ETMarkets Fund Manager Talk-Amidst frenzy in smallcaps, stay selective rather than aggressive: Aditya Khemani

With markets scaling new highs and FII inflows strong, would you say India is in the initial stage of a strong bull market phase?
While Nifty is at a new high and is creating a lot of buzz, the fact remains that it is up just 4% from October 2021 highs. So, I would say that one should be more balanced and measured in terms of return outlook from the markets. Early to mid-teens return annually is what I would say will be a reasonable expectation.

Though I will agree that we are very close to a Goldilocks phase for the Indian economy where global developed economies are still grappling with high inflation and interest rates.

So, overall the construct of the Indian markets remains positive and hopefully, it will be India’s decade of wealth creation.

How comfortable are you from a valuation perspective, be it large or midcaps?
At an aggregate level, Nifty 50 is trading at 20x its 1-year forward EPS, and Nifty Midcap 100 at around 24x, which is almost equal to their 10-year averages.

But India’s macro at the current moment is much better than what it has been over the last 10 years.

While the valuations are similar to the long-term average, the macro being much better than the last 10 years, gives me a lot of comfort on the return potential of the Indian markets. But, one should be careful of the excesses that have built up in some pockets of the small and midcap side over the last 3-4 months and be very selective in that part of the market.

Midcap and smallcap funds have seen higher inflows than largecap funds in the recent months. What’s driving this and do you see the trend continuing?
Money always chases returns. Hence, when the small and midcap part of the market starts doing well, one always sees money following there. Also, when the broader economy does well, we see that smaller and midcap companies do better relative to large caps. Hence, this is ultimately leading to better inflows.

But smallcaps are much more volatile than large caps, so one should be careful in that part of the market, especially with the rally one has seen in that part of the market over the last 3-4 months.

One has seen a few smallcap funds stop subscription in their funds over the last one month, indicating difficulty in deploying profitably currently due to valuations.

So, one should be careful and very selective with micro smallcaps and smallcaps.

How have your largecap and midcap funds performed in the last 1 year? Could you also share your broad stock-selection strategy in the midcap category?
As a fund house, we have seen some of our funds in categories like large and midcap, midcap, taxsaver do exceedingly well over the last one year and are at the top. There are a lot of factors which go towards stock selection in the midcap side.

Firstly, large wealth creation happens when you marry a great sector with a great management team within that sector.

So, top down one needs to choose segments which can grow at a higher rate for a reasonably long period of time.

Ultimately, you need companies which can deliver high ROCE and high earnings growth for a longer period of time.

What kind of asset allocation would you recommend investors at this stage?
Asset allocation is a very powerful tool and will vary from person to person. I would think broadly equal allocation between large, mid and small funds could be a good starting point.

Large caps give higher stability to the portfolio and the SMID gives you slightly higher returns over the long term even though short term volatility could be higher.

What’s your fund house’s view on the consumption sector given that the rural market is yet to see visible recovery?
One has to remember that India is a country with a per capita income of approximately $2500, and this number should double over the next 5 years. Hence, consumption as a category would do well.

We are very positive on consumption categories which derive their sales from the top 10 crore rich people as we have seen that demand in this segment of consumer is strong and is non-volatile.

We are also positive on the 10 crore plus middle class, as one will see a lot of people move up to this category from lower down the curve.

We are not very positive on categories which derive a large part of the sales from the bottom 120 crore people. Even though it’s a big part of the population, we see this part of the population getting hurt the most out of higher inflation or any adverse events like Covid.

So one is approaching the different segments differently but we will be positive on overall consumption as a whole over the longer term.

What major upside and downside risks do you see for equities for the rest of 2023?
The upside risk one can see is that India as an economy is very well placed with the macros looking very good. And with a lag, when one sees the micro pick up reflecting in higher earnings growth, one can see strong buoyancy in the equity markets.

But, usually the economy remains strong in follow-up to the General Elections as a lot of pending infrastructure projects see completion, leading to higher economic activities.

Downside risks would be sharp uptick in commodity prices, especially crude oil. Whenever prices have spiked, we have seen the macro weaken as inflation will move up, current account deficit will move up, exchange rates will get more volatile, etc. And usually when this happens FII flows turn negative, leading to weaker equity markets.

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