Karthik Kumar, Fund Manager, Axis Mutual Fund, says, “from a risk-reward basis, largecap as a space looks quite attractive. But having said that, there are still opportunities in the midcap and smallcap space at a stock level. Over the last year-and-a-half, the earnings differential was strongly in favour of the midcaps and smallcaps and it was quite sizable compared to the largecaps. Now, as we go into FY25 and FY26, that differential in earning growth rate comes off drastically. What matters is stock selection and being very picky in midcaps and smallcaps.”
The market is moving sideways and we are witnessing a lot of stock specific movements. But then this is a time when investors cannot decide whether it is time to enter the market or book profit if at all. As a fund manager, what is the sense that you are making out of this current market movement? Do you look at it as a very healthy correction that was needed, which was overdue and it is time for investors to hold on for some time, take a pause and then see if at all new money is to be put in the market?
Karthik Kumar: We need to put things in perspective. We are coming off a very strong 2023 and December 2023 in particular. So, Nifty was up 21% for 2023 and it was up just 8% alone in December. So, it is very natural for markets to take a pause subsequently. This is also healthy in a sense because it cleans up a lot of the froth. I do not think it is unnatural in any way.

Second, there is also seasonality to this. Starting 2001, the January to March quarter traditionally has been the weakest quarter for our market. So, 54% of the time, the Jan to March quarter has resulted in negative returns and the average return during this period has been negative 1%.

But there is a third angle to it which is that the heavyweights, both from a sector perspective and from a stock perspective, have reported slightly disappointing numbers early in this reporting season and so that also has contributed to the volatility. All the three factors together explain why our markets have been a bit sideways to slightly down since the turn of the year.

Specifically talking about valuations, because a lot of concerns regarding this have come up in the investors as well. Talking about midcap and smallcap, are they really in the overvalued zone? The kind of volatility we are witnessing now, midcaps and smallcaps would be the first to give up and we will see the trajectory being shifted towards the largecap. In terms of valuation, how do you see it across market caps right now in this current market moment?
Karthik Kumar: Let us just break that down. Largecaps are trading at almost 20 times next year’s earnings, which is not outright expensive on an absolute basis. But we are trading at a significant premium to our regional markets.

Now, if you come down to midcaps and smallcaps, they are trading at their all-time highs in terms of valuation on an absolute and a relative basis. If you were to look at their contribution to market cap, midcaps and smallcaps now contribute around 18.5% of the market cap individually, so that is the highest that they have ever contributed. All these things highlight one point which is that the asset revaluation or the gain through just expansion and multiples for the asset class which is the midcaps and smallcaps is pretty much done.

What is important right now is stock selection. What has supported this expansion in multiples over the last year-and-a-half is essentially that the earnings differential was strongly in favour of the midcaps and smallcaps and it was quite sizable compared to the largecaps. Now, as we go into FY25 and FY26, that differential in earning growth rate comes off drastically. So, again, in this case, what matters is stock selection and being very picky about stocks in midcap and smallcap. Just to summarise, from a risk-reward basis, largecap as a space looks quite attractive. But having said that, there are still opportunities in the midcap and smallcap space at a stock level.

Also, let us talk about the global trends and then perhaps what kind of a new risk an investor needs to keep in mind, because global trends show signs of softening economies and concerns over inflation have not come down as was expected by the end of December 2023. What could be the new signs of concern or new risk factors or triggers that could spoil?
Karthik Kumar: Firstly, as a house, we remain quite constructive on our markets in general, primarily because our GDP is quite resilient and is expected growth rates both from economic perspective, also from a market perspective, the growth rates are one of the highest in the region and also globally, so we are quite constructive on the markets.

Now, as long as there is a softening in US economy or a soft landing and the European markets kind of experience a mild kind of recession, that should result in benign commodity prices and hence benign levels of inflation, at least the trajectory should come down which should give central banks much more room to manoeuvre their interest rate policy.

Environments like this typically are quite conducive for emerging markets, both in terms of flows as well as in terms of performance. So, I think the macro environment as long as it stays within the kind of spectrum that I have kind of laid out, should be good for emerging markets and our markets in particular.

From a style perspective, the kind of style that should do well is a GARP-like style where you are focussed on growth at reasonable prices, that the kind of style that we follow within our investment platform should kind of do well. Fa risk perspective, I would lay out two main things, primarily the geopolitical developments in the Middle East, that could have ramifications in terms of regional stability, impact on commodity prices, and also supply chain disruptions which in turn could lead to inflationary effects globally.

The other thing to keep an eye out for is what is happening in China, the government’s efforts to stabilise the economy and the markets. They are taking active steps, but it is just something to watch out to make sure that that is going the right way as well. So, those are the two things I would highlight from a risk perspective.

Let us talk about Axis Quant Fund. And as far as the exposure across market caps is concerned, the kind of split that you have decided for the fund, is majorly largecap driven where I can see a 66% exposure in a largecaps, midcap has around 18.5% and smallcap around 14.2%. What is the kind of strategy that you have opted for this kind of a fund? How is it differentiating from the rest of the quant funds available?
Karthik Kumar: Firstly, this fund is completely cap agnostic. So while there are broad ranges that it works in, basically it comes down to where the stock selection opportunity is from a bottom up basis and we are happy to go with that. So right now, the split as you defined is quite balanced. While it is around 60% in large cap, we have got sizable exposures in mid caps and small caps. The philosophy with regards to investment is we are focused on the style as I call it GARP, which is quality and growth at reasonable prices. That is what we are focused on.

In terms of our positioning today, we continue to remain bullish on pharma and automobiles primarily driven by two-wheelers and two-wheeler ancillary industries. And we remain slightly underweight in financials. Within financials, largely the big banks and we also continue to remain underweight on the IT sector.

Did you say you are underweight on FMCG and IT sector right now?
Karthik Kumar: No, I am underweight on the financials, largely coming from the big banks and the IT sector.

Sectors where you are consistent as far as your exposure is concerned?
Karthik Kumar: I am overweight pharma and I am overweight consumer discretionary and I am overweight power. The other two sectors that I highlighted were largely the underweights and the rest I am largely in line with the markets.

Going ahead, for a few more quarters, as far as FMCG space is concerned, we have triggers like Budget and also triggers like the elections coming up, although it would not be feasible for you to just change the strategy going to these triggers. In coming quarters, are you banking on sectors like FMCG, healthcare and power, especially?
Karthik Kumar: We remain quite constructive in both power and healthcare sectors for fundamental reasons. That comes out through the quantum model as well. With regards to FMCG, I would be much more selective within that space and go for stocks where there is reasonable visibility in terms of growth because right now in FMCG, what we are seeing even through the earning season is that with the companies that have reported so far, the volumes have been quite subdued.

So while the numbers both at a top line basis and a bottom line basis, have been in line, they have been nothing great to write home about. So, that is something to keep an eye out for. The commentary so far has been quite tepid from the companies that have reported as well. So, those are the things that we would keep an eye out for. And if the sentiment does change, if the outlook does change, then I am happy to align our portfolios accordingly. But so far, it looks like there could be better opportunities down the road.