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S Krishnakumar, Director, Lion Hill Capital, says “given the kind of growth that is seen at this point in time, valuations are expensive in most pockets of mid and smallcaps. One would probably do better to book some profits and be ready for any good correction to add into them again.”

It is just not stopping 22,400 now. People are expecting some correction but this is not obliging. Are we heading into a pre-election rally or is the election now just a matter of formality? It is already priced in.
S Krishnakumar: Like you rightly said, there is a lot of good news that happened in the last three months which got factored into the valuations already, be it earnings growth, we had a fairly good earnings season. Most pundits believe that the BJP will come back for a third time. Given all that, and the fact also that interest rates have kind of peaked globally and it is just a matter of time in the next six months, when they will start cutting rates. All these are already into the market in terms of the premium valuations that one would look at across most sectors. So in the short term, it is very difficult to call, I do expect continued volatility. Of course, valuations and other fundamentals point to a time consolidation or a correction for the near term. But the FIIs have been a little soft on India in the first two months and if they choose to come in the FOMO factor, then you could also have a euphoric move in the next couple of months.

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So it is very difficult to call the short term, but long term, the India story remains intact. We are one of the best placed markets and countries to grow well in the next decade and if you factor in that, you would have to sit through a correction that is kind of on the horizon at some point.

How is the portfolio allocation looking? Have you been a buyer for the last few weeks or mostly researching and sitting on the side?
S Krishnakumar: I have been raising cash probably at about 25% plus cash at this point in time. So probably, I am definitely in a camp which believes that there could be good opportunities that will open up when there is a kind of a correction in the next couple of months because all the good news is in the price and if you look at global markets also, it is a very concentrated rally that has happened in the US, etc. I expect a bit of ease on equities in the near term.

What is your largest holding looking like? In fact, in either name, if you are not comfortable sharing names, talk to us about the theme which are the most two-three meaningful positions in your portfolio?
S Krishnakumar: Financials will always remain one of the large exposures and one would only try to juggle around between banks to NBFCs vis-à-vis wealth management space. Relatively speaking, depending upon where you are on the rate cycle and who could benefit. Within that, wealth management definitely has a huge runway over the next decade and we are seeing a lot of medium HNIs, MHNIs as you call it also coming into wealth management and offering, taking services. So that is a huge space that you should be looking at.

The next would be definitely from a consumer cyclical perspective, auto, auto ancillaries and discretionaries are something that one has to be well positioned and I am also positioned there and I believe that probably there is a little bit more value on the ancillaries at this point in time and that is where we should try and play the auto cycle in the next couple of years.

With travel resuming and business confidence also doing well with foreign traffic coming back into India both for business and for leisure, the hotel space and the hospitality is definitely well positioned to have significant upsides on profitability and cash flows, which is going to be very big, and you could see them expand quite aggressively in the next three to four years.

Lastly, hospitals and healthcare is again a very defensive space that one should be in because as affordability improves and insurance penetration is going up, people are probably more conscious and are kind of moving, upgrading themselves to better hospitals etc. In the listed hospital space, there are tremendous opportunities across such on both national players and regional players, which we are quite positive about.In hospitals and diagnostics, is valuation not a challenge or are you looking at adding these names on the current issue of administration of the costs and all if the stocks come down on that, would you be a buyer?
S Krishnakumar: I think it is very important that there is a bit of rationalization of tariffs etc. But India is such a vast country that one has to encourage more capacity creation etc. so my belief is that hospital companies will be able to maintain and improve on profitability, given the kind of services that they offer and health consciousness services improving across the board.

I would definitely look at using any corrections to kind of add to positions there. Diagnostics is again another sector, but there is probably a little bit more ace there. Relative to valuations, we find that there is still a fair amount of competition and pricing issues there. I would probably be a little bit more circumspect on diagnostics but play it through the hospital sector.

What are your thoughts on the pharma space? It is perking up in trade today and last few months. Names like Cipla, Lupin, even Sun Pharma have done very well. But even more the commentary coming from these guys are very good for the next few quarters.
S Krishnakumar: As the markets are heading into a phase where the frontliners which are leading the rally could be in for some consolidation, money is moving into other defensive areas and given the consumption issues on the FMCG side, particularly in the rural segments and the pressures on the IT companies from a concern on IT spend etc.,

The only other sector that is looking available is pharma. And within pharma, if you look at the meltdown in chemical prices and bulk prices etc. that happened in the last 12-18 months, is now starting to help the input pricing cost for the pharma industry. That is helping them draw back a lot of profitability and given that they also have been sizing up in the last couple of years, operating leverage benefits are also kicking in.

So a combination of gross margin expansion, better pricing and cost control in other areas are helping pharma companies and particularly the branded players. There is definitely a move towards defensive growth kind of sector which pharma offers at this point in time.

You have managed a smallcap, midcap scheme for a very long time. Which side of the argument are you? There is froth in smallcaps and midcaps or not at all?
S Krishnakumar: Even the regulator and AMFI have come out with views that a bit of a bubble probably has been building up in the small, midcap space, particularly in the mutual funds schemes where a lot of inflow happened in the last 12 months. There is a clear shift and tilt towards mid and smallcap funds away from largecap funds. That is putting pressure on the fund managers to keep finding the right ideas or allocating more to the same at higher valuation. So it is a tough call.

While benchmarks are always fully invested, if you hold a higher amount of cash, you would probably underperform when the market goes up like what is happening now because of flows. It is a tough situation for the funds. But on the balance, valuations are at a premium historically and relative, basically. I would think that given the kind of growth that is seen at this point in time, valuations are expensive in most pockets of mid and smallcaps. One would probably do better to book some profits and be ready for any good correction to add into them again.

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