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Welcome, everybody, to Advocata Studio. We are doing another episode today. And for a change, we are actually going to focus on the equity markets, the investment climate as a whole, but mainly focused on the equity markets. 

And to speak to us about it today, we have Mr. Kuhn Vinayagar Sundaram, who is the Chief Investment Officer of CitySmith Asset Management Company, which is part of the broader CitySmith Financial Services Company. So welcome to the show, Mr. Kuhn. Thank you. 

Thanks a lot, Sharad. Thanks. So Kuhn, we are meeting shortly after the central bank made an important monetary policy decision. 

The overnight policy rate was hiked by 100 basis points, which, while a lot of people would have been expecting a rate hike, I'm not sure a lot of people were expecting them to go all the way with 100. Initially, now we know why they took this measure. Inflation was going a little out of control. 

The currency was very volatile. And there were certain other factors as well. But from an equity investor's point of view, what should the investor be feeling right now? How does this change the climate? Yes, Sharad. 

So the rate hike, like you mentioned, to some extent, the market was expecting it. But the extent was definitely a surprise. Those 100 basis points front-loaded move on interest rate hikes. 

And also what's important is that the macro environment for equity investing, for risk-taking has been very stable over the last two to three years. So we've been through a three-year policy easing cycle, which started back in mid-2023. With this hike, that's been the first hike since basically the COVID and the economic crisis era. 

So we are getting, we're slowly starting to regime shift, might be starting where we get to a bit more tightening as things go along if things don't sort out pretty soon on the Gulf side. But interest rates moving up, it's 100 basis points move. It's a bit of a surprise. 

So the market did react yesterday. And on the bond market side, of course, there's already been some expectations of a rate hike. The bond market was kind of predicting that. 

And now that it played out, the equity market was quite resilient up until that point, but it did see some selling yesterday. But however, what I want to kind of, looking at the larger context is 100 basis points move. We go from 7.75% on the policy rate to 8.75%. It's going to transmit into higher rates. 

Possibly on the lower end, we already saw a bill auction being undersubscribed, but also with higher rates. And we also see that transmitting into higher rates on the longer end of the curve as well. But that said, it's not going to be a situation where interest rates are significantly higher to result in domestic fund flows moving significantly out of equities. 

Definitely, I think people are going to be a bit more conscious about investing in equities because it's not a policy easing cycle anymore. And the central bank is providing a direction that it might be looking at hikes if necessary going forward. So obviously, high interest rates are not good for economic activity, demand, as well as corporate earnings. 

But what I would also like to stress is that it's only 100 basis points move. It's also a preemptive move by the central bank in order to ensure that inflation doesn't get out of control and price stability is maintained. And at the same time, there's a transmission lag. 

So it's not like, you know, you increase interest rates, and it's immediately going to have a big impact on your demand or corporate earnings. Generally, what we've seen in the past is that it takes about six to nine months for things to play out. So it's not a concern for 2026, I would say, as an equity investor. 

It's more of a concern as we go into 2027, as we go into the medium term outlook on equities. But right now, it's not too much of a concern because interest rates, it ensures that inflation is under control and interest rates don't, you know, spike significantly. Yeah. 

And it is, as I mentioned earlier, it is a measure taken looking at the macro picture. Yes, there may be casualties in certain sectors, but it's looking at the macro picture and how to, you know, manage the economy better. So in that sense, wouldn't that ultimately benefit the equity investors as well? Right. 

So yeah, so because I mean, you don't exist in a vacuum, right? Right. Absolutely. The market. 

Yeah. So inflation is the biggest devil that is there. Yeah. 

So you don't want that get out of hand. So now, you know, there is pressure. And it's obviously supply driven. 

And but then the longer this crisis goes on for it starts reflecting in real economy as what we are seeing with the dollar crisis that the short lived dollar crisis that we saw. And then it also affects everyday purchases, corporate earnings over time will get impacted as a result of that. So you need to tame inflation. 

So you don't want a repeat of 2022 what happened there was, you know, inflation went out of control. Market was very, very solid leading up to 2021. And we saw the drawdown that we had in 2022. 

So you want to kind of alleviate that concern initially. So I think from that perspective, I think Central Bank has made a move. Now it gives them that space to watch what happens at least for the next couple of meetings, and see if any other further measures are required. 

And the reaction from the equity market also seems to suggest that, you know, it's not too concerned yet. You know, it's also we need to look at the broader picture, it feels like the supply driven crisis, very dependent on what happens out of the state of almost if that crisis is sorted, things can, you know, get back to normal, it's not it's not gonna, you know, kind of spiral into a major crisis. So in that sense, interest rates, as long as you know, even the long end of the curve is still around 12%, that is still manageable for equity investments. 

Because as when you when you invest in equities, historically, it's as a class that provides you more than 15% on an annualised basis. And you're looking at investing in companies that give you a return on equity of more than 15%. So it's still better off investing in equities, it's just that in the near term, there's going to be some choppiness, there's going to be some earnings weakness because of the crisis. 

And it's about seeing through that. Right. Moving into the sectors, Goen, now, we were talking about it from the investors point of view, but from a company, listed company point of view, how does this affect their plans in terms of specially investments and expansion? Again, do you see the transmission being, you know, long term in terms of medium term? Yeah, so I think, so looking at the private sector, one of the reasons why the central bank decided to hike rates was that despite the supply crisis, because to some extent, some of the prices have not been cost reflective, the demand hasn't taken a hit. 

So demand has continued, private sector credit demand has been very strong. That also has a lot to do with them. You know, it's preemptive stocking as well.

So that means that the economy or the sentiment in the economy had not weakened significantly, because the economy still feels that this is a global crisis. Yes, we have a stressful three months or six months ahead of us. But it might not break the economy, right? That's the current status quo. 

Obviously, things can get worse depending on what happens geopolitically. But to answer your question, I think things will see a slowdown for sure as interest rates go up. I think every company is going to relook at how they want to spend their money and how they want to gear up, increase debt, etc, in terms of a new capacity expansion.

What we also saw adding into this year is that there was a fair bit of unutilized capacity also, you know, they were mostly companies were getting debt for working capital per se rather than expanding significantly. But this was the year when that was going to change, because we had Bitwa, we had to do a fair bit of CapEx. This was the year where the government also had that space to, you know, start spending a bit more on CapEx. 

Obviously, there's going to be a slowdown until we see clarity. It's not necessarily because everyone is, you know, really worried about their purchase of the wallet or the purse, but rather, they don't know what's coming in the next six months. So you're going to need some certainty until you can take that foot forward and spend more on CapEx. 

So CapEx will likely be a bit slow, especially in the first half of this year, maybe going into the next quarter as well. But in the last quarter, depending on what happens in the Gulf, we might see companies go out and spend again in the event that they need to increase CapEx again. But right now, it's more of a wait and watch is what we are seeing. 

That's the approach that a majority of the companies are doing. And right now, it's about managing the stocks that they already have. And how do you adjust the prices in such a way that you don't result, that doesn't result in a demand collapse. 

So it's about managing that aspect at the moment. Right. Now, the first or the fourth quarter of the last financial year, the earnings have started to come in. 

How do you, from the ones you've seen, what is the vibe you're getting in terms of how much that quarter was impacted? Because really, you only had one month that was impacted, right? February 28 is when the outbreak of war happened. Yeah. So we are talking really much. 

Yeah. How much has even that month affected the earnings? And I can ask this afterwards also, but how do you foresee that affecting the first quarter, or especially, you know, second quarter of 26, but also first quarter of the financial year? Yeah. So looking at the earnings picture for the quarter end in March, what we see is that earnings are still very robust. 

We're quite healthy, 15% plus tracking. We've seen results for about 150 companies out of, that's about close to 50% of the companies have reported, the rest of them report during the course of this week. So earnings, yeah, we've had one month of impact, but that was also the month where we had the most amount of panic, the most amount of intense fighting, and also large premiums on oil, because it was a very stressful month. 

That was the shock itself, and the market reacted pretty badly in terms of leaving aside the earnings, even the market reaction was quite bad. We had the first double digit decline in the index in a very long time. Then came the recovery, but in terms of earnings, we don't see stress yet. 

In the March quarter, most of the companies are still reporting good numbers. Volumes are not a bit much of a worry. It has continued the momentum that we saw, because if you really adjust, earnings which has been very strong going into this year as well, last year on the nominal terms, you may not see much of earnings growth, but if you adjust for some of the one-offs in the base year, it was still a 40% growth year last year in earnings, and index went up by about 40%. 

So it's not really multiple expansion, but rather earnings driving the index, as opposed to what happened back in 2021, when it was easy money driving the index, multiple expanded, it was not really an earnings story. But this time, earnings is an important factor. In the short run, it's all supply and demand, and it's all news flow that drives the prices. 

But in the long run, how well is the company's or index's earnings doing? How well is the cash flows? That really determines where the index is going. So far, we don't see a stress, but in terms of policy actions, in terms of price actions, full prices going up, all of that started happening in March. So first quarter of this year, we are going to see some stress. 

But the good thing with corporate earnings is that usually the June quarter is a bit of a slow quarter, because that's the quarter where you don't have much season. In April, you have the New Year. So then some of the manufacturing takes a stop and takes a break during that period. 

And then tourism goes into an off season. So June is generally a weak quarter anyway. So we will see some stress.

But the stronger quarters of the year are usually the December quarter and the March quarter. And the way things are playing out, given multiple reasons why the war situation and the oil situation has to sort out in the next two months, hopefully, we should be OK just in time for the fourth quarter being strong again. So next two quarters, definitely we are going to see some impact of the war driven price increases that having an impact on volumes and in return earnings in June and September quarter. 

And the market needs to be prepared for that. Right. In terms of, again, sectors, Koen, which ones have been worst affected and which ones have actually been quite resilient? If we start from the resilient ones? Yeah. 

So in an environment where you have a crisis of this sort and inflation spiral, right, you ideally want to position yourself in anything that kind of gets the benefit of inflation, as long as the prices are cost reflective. Yes. Right. 

So that you drive, you kind of ride the wave of inflation, you get higher prices as long as the company is able to pass on that price and is able to maintain margins, you make good money there because earnings are going to be good. And then secondly, banks, interest rates can go up, the banks and the business of, you know, borrowing short term lending long term. So when the yields are more, you know, slanted and the long yields are higher, they tend to benefit a lot more. 

So interest rates going up will obviously benefit their names. So banks, although price action kind of does not suggest that yet, banks are a good play given the current environment with interest rate hikes starting to play through. In terms of the segments, so I would focus mostly on companies that have even consumer staples, anything that has the ability or has that tail course, anything that has the ability of being able to pass on prices without having a significant impact on their cost base, would be able to maintain their margins, would be likely be able to even get market share from the smaller players because smaller players are going to have working capital strain. 

This is a good time for the larger players to usually get more market share and strengthen their positioning. So you want to be in quality fundamentally driven names. Even as an asset management house, although we take tactical place, those small trades and tactical positioning once in a while, our core portfolio is always on a diversified range of quality companies. 

So they have that cash buffer, the gearing and whatnot to kind of get through a crisis like that. So you want to be in those fundamentally good names and also names that have that ability to pass prices and still maintain margins and have a robust earnings. And also maybe not too much gearing because as interest rates slowly go up, I don't think it's still a concern because 100 basis points increase is not going to significantly blow up your finance cost. 

But ideally, if you don't have debt, you get that benefit as well. So those are the segments that I would focus on if I'm looking to do anything tactical, so fertilisers and names like that, because there is a supply crunch, there is an inflation driven spiral that's going to increase prices and margins are going to be better. On the things that I would maybe tactically not look at it right now would be, tourism is heading into an off season. 

But it also means that for the end of the year, this is when you position. You don't necessarily want to buy stuff that are running. It's a way you position yourself. 

So obviously, the next two quarters are not going to be great. Consumer discretionary is going to be weak given the current scenario. And as a result, prices will take a hit when the earnings will come. 

And that would allow you the opportunity to position yourself in those names for a shift in sentiments later on. Like if the war were to go away and if interest rates are not going to continuously be hiked. Interest rates are still at a level where it still supports the consumer. 

So you will have a situation where going into the fourth quarter or the early part of next year, where we might see a very strong earnings outlook for some of the names that are not really preferred right now. So you have the opportunity to position. So if you're thinking long term, and if you have that holding power, go for... It's always, I mean, equities, if you don't have the holding power, unless you know what you're doing in trading, that's a different story. 

But if you don't have the ability to buy and hold something for at least two, three years, try not to put too much money into equities, because you need to have that ability to hold. And it's important that, you know, the markets are always going to be sentiment driven, right? When things are bad, prices are going to come down, people are going to be very negative, and you're going to be focussing more on the negatives and traders are going to exit good stocks, it gives you that opportunity. And then later on, when things sort themselves out, you know, you get the benefit in terms of price action. 

Just picking up on that point, Sri Lankan investors, culturally, do you still see them as more, you know, coming and make something and get out like this long, short term ones? Or are we maturing to a stage where we are we are thinking more, okay, I have holding power, let me, I'm not talking to talk to your investors, I'm talking in general. Yeah, but but then again, to give you some statistics, equities is, is something that I see in Sri Lanka has huge potential, it's going to grow significantly over the next 10-15 years as the new generation comes in. And as they assess as digital native generation, they are looking at exploring options outside of their traditional FDs. 

And we are you, we are the parents in the previous generations invested generally, right. And to give you some stats, I think we have only about 25 to 35,000 active traders, people who trade, at least do one trade a month. And I think although there are 1 million accounts, CDS accounts, I think probably only about 300,000 to 150,000 investors at least trade, you know, have active accounts, right. 

So that's in a population of 22 million, we're talking about 1% of the population. So the fact that the market size itself is going to increase is, is an opportunity that you that people should not fade, they should not be looking at just okay, the next three months are going to be this way, let me buy something, make my 20% and get out, it's not the story. You know, it's about how you build a portfolio for the next five years, 10 years, because I think what we've seen locally is that companies are very resilient companies are very some of the best governance in terms of, you know, despite what's happening on the banking sector recently, and all the concerns around it. 

But generally, I think some of the Sri Lankan companies are very well governed companies, you get very good information to analyse and invest. It's all about, you know, being patient and getting started early and continuing that journey, like as a youngster. Because it's been a great compound, despite all the things that we've had, I mean, to just give a bit of sense about equities for the last 5-10 years, or maybe even 15 years since the war, all the things that we've had, all the crises that we've had, I think, except gold on an LCR term, equity, there's no other asset class that has done as well as equities, we're talking about 17-18% annualised returns.

Because equities bounce back immediately. Yeah, and also, at the end of the day, these are stocks and companies, right? So they're run by real people. They're agile, they'll adjust to what's happening in the economy, you know, when there's a recession coming, or when demand condition is not great, they make decisions to, you know, run the business in a certain way. 

And when there are opportunities to be taken advantage of, they switch around. So you have that nimbleness and that agility with equities. And also, I think, in general, what has really helped equities is that earnings has been quite strong in the last few years, last five years, especially. 

It's been mostly an earnings driven story. And then we've come out of a crisis where valuations were very cheap. Now we've kind of reweighted to a level where it's still not very expensive, it's still very reasonable compared to other peers. 

And even the last five years, equities have done exceptionally well. It's, you know, we're looking at 25% plus annualised returns. So you, I think the focus should not be on just trading and tactical plays, it should be the bigger, it's okay to do that, but should not fade the larger compounding machine that equity has been over the last few years. 

Speaking of that, our performance, is there a regional comparison you can make with maybe South Asia or even beyond, in terms of valuations, where are we? Yeah, I think so. Emerging out of 2022, we were one of the cheapest, because we were coming out of a crisis and the risk premium. So the valuation is a factor of growth, it's a factor of how much risk is there in investing in a particular nation as opposed to other nations, right? So at that point in time, valuations was much cheaper, because there was a heightened risk premium. 

We didn't know how the macros can play out. There was not enough confidence on the central bank and how that was going to tame inflation, the ability to tame inflation, etc. But over the last two, three years, we've had a very stable macro situation. 

We've had a government in power that's had majority and able to take decisions. And then we've also had multiple acts and legal measures being taken in order to ensure that we don't be indisciplined, in terms of how we run the macro in general, right? So as a result of that, some of those risk premiums have gone away. So now we've gotten to a state, I think the market trades at about 10 and a half times forward earnings. 

On the current earnings, about 11.5 times. So this is more or less in line with majority of the peers that you see in the South Asian space. And we are talking about frontier markets, talking about India and Malaysia and Thailand. 

So those are much larger economies trading at a significant premium. But I'm talking about Pakistan, talking about Bangladesh, talking about Philippines and names like that. So we are in that bracket.

We are not necessarily cheap anymore like we used to be. Maybe Pakistan is cheaper than us. But Pakistan doesn't quite have the same political stability that we have. 

So as foreign investors looking from outside, what they want is a bit of political stability. They need to be able to see how the macro is going to play out. Because for them, currency risk is a massive risk. 

You don't want to be ideally investing in a country where there's a currency risk. Because even if you make 20 percent on your equity holdings, you don't want that to be washed away with your currency. So from foreign investors perspective, I think given that two years of relatively stable currency also has ensured that we are in a much stable footing. 

I won't say that the valuation is too demanding or expensive or anything of that sort, especially given where other markets are trading. They are trading at much higher premiums. Larger markets are trading at premiums and developed markets are trading at even higher premiums. 

But they are also driven by different cohort of earnings and cohort of companies that are not really present in Sri Lanka. So I would say from a foreign investor's perspective, the reason why they haven't quite come back into our markets is a bit of a question mark for me. But that also means that anyone who's... Do you attribute the recent outflows or the recent, when I say recent, the past few months, the outflows that we've seen from the CSE, is it a lack of confidence in Sri Lanka as a whole or is it purely the global... I believe that it's more of a repositioning story.

Like what we are seeing is that, okay, given the geopolitical... I think that's also one of the reasons why you saw gold kind of doing exceptionally well leading into 2020. Because we've had a kind of a very unpredictable, unstable geopolitical environment since about early last year. So I think a lot of global investors who are not dictated by where they put money, they can go anywhere they want, right? So global developed market investors, they've normally come to our markets for higher returns, higher yields. 

And when, you know, the developed markets are providing you that kind of returns and, you know, in an environment where the geopolitics are a bit unstable and, you know, countries in the South Asian region is obviously very exposed to the current account problems that come out because of a currency crisis or a global crisis, right? So I think that's what's really driven the outflows more recently. Earlier on, it's because of the economic crisis, of course. They've not looked at our markets yet because they're getting good returns elsewhere. 

Yeah. And the US bond yield curves are... Also quite high, 4.5%. But even equities are doing exceptionally well, right? Because it's driven by a completely different paradigm shift in how markets are operating. That's mainly tech driven actually. 

Yes, yes. Because I think if you look at US manufacturing, it's been in a long recession. It's just coming out of recession. 

The AI is propping up the US market. Yes, yes. And, you know, Europe has not done as well. 

It's mostly the US market. But the moment some of those themes start taking a breather, we might see more flows into our markets. But from a Sri Lankan investor's perspective, you don't have that luxury of investing anywhere you want. 

Yeah. So then your options are limited. And then within that space, I think equity has, especially if you're a youngster, you have that ability to hold longer term, I think it's a good space to put some money in. 

When you talk about young investors, now, I'll make this part of a broader question. We have been talking about broad basing the CSE for years, if not decades. At least in the post-war environment, do you think we have really taken significant and material steps towards achieving that? And has that been successful? Because my personal opinion is it's still a very small club. 

And I think you alluded to that there might be 1 million accounts, but about 300 active. Yeah. Why is that still the case? Yeah, but it's changing. 

I mean, that's a good welcome sign. I think, like with many things, COVID is a blessing in disguise, especially with this as well, because the moment you started being able to open accounts digitally, we are seeing that traction. One thing, of course, with equities, it all depends on the market performance. 

Also, people obviously get attracted to it when the market performance is good, and the last five years have been good. So last year, I think we had, if I remember, I'm not sure if the numbers are correct, but we had close to about 45,000, 50,000 new accounts. Because last year was a particularly good year.

Yeah, last three years have been very good. To give you some numbers, I think 2023 was a 25% year. 2024 was almost a 50% year. 

These are massive numbers when you compare against FDs or your alternative asset classes, right? And then last year was a 41%. Three years of very strong growth. And that's naturally attracted more people. 

But I think the digital element of being able to not having to go to a broken open account and be able to do everything online is definitely resonating with the new generation. You know, those who are in the early 20s, who are more digital native, and would necessarily don't really even talk to people. They like to do everything online, right? So I think that's helping. 

And also because of the fact because of what we've seen with currency depreciation, because of what we've seen in terms of inflation, etc. I think now there is a requirement to kind of move out of just traditional asset classes. You need to look at and explore other areas where you can beat that and make, kind of, hold your purchasing power. 

So that's naturally going to drive more people to invest in equities and look at this market. What's being done from the CSE end? Of course, I think, and also another way of getting exposure to equities is like, let's say you're a very busy person and you can't track the markets or you don't have the necessary knowledge. You can get it through unit trusts and mutual funds. 

In India, they call it mutual funds. In Sri Lanka, it's unit trusts or collective investment schemes. So through that, you have that opportunity to invest with small sums of money and you're letting a professional fund manager manage the money for you without having the hassle of having to watch the market. 

So that is also saying traction. It's still a very small market. It's about only 600 billion in terms of size. 

Majority is still money market funds, but equities are slowly gaining traction. But even number of unit holders would be probably less than 200,000. Because that also has not been really marketed properly. 

Yeah, but a lot of work is being done. It's just that the uptake has been slow, but it's improving. But it's one of those things, right? There's going to be that one good year where you suddenly see that momentum come through and suddenly everyone starts talking about it and suddenly it goes. 

And I think there's been interest across the board. There's quite a bit being done both from the CSE side as part of CitySmith also. We engage in a lot of activity to kind of create that awareness, not just within Colombo because Colombo is okay, but it's outside of Colombo in other parts of the country where a lot can be done to improve that awareness. 

There's a lot of misconception around it because people, like you said initially, people look at equities as a short-term thing like where you put money and you try to make money and generally what you do is you go and buy into a hype cycle and you lose money. You're getting in at the wrong point. So there's a lot of misconception that needs to be taken out and the Unitrust is a good way to kind of get exposure initially until you figure out how the whole thing works. 

And there's a lot being done and hopefully we'll get to a point because I think you can see that with some numbers as well. Even liquidity wise, it used to be maybe about 5-10 years ago market liquidity on a daily basis was probably about 200 to 500 million rupees, whereas we are now doing close to 5 billion. Obviously inflation and the currency has weakened, that's one thing, but still we are doing an order of magnitude more than what we used to do. 

So there's more liquidity in the market now, there's an actual functioning market, spreads are a little lesser, you can easily buy.

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