Share with us your outlook on equity market. What are the key triggers and risks for the market?
We view the markets from three perspectives – economic and earnings growth, liquidity and valuations.
Economy is clearly on the path of recovery from the COVID setback. As the lockdown restrictions have progressively been relaxed, we have seen improvement in growth indicators and also a broad basing of growth, with more and more sectors showing improving growth. A large part of this growth is still a journey to normalization to pre-Covid levels. However, even pre-Covid, Indian economic growth was close to bottom and hence we feel economic growth should start improving from FY22, beyond just normalization. Liquidity is quite abundant with central banks across the globe keeping interest rates low and injecting liquidity by buying bonds. This liquidity deluge has helped major indices to cross pre-Covid levels and trade at very high valuations. Nifty P/E is more than 1SD (standard deviation) higher than average. Nifty’s P/B at 3.2x is also high and among the highest levels seen since 2008. So the improved liquidity and improving earnings are in a sense priced in by the markets.
However, while headline valuations are high, the rally has been narrow and led by few sectors and stocks. Mid and small cap indices are still below the January 2018 highs as are large number of large cap stocks. This clearly gives opportunities for stock picking.
A major risk to the market is clearly any resurgence / second wave of COVID. Another risk that is underappreciated is the resurgence of inflation as a consequence of excess liquidity and fiscal stimulus.
Markets are at all time high. In such a scenario, why do you think it is right time to invest in large cap funds?
As stated in the earlier question, while the aggregate market valuations are high, there is clear and huge divergence in the valuations of leaders of this rally and rest of the market. Based on our analysis, the top 15 Nifty stocks gave a cumulative return of ~81% between December 2017 and October 2020, while the bottom 35 stocks within Nifty gave a cumulative return of negative 22%. Thus, about two thirds of the large cap stocks are trading well below their all time highs and at valuations below their long term averages. Market’s expectations of earnings growth are also not very aggressive for this set of stocks. Thus, the investor in these set of undervalued stocks would get the benefit of both earnings growth and multiple rerating, over the next three to five years. This is the opportunity set we would be focusing on.
Experts believe that generating alpha in large cap funds is very challenging. Your comments.
We don’t subscribe to this view. For generating proper returns in any category, what is needed is the right investment discipline and framework and proper time horizon for investments. Each category has its own set of challenges.
Take us through the stock selection strategy of ITI Large Cap Fund.
Similar to our other equity funds, we will use our ‘SQL fund house investment philosophy in managing the ITI large cap fund. Here S stands for margin of safety, Q for quality of business and management and L for Low leverage.
We will look for stocks with following features:
- Stocks from industries undergoing cyclical slowdown / facing maximum macro headwinds,
- Stocks where valuations are attractive and can potentially attract global liquidity
- Stocks from sectors where government policies are encouraging
- Stocks that benefit from the shift towards organised businesses from unorganised businesses
- Stocks that belong to core sectors of the economy
The key themes we are bullish on over the medium term are:
- Make in India and import substitution
- Rural plays
- Improvement in Infrastructure
- PSUs where order book and earnings growth is visible
We would be investing entirely within the large cap universe defined by AMFI. At the time of investment, the stock will be within the large cap universe. We may continue to hold a stock even if post purchase, the classification changes.
How different is ITI large cap fund from other large cap funds.? Why should distributors recommend ITI large cap fund over others.?
We would be currently focusing on the two thirds of the large cap universe where valuations are at significant discount to the market and valuation differential between secular growth stocks and cyclical is very high. Our experience tells us that strong companies trading at attractive valuations should not be ignored even when headline market valuations are very high. So investment in an SBI or L&T in dotcom boom of 2000, in Hindustan Lever or Sun Pharma at the infra boom of 2008 or Infosys in 2017 gave very good returns even from all time high market levels. We believe this investment strategy is very differentiated. The strategy has potential to generate handsome returns over the next three to five years. Also by virtue of investing only in large cap stocks, potential draw downs in the event of a market correction from all time high levels would also be relatively lower.
What are the sectors you are bullish on?
We are generally bullish on stocks which are plays on economic recovery or coming out of industry downturn. The key sectors we are bullish on industrials and engineering, utilities, metals and select pharma and financial stocks.
