Ravi believes that the current position of midcap index provides enough headroom for its future growth. “It is interesting to note that while the market capitalization of Nifty 50 Index is near its all-time high, the market cap of the stocks in the Nifty Midcap 100 is about 31% lower than its peak market cap indicating that there is enough headroom left, on a relative basis, for midcaps to grow.”
.What is the rationale for launching Principal Mid Cap in the current market conditions?
While the frontline indices like S&P BSE Sensex and Nifty 50 are scaling new highs, the mid and small cap segments of the markets have seen a lot of volatility in the last few quarters. They have underperformed the narrow large cap indices as select large cap stocks have driven the markets higher. In this period, the relative overvaluation of the midcaps over large caps has corrected and now the mid cap indices are trading at a small discount to the large cap index. Over the past quarter we have seen the breadth in the markets improve and smaller large caps and mid caps have also been part of the rally. The attractive relative valuation of mid caps, coupled with the strong fundamental story behind many mid cap stocks and the improving breadth in the markets make it a good time to launch a mid cap fund.
Tell us the fund management strategy that you will deploy for this fund.
We will follow a bottom up approach to stock selection and will aim to build a diversified portfolio of around 50-60 stocks with exposure across sectors. The universe of stocks will be selected to include companies having a robust business model and enjoying sustainable competitive advantages with earnings expected to grow better than other companies in their sector. To control risk, the exposure to a single mid cap/ small cap stock will be capped at 4% of the portfolio.
What are the opportunities that you foresee in the mid cap category?
Many mid cap companies are leaders in their own niche segment and have a strong connect with the end consumer or are often significant part of the supply chain to large cap companies. Well run mid sized companies have features of a large company like a good governance structure and efficient capital allocation while being run by a driven, entrepreneurial management team executing to deliver growth. Potential opportunities in mid caps would be in companies which are seeing earnings growth better than consensus, companies undergoing business transformation or restructuring to re-focus their business on the high growth areas, companies focusing on value migration leading to improving margins or those where intrinsic value is being unlocked as a result of corporate actions etc. Lastly, as the Indian economy has evolved and many new sectors have opened up like e-commerce, healthcare, movie exhibitions, logistics, fintech, etc.; these also provide good investment opportunities.
How is Principal Mid Cap Fund different from other mid cap schemes in the market?
The in-house research that we do in addition to the external and third-party research reports forms the nucleus of our equity investment process. Our robust equity investment process is based on 6 pillars. These pillars help us identify companies that have competitive business dynamics, efficient operational metrics, with good management quality leading to sustainability of profits. Our ideal picks will be those where these are coupled with efficiency in distribution of capital and fair and attractive valuations.
How will corporate rate tax cut help mid cap companies?
After the tax cuts, Indian corporate tax rates are in line with most countries in Asia-Pacific, which would lead to global companies considering India as one of the leading investment destinations. The lower tax rates for manufacturing units set up after October 1, 2019 would also help companies in the mid and small cap space. For example, companies in contract manufacturing which are usually mid sized companies would also benefit from the lower rates.
What is your view on the current valuations of these stocks?
It is interesting to note that while the market capitalization of Nifty 50 Index is near its all-time high, the market cap of the stocks in the Nifty Midcap 100 is about 31% lower than its peak market cap indicating that there is enough headroom left, on a relative basis, for mid caps to grow. Further, as said earlier, the valuation premium that the mid cap index enjoyed vis-à-vis the large cap indices in recent years has turned to a discount. As such, we believe the current markets provide a decent entry point into a portfolio of select mid caps.
There are only 150 stocks in the mid cap category. Don’t you think that mid cap space offers limited opportunities?
Given that we will probably have 50-60 stocks in the portfolio, a mid cap universe of 150 stocks gives us enough choice to pick stocks. Besides, we have 35% of the portfolio where we have flexibility to pick stocks from a broader list. Further, besides stock selection, sizing of positions and points of entry and exit in stocks also contribute to returns and as such should help in differentiating our performance.
Where will the fund deploy the rest 35 percent of the corpus to boost returns?
The balance 35% of the portfolio would comprise a mix of large, mid and small caps. It is possible that large cap stocks which we are positive on, may be around 10-15% of the fund which will also help in portfolio liquidity.
Why should advisors recommend this fund to their clients and how should they position it?
Mid cap stocks have created value for those investors who invested in a portfolio of quality mid caps when valuations were reasonable and who held their investments through the cycle. Investors who are investing for the medium to long term and who are comfortable with some volatility should have a part of the equity allocation in mid caps. The proportion of allocation should be based on investors risk appetite and financial goals.
Of course, select mid caps which have staying power and compound over time to transition into large caps can also contribute to handsome gains in the portfolio.
With the economy facing several hurdles to recover, what according to you could boost the weak market sentiment?
We think that some of the headwinds which impacted the economy over the past 12 -18 months could ease going forward. While liquidity in the money markets has been ample, credit for corporates, especially mid sized companies has been relatively difficult. We are seeing incremental signs of that gradually easing. Food prices (cereals, pulses and milk) have shown a rising trend of late. This, coupled with expectations of a good rabi crop could lead to better income and consequent demand recovery on the rural side. Besides, the government has taken many steps on the supply side like cutting corporate tax rates, improving ease of doing business for exporters etc. These too will have an impact in the medium term. Finally, inventory levels in the system are low which is a positive as these will need to get replenished when recovery starts.
In terms of the market however, sentiment has already started to gradually improve. Smaller large caps and mid cap indices have done well in the rally in the past quarter whereas the rally was earlier confined only to select large cap names. Steps like strategic sale of some PSUs, progress on resolution of some long pending IBC cases and RBI taking steps to resolve stress in HFCs also should keep sentiment supported. However, we expect markets to move sideways with an upward bias as they watch for earnings recovery and macro parameters like the fiscal deficit.
To know more about Principal Midcap Fund click to the below Link
https://www.principalindia.com/mutual-fund-list/nfo-mutual-funds/principal-mid-cap-fund
To hear Ravi Gopalakrishnan about the Principal Midcap Fund click to the below Link
