive territory either: the P/E ratio based on estimated one-year earnings for the benchmark 30-stock Sensex is 15.5. The long-term average P/E ratio of the index since the early 1990s, when the economy first began liberalising, has ranged between 15 and 16, Khemka says.
‘While we might be in the early stages of a strong sustained earnings cycle, earnings multiples are still in line with historical averages. As such, valuations are reasonably attractive and we are very positive about the medium-term outlook for equities and the economy,’ he adds.
Betting on a boom
So how is Khemka positioning his fund to take advantage of the expected upturn in the earnings cycle?
Khemka says his investment style, while having a macro overlay, is very stock specific. ‘We have historically found more compelling alpha-generating ideas in some domestic sectors, such as consumer discretionary, financials and industrials,’ he says.
‘Most of the capital allocation has been to these sectors because of the stock-specific opportunities these sectors present. Of course, in the past three years, these sectors have faced the most headwinds because they are domestic economy oriented and the economy has slowed.’
A look at GSAM’s India equity fund reveals, however, that the top three holdings at the end of September are all from IT in the software services exporting sector: Infosys (5.6%), TCS (4.3%) and HCL Technologies (4%). IT claims the second-largest allocation in the fund at 18.7%, behind financials, which accounts for 22.2%.
‘Information technology is a very good, very sound business with a compelling value proposition,’ he explains. ‘The sector is highly competitive compared with global peers. The stocks offer high returns on capital and on equity; they are also attractively valued compared with global peers as well as with other stocks in several other sectors in India.’
Another sector favourite is financials, which covers banks, non-bank finance companies and real estate companies. Khemka says there have been some good stock opportunities there, especially in real estate. ‘We have tended to find attractive opportunities in private sector banks as well. However, we usually struggle to identify good state-owned entities,’ he adds. There are three banks in the fund’s top 10 holdings, all within the private sector: IndusInd Bank (2.2%), HDFC Bank (2.2%) and ICICI Bank (2.1%). Khemka’s investment style is textbook: ‘Outsized returns are earned in the long term by investing in sound businesses that are available at a substantial discount,’ he says. In addition, a key figure he watches is cash flows. ‘Our investment approach is very cash flow focused. We make our own assessment of the cash flow generating abilities of a business.’
His investment style may be textbook but the GSAM veteran, who holds an MBA in finance from Vanderbilt University, claims he actually isn’t much of a reader at all. ‘There are a lot of investment books I would like to read, but I haven’t got around to doing so,’ he says.
His overall understanding of the financial markets, he says, comes primarily from discussions and debates he has had with other investors. ‘I have gained immensely from the discussion of investment ideas and concepts with other investors who have read these books. I gain the knowledge from these indirectly. It is also a continuous learning process and I think I have been very fortunate to work with a strong set of investors throughout my career,’ he adds.
Investing lessons and a funeral
The initiation into the boom and bust world of stocks began quite early for Khemka, when he was just a teenager. That’s something he shares in common with cricketer Tendulkar, who also first wielded the bat at 11 and was just 16 when he became India’s youngest test cricketer in 1989.
For Khemka, 1985 was the turning point. ‘In 1985, when I was 13 years old, my great grandmother passed away,’ he recalls. ‘When the extended family came together for the funeral rites, all anyone was talking about was the boom in the stock market.’
It was India’s first stock market boom in recent economic history. The then prime minister Rajiv Gandhi had made the first attempt to liberalise the Indian economy and encourage private investments. ‘It was the first stock market boom I saw in my life,’ Khemka reminisces. ‘It sounded so exciting: it felt like you could double your money every year. I thought I could become a “crorepati” (an individual who has Rs 10 million) in 10 years by investing Rs 10,000 in stocks.’
Most Indian households typically do not invest in stocks: families tend to be ultra-conservative and park their savings in gold, real estate and bank deposits. However, Khemka’s family belongs to a community of traders that actively invests in stock markets. ‘My family did put a good amount of their savings in stocks and operated businesses,’ he says. ’On average, we invested in 100-200 stocks.’
In those days, a company’s annual reports used to be in physical form. ‘My grandfather would ask me to read those reports and summarise the company’s operations for him,’ he says. ‘It further enhanced my interest in the stock market.’
While he doesn’t reveal the name of his first stock purchase, he admits that ‘it did reasonably well. And it is still listed on the stock exchange’.
‘I bought another stock too on that day, but that company was eventually acquired,’ he adds.
Even after all these years, the allure of stock investing remains strong for Khemka. He compares his investing approach to the way a sportsperson approaches their game: ‘The motivation to improve yourself and become better than others is what keeps a sportsperson going.
‘It’s the same for me too,’ he says.
Khemka’s years of investing in India, initially in a personal and later professional capacity, have convinced him that it’s time for the country’s economy to lift off again. ‘Simply with the proper execution and governance, which is the platform Modi was primarily elected on, India’s growth can improve to 7-8%,’ he says.
‘In the near term, it doesn’t need heroic efforts to improve the growth rate,’ he adds, noting that the recent 4.5-5% growth streak is equivalent to recession in some countries. That can only mean good news for stocks. Khemka also makes an interesting observation: In India, the market cycle has historically tended to last seven to eight years. ‘That doesn’t mean we can extrapolate from that because you can’t count on history to always repeat itself,’ he adds, but ‘it is interesting to note, nonetheless’.
‘The first stock market boom I saw was in 1985, which was followed by the 1992 boom (that ended in the ‘Harshad Mehta scam’),’ he points out. ‘Then, in 2000, we TMT market boom and more recently, we had the 2007 boom, which culminated in the first weekend of January 2008.
‘Hopefully, this one will be longer,’ he adds.
This article originally appeared in the November issue of Citywire Asia magazine