Can investors make money as consumption rises?

Foreign investors have long been drawn to India's booming consumption story. But over the last three to four years, domestic retail investors too have warmed up to the idea of making wealth from their own consumption.

While diversified funds give some allocation to consumption oriented stocks, concentrated thematic plays promise a bigger bang for your buck as they clocked an average 15-19% annual average gains in the last three to 10-year time frames. DNA Money spoke with investment experts to seek answers to the four big questions that every investor has. Read on.

Theme basics

India is a consumption-driven economy. Given that we have the second largest population in the world, emerging middle class and increasing focus on improving the income levels for the bottom end of the society, consumption remains a compelling theme for investment, says Amnish Aggarwal, head research, Prabhudas Lilladher.

As per UN population database, 47% of India's population is below 25 years, and 64% below the age of 35. By 2010, India is expected to have the largest working population resulting in lowest dependency ratio, thus increasing disposable income and thereby fuelling consumption, points out Devang Kakkad, head research, Equirus Wealth Management.

Yes, demographics counts. "Around one-third of the population (430 million) is millennials. They also constitutes around 45% of the workforce, have high aspirations and doen't shy away from spending more. The beauty of India's demographics is such that the proportion of the working-age population (15 to 64 years) to the non-working population will further going to rise over next two decades," says Ankit Jain, fund manager-equity, Mirae Asset MF.

Globally, it has been observed that the moment a country's per capita GDP crosses $2,000, there is a disproportionate rise in discretionary spending. "India's per capita GDP is expected to cross this milestone in 2019-20, thereby paving the way for increased spending spearheaded by millennials which are 35% of India's population. Going by the millennial idea of eat well (FMCG, retail, quick service restaurants and healthcare), feel well (consumer durables, telecom, media and entertainment and auto) and live well (consumer electrical, paints and tourism), consumption as a theme is likely to be in focus," says Rajat Chandak, fund manager, ICICI Prudential AMC.

As the per capita income improves the consumption pattern of people will uptrend and up move. "This narrative was seen in other emerging markets like Vietnam, Malaysia and the same will happen in India. So for anyone investing in Indian equity this theme is a must own," points out Mahesh Patil, co-CIO, Aditya Birla Sun Life AMC.

Individuals today are also consuming more compared to a decade ago. This changing consumption pattern is expected to benefit targeted sectors and companies that cater to these needs, ultimately, benefitting investors, says Karthikraj Lakshmanan, senior fund mnager, BNP Paribas Asset Management.

"The consumption theme offers a diversified range of sectors to invest in like consumer non-ddurable and durable, auto, pharma & healthcare, banking, construction materials, etc," notes Dhaval Kapadia, director – portfolio specialist, Morningstar.

Max exposure

Most diversified funds have exposure to consumption-oriented companies. Then, what is the argument in favour of pure-play consumption funds? Most diversified equity funds vary their sectoral exposure based on the fund manager's views on the market, but sector focussed funds, like consumption funds, maintain a focussed exposure to stocks of that particular sector, says Aggarwal. In a diversified fund, weight to these businesses is most likely linked to underlying benchmark, avers Mirae's Jain.

Consumption focussed (thematic) funds will have at least 80% exposure to consumption theme, says Kakkad. There are 10 consumption thematic mutual funds with the biggest ones being Sundaram Rural and Consumption, Tata India Consumer and Aditya Birla Sun Life (ABSL) GenNext. ICICI Prudential Bharat Consumption Fund's new fund offer closes on April 9. "In a thematic consumption fund, there is an opportunity to invest 80%-100% in B2C companies, which could help give more exposure. In our observation, B2C companies in the past have generated superior business profits over medium to long term, as compared to B2B companies, which has reflected in their performance as well," says Lakshmanan of BNP Paribas.

Pure play funds like ABSL Gen Next Fund have exposure to consumption and financials which aid consumption. Patil says that unlike diversified funds this fund has a higher allocation to sectors which are less cyclical and anti-fragile. This means volatility would be lower for similar return over the longer term.

Not everybody agrees that pure-play is good. "Bear in mind that thematic funds are ideal for seasoned investors who have sound domain knowledge regarding a theme. It is preferable that new investors with one to three years of MF experience opt for diversified funds, with a large cap bias and multi-cap funds," cautions Navin Chandani, chief business development officer, BankBazaar.

If the theme does not play out as expected, investors could end up with lower returns than the broad market. Due to their focussed strategy, sector funds, including consumption funds, are a high-risk-high-return proposition for investors, adds Aggarwal.

Rich valuations

Consumption stocks are richly valued. Plus, many think they are cyclical. Fund managers have to navigate these two risks. You should be ready to give at least five years' time, with regular reviews annually and intermittent corrections if required, to get the best out of them, says Chandani.

Consumption stocks have seen steady re-rating for the last 10 years and many of them are trading near or at lifetime high multiples. But Prabhudas Lilladher's Aggarwal argues that the cyclicality in consumption stocks is more for discretionary segments.

Jain of Mirae agrees. "The whole idea of these stocks trading at a substantial premium is also because most of these businesses do exhibit relatively lower earnings volatility because of secular demand drivers and low penetrations." He, however, adds that certain pockets of consumer-oriented businesses are trading at a substantial premium to historical average and see limited scope of re-rating.

Consumption stocks are moderately cyclical in nature vis-à-vis themes such as capital goods, real estate, steel. "Given the varied sectors that consumption funds would invest in, fund managers have the flexibility to manage both stretched valuation as well as volatility," says Kakkad of Equirus Wealth.

"We are of the view that within the consumption space there are investment opportunities available at attractive valuations. Given that cyclicals are currently going through a down-cycle, we believe this can be an opportune time to accumulate cyclical names," says ICICI Pru's Chandak.

Lofty valuations can be justified, selectively. "Companies on valuations may seem expensive but from a growth standpoint we believe they are compounding stories. However, for consumer cyclicals, the call is more nuanced," says Lakshmanan.

Patil feels that if one invests properly in this theme, growth will surprise and valuations will catch up. "During some years, due to non-structural problems like monsoon, prolonged variance in temperature, some sectors like staples, durables, might see some slowdown. But we have to navigate those times and look to buy more if valuations become reasonable," he says.

Elections ahead

Elections are an important event for the consumption theme. Election year witnesses increased spending on public welfare, local infrastructure, loan waivers and other promises which improve public sentiment and induce more spending.

"Government stimulus like loan waiver, direct transfer, especially in an election year, helps drive the rural consumption. This does aid consumption in short term, but bigger theme is how job growth momentum continues post-election," says Patil.

Earnings growth is also expected in consumer-focused sectors like paints, media, building materials, retailing and possibly telecom.

Consumption play, in general, is usually a low-beta strategy. "Hence, during times of uncertainty such elections, consumption theme helps as a defensive strategy and also minimises risk and volatility," says Kakkad.

Chandak says that while economic activity tends to gather pace around election time and consumption as a theme may emerge as one of the major beneficiaries - investments should always made with a long-term view.