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Upadhayaya further says: “It is not that mid and smallcaps will not give returns or correct a lot at this point of time, it is just that from a risk-reward perspective, it makes sense to have a little bit of tilt towards largecaps and that is what we have been suggesting to most of our investors.”
We were discussing multi-baggers, CG Power, Indian Hotels, Tata Motor, PSU stocks. It is just amazing, in three years some stocks have given 50x to 100x returns.Harsha Upadhyaya: We are definitely in a good rally since the Covid lows and the market itself has gone up more than 100% when you look at the largecap index and when you look at smallcap or midcap indices, they have also done much better. And within that, there have been several multibaggers. Definitely, it has been a great rally that we have seen in Indian markets for the past three years.
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What do you make of the Sebi alert or notification which went to AMFI and AMFI has written to mutual funds that buyer beware, put systems in places in the small and the midcap space. Do you think that will have a detrimental impact on flows and the way mutual funds are doing risk management?
Harsha Upadhyaya: I would not think so, because some of these risk controls were always there. Probably, it was not in the public domain in terms of what our investment committees and our fund management team used to look at. Now, there is a uniform standard format within which, the AMFI will disclose all the funds which are in that category in terms of the risk disclosure. It is a standardised format which will enable investors to look at individual funds within the midcap category and smallcap category and see where the liquidity is, what is the investor concentration, how concentrated is the portfolio, various other things.
Some of these were anyways there in the fact sheets of individual funds, but going forward, it will be available on AMFI website, so that is the only difference. So, to that extent, it is just an increased level of disclosure and nothing to worry in terms of anything else in the industry.
I wanted to understand your take on some of the top themes that are really in the spotlight. For instance, generative AI, digitisation, all of that. How do you see that changing the landscape for the entire IT space and newer age tech companies adapting to these big technologies?
Harsha Upadhyaya: It is too early to comment on which companies will be really leaders in these segments. Right now, many of the incumbent companies are attempting. There are many startups which are working. They may not be in the listed space today, but over the next couple of years, definitely there will be more of such companies coming into the listed space as well. So, over the next couple of years, the landscape will be a lot clearer in terms of who is going to lead this space.
I am sure all the companies in the IT segment are looking at this change and nobody can stop technology coming in real space. So, to that extent, the opportunity is definitely in front of everyone. We need to wait and see how many of those companies will be able to capture that opportunity and how soon?
You made a very interesting point that really stuck out, saying that erratic reactions to results are showing investors could be nervous at these valuations. What do you think could spoil the party?
Harsha Upadhyaya: Clearly the fundamentals are very strong, no doubt about that. Whether you look at the economic backdrop or the corporate landscape, the fundamentals have been very strong at this point of time. If you look at the next several weeks, it is going to be quite event-free in that sense. I think the flows and sentiments will dominate the market. So, depending on the flows and sentiments, we will see the short-term movement in the market.
But from a longer-term perspective, we still continue to be very positive on markets. We may not get the kind of returns that we have got in the last three years, but that does not mean that equities as an asset class will be inferior to many other asset classes. Equities will continue to really give decent returns in our view just that the volatility could increase given higher valuations at this point.Given how steep the run-up has already been in the broader markets, would you say keep a larger allocation right now to largecaps? Is that a safer place?
Harsha Upadhyaya: Yes, that is a prudent view. I do not know whether everyone will adopt that because if you look at the recent returns, but largecaps have definitely underperformed mid and smallcaps. So, many retail investors generally look at past returns and try to take positions, that is where we are making such statements indicating that this is a segment which is relatively better in terms of valuations.
It is not that mid and smallcaps will not give returns or correct a lot at this point of time, it is just that from a risk-reward perspective, it makes sense to have a little bit of tilt towards largecaps and that is what we have been suggesting to most of our investors.
Everybody is bullish on private banks. Everybody likes private banks and when a consensus trade is out there, it rarely moves. So, isn’t that the challenge with financials that everybody is invested, the sector will grow, but the appetite to increase say, from a 35% weightage or a 30% weightage is not going to come in and that becomes a restrictive factor for financials in general. A new buyer has to come in and that new buyer is not there.
Harsha Upadhyaya: If you look at the very strong returns that come in any sector or any stock, it usually coincides with under-ownership as well as improvement in earnings beyond what the market is expecting. And if you look at this segment, the banking and financials, we cannot say that it is under-owned. Yes, it may be under-owned compared to where we were maybe a couple of quarters earlier, but it is still not such an under-ownership that any improvement will really drive the markets, will drive this sector to a very large, very high levels.
So, to that extent, the improvement is expected, but it is going to be very gradual. As we see interest rates moderating probably, there will be a little bit of legroom for banks to improve on their fundamentals and also right now there is a serious scramble for deposits that also has to kind of normalise. So, we will have a couple of quarters of maybe not such a great set of numbers from the banking segment. I am talking about private sector banks.
It is better to remain in banks which have a better credit deposit ratio so that at least their growth remains reasonable at this point of time. There are no asset quality worries. And to that extent, nobody needs to worry about the quality of the book at this point of time. Overall, it will still do better than what it has done in recent times. I do not know whether it will be a leader in terms of driving the markets to newer highs in this cycle at least in the short term.
What about the outlook on the broader markets in general? If you could just give us a sense as to where it is that you are sensing opportunity. Do you believe that even over here we are looking at valuations getting a little bit expensive? What is the road ahead long-term when it comes to the broader markets?
Harsha Upadhyaya: If you look at just the last three years of earnings flow, let us say from the Covid lows until now, the market has moved more or less in line with the earnings that we have seen for the last three years, roughly about 30% to 35% CAGR earnings and that is how the markets have also delivered returns. So, the point here is if you expect the similar kind of earnings going forward, then probably the market valuations can sustain or can even move higher. But if there is any hiccup in terms of earnings growth potential going forward for any reason, then I do not think that there is enough cushion in terms of valuations.
However, the scenario in largecaps is quite different. The largecap valuation, according to us, is probably expensive by about 6% to 7% from historical range at this point of time. So, a shallow correction or a time correction would actually improve overall valuations for the largecap segment. So, even if there is a correction, I do not think that will sustain for too long a period. Investors will definitely see positive returns in this segment.
However, when you look at midcap and smallcap valuations and compare it to historical range of valuations, they are quite high. They would be anywhere between 20% and 45% premium to historical range. So, to that extent, if there is any hiccup in terms of the earnings trajectory, we are not seeing any of that right now, but since the valuations are high, one should be ready to face that kind of volatility. These two segments can depict a lot more volatility than largecaps and that is the reason why we are saying that there should be a tilt towards largecaps.
Where do you find value in the market right now? I know most of it is priced to perfection or actually more than that, but any value buys that you think there are still?
Harsha Upadhyaya: Very difficult to find. The market is trading at all-time high valuation levels, at least in the broader end and many of the sectors have moved up quite meaningfully in the last couple of years. If you look at pre-Covid valuation levels for any sector and today’s valuation, I would probably say only largecap banking names are at a valuation which are lower than probably pre-Covid levels. There is nothing else that seems to be lower than three-four-year-old valuation levels at this point of time.
So, it is definitely difficult to find value buys in this market, but there are several sectors which are likely to grow at a decent teens kind of earnings trajectory. Those are the names which will have potential to outperform the market. Maybe the volatility will increase, but still there is enough growth on the table.
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