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While the debate on valuations in the Indian equity market continues, veterans of the alternate business: Ajay Vora, EVP & Head - Listed Equities, Nuvama Asset Management, Madanagopal Ramu, Head - Equities and Fund Manager, Sundaram Alternates and Pramod Gubbi, Founder, Marcellus Investment deliberated on the valuations of market segments at the recently concluded Cafemutual India Investment Summit 2024 held at Ritz Carlton, Dubai.
The session was moderated by Deepak Nair, Senior Vice President – Zonal Head - Private Wealth & Banks, Motilal Oswal AMC. Here are key highlights of their insightful discussion.
Value in current market
Madangopal Ramu: We try to be very realistic in our growth expectations. Urbanization, growth of infrastructure and a young working population have led to good opportunities in India. However, the interest rate in India is still higher compared to competing countries, which leads to an adverse impact on manufacturing.
We have created alpha through structural stories in mid cap and some specific cyclical stories in small cap. In large caps, we focus on revival stories of companies, where they give high returns over a period of time.
Lowering of GDP projections by RBI
Ajay Vora: Slower government capex due to heavy monsoon and elections are the primary factors that have affected the growth rate. Higher interest rates and inflation have also affected the rural economy. There has been corrective action by the government and there have been attempts to increase spending.
Over the next four to six quarters, if the government picks up on the spending, it can lead to an improvement in the liquidity cycle and India can go back to earlier projection of growth rates in the next four to six quarters.
Revival of foreign institutional investor (FII) inflows in future
Pramod Gubbi: FIIs do not come in a single block. On one extreme, there are large investment banks who come in and go out very quickly. Next are global or emerging market funds, who might move their allocations away from India or into India. As China has made it clear to not support private capital, India is the only emerging market left due to which a lot of long-term allocation is moving into India dedicated funds.
Pension funds and endowments are also getting attention. However, valuations still remain a concern. India is at a cyclical high in terms of valuations and a cyclical low in terms of earnings growth.
Due to this, long-term asset allocators are currently waiting on the sidelines. In fact, a market correction can be healthy to bring in long-term capital into India.
In the short term, valuations are bad. Small caps, which have done well in the recent years have taken a bigger beating in the last two quarters. Small and mid cap valuations are still higher than their January 2008 peak. The right thing to do right now would be to reduce allocation in small cap. It could be done by redemption or increasing allocation in large cap. It is important to follow a bottom-up approach and leave stock selection to the fund managers.
Market caps benefiting from premiumization, globalization and transformation themes
Ajay Vora: The biggest theme that can play out is consumption. We have seen that India’s disposable income is on the rise. With increase in discretionary expenses, consumption can increase by twofold in the next 5-7 years.
Specific pockets like textiles can grow due to increase in exports in a short span of time. My focus is on small and mid caps where investors with longer investment horizons and higher risk appetite can get non-linear risk reward and where compounding can be in excess of 20-30%.
Investment in manufacturing
Madangopal Ramu: There are companies in this segment, which have grown tremendously. However, their valuations have also increased by many times. Even if there is a small decline in earnings, there will be a sharp correction in their valuation. India has tough competition from China in manufacturing. So, it is better to look at domestic consumption-based manufacturing. There are segments like solar cell manufacturing, battery manufacturing which will have advantages due to government restrictions on imports. Some lead battery manufacturers are moving towards electric vehicles which also is an opportunity.
Alignment of changes in portfolio across market caps
Pramod Gubbi: We only focus on delivering alpha and do not do size allocation as it can vary based on investor preferences. Currently, there is more value in large caps. However, from a long-term perspective, there are significant growth opportunities in small cap. Currently, a lot of small cap funds are also allocating in large cap as much as they are allowed. However, the illiquid nature of small caps means that inflows will ensure that valuations are kept high.
For small caps to have attractive valuations again, the inflows will have to stagnate or revert back to large cap funds. At that stage, the gap between the valuations would lead to a proper correction. I am waiting for the right prices to get into the small cap.
Value-style investment in mid and small caps
Ajay Vora: There are pockets of small cap where value has emerged but they are still at a significant premium compared to large cap. However, I believe India is a bottom-up market and you can find value in small and mid cap in any kind of market.
Comparing valuations to their historical averages in new sectors
Madangopal Ramu: Midcap has both kinds of companies: the one on upward trajectory as well as the ones on the downward. In recent years, both kinds of companies made money but now it will be important to choose the right companies.
In this scenario, buying companies from emerging sectors who are expected to grow at reasonable valuations makes sense. When earnings growth reduces in the market, it will reward quality growth even if it is costlier. Currently, there are such mid cap companies which are trading at 40-50 PE but fund managers will have to give the premium for future returns. Once the breadth of performance narrows, this outperformance will continue.
Consistent compounders
Pramod Gubbi: Compared to previous years, Indian economy is now much more broad-based and opportunities have widened. New business models are entering the market. Technology and digital marketing allow smaller companies to grow and reach their target markets. Due to this, fund managers need to be more aware and make sure that their portfolio reflects the change in economy. It is important to accept mistakes and adapt to changes accordingly.
Portfolio allocation across segments
Ajay Vora: A 40% allocation in large cap and 60% allocation in mid and small cap, one can expect very high compounding.
Madangopal Ramu: I recommend a 30-30-30 allocation in large, mid and small cap with remaining 10% in cash to balance alpha generation and risk management.
Pramod Gubbi: I believe there will be a correction in small cap at some point and you need dry powder to buy that correction so you need some allocation in cash or a segment, which has not corrected like large cap.
You can watch the complete session by clicking here.