The fund manager is bullish on BFSI, healthcare and capital goods. Edited excerpts from a chat:
How do you assess the current state of Indian equity markets? Is there room for upside and where are we in the bull-bear market cycle?We do not predict market levels, what we focus on is valuations which are still above average. Small and mid-cap are expensive while large caps are in the fair value zone. We have an internal model for asset allocation which is used for equity allocation in some of our asset allocation strategies and that model is suggesting around 60-65% asset allocation to equity.
Market cap of companies is essentially the discounted cash flow of future earnings. It does not change materially based on short-term events. What changes surely is the narrative, so stocks which were riding on narratives are relatively more at risk than those which are backed by solid underlying growth.
Finally, we need to consider the macro shock in terms of sharp increase in US tariffs on goods and its impact on global growth, which is difficult to estimate given changing variables.
Do you think that the valuations of small and midcaps are justifiable?Historically we have seen midcaps providing better risk adjusted returns over largecaps while smallcaps had relatively lower risk adjusted returns. Valuation premiums of midcaps over largecap have now expanded to more than 1 standard deviation. Median valuation in midcaps is higher than the previous market cycles. Significant corrections over the last few months have reduced froth, yet valuation at aggregate levels do not provide comfort.What is your approach to portfolio construction in this environment—are you leaning more towards large caps, midcaps, or small caps?In the two equity strategies I manage, namely UTI Value fund and UTI Dividend Yield fund, allocation to mid and small cap has been in the range of 30-36% over the last 1 year, with a downward bias. We find value in large cap over Mid and Small cap based on historical valuation averages. Ability to navigate the current volatile global environment is also higher in large cap over mid and small caps. The environment of earning upgrade cycles favour mid and small caps, we have clearly moved to a downgrade cycle over the last 2-3 quarters. However, at a stock level we continue to look for opportunities across market caps.
With the ongoing global macro uncertainties, particularly around tariffs, how are you positioning your portfolio to hedge risks while staying invested?Tariffs announcements on April 2nd have turned out to be much higher than expected. The fact that India has relatively lower tariff as compared to its Southeast Asian peers, or we have lower exposure to exports, is less relevant in an environment of trade war which is likely to reduce overall demand for goods. Global growth is likely to get impacted negatively while financial market volatility has inched up. We are in an environment of higher equity risk premium and uncertain earning outlook. Investors should take these factors into account while investing. We remained focussed on investing in companies with strong operating cash flows, stable working capital cycles and low to negative financial leverage.
Which sectors are you overweight on, and which ones are you avoiding right now?I am positive on BFSI as a sector, especially large private banks. We are at the early stage of relaxation of regulatory policies for banks and NBFCs as well as more accommodative monetary policy. The monetary policy has turned expansionary, after timely diagnosis of the issues in unsecured lending at an early stage and largely eliminating terminal risk. The market has ignored the highest ROA profile in history for banks, low to mid-teen loan growth in an environment of low single digit volume growth across sectors, decent asset quality, adequate capital. Large private banks stand out from an intrinsic value framework and provide an opportunity for those of us who follow the intrinsic value approach.
Healthcare as a sector has a long runway for growth. The share of healthcare in overall GDP is less than 5%, which is likely to trend up as we age as a society and transition to more organised healthcare. The per capita number of hospital beds are at a fraction of global averages and the diagnostics test has low penetration. As insurance picks up either through private sector or government policy, we expect greater focus on wellness and quality of healthcare to increase. We have a positive view on healthcare with more comfort on companies which are having a significant share of profits coming from domestic markets.
The capital goods sector is one which is still pricing in mid teen growth with high margins to continue for perpetuity. We understand that this sector is cyclical with sharp volatility in earnings when the cycle turns. The order book of capital good space is strong and margins may also remain strong for next few quarters. However, if we take a step back, we see the market ignoring any cyclicity in the sector as well as risk of margins reverting to mean. Order books are healthy but the possibility of a slowdown in growth is high, given fiscal tightening has begun and the global environment has turned adverse.
If you had to highlight one key risk for markets in the next 12 months, what would it be?The global trade environment has seen an unprecedented shift over the last few weeks. Initial expectation of tariff policy of the US moving towards the principle of being reciprocal has given way to the reality of it being linked to trade balances. Hence the outcome of negotiation on tariff structure and principles of the same is unclear. The impact of the new tariff policy of the US on global trade, growth and geopolitics and its interplay does not have a historical template to fall back upon. We are unclear about the duration of these tariffs or the retaliatory measures by other nations, this has increased uncertainty.
The Street seems to be in favour of a better-than-before Q4 earnings season. What’s your take? Will Q4 mark the end of downgrades that we saw in the previous 3 quarters?PAT growth in 9MFY25 of domestic consumption-oriented companies is in single digits, while exports, capital markets linked and industrial have done better. Expect BFSI, consumer durables and healthcare to report decent earnings in Q4. However, at an aggregate level earnings may see downgrades in estimates for FY26 as global growth shock is not accounted for in current earnings estimates.
