One of the brokerages which you may be reading is calling for a strong pre-election rally. This is in the face of the fact that almost two-three months in a row largecaps have turned very quiet in trade and the midcap and smallcap parts are rallying. Your fund must be doing very well in the smallcaps because you launched it at the right time. What do you think of the prospects?
Clearly, the economy is doing good and by default, markets are an outcome. We are bound to get investors across the space as a country, as a market. I think those issues are in place. Relatively speaking, for a change, one might end up saying that yes, largecaps look slightly more attractive right now. The way valuation catch-up happens across large, mid and small spaces, over time, markets normalise and move in cycles. I think largecaps look attractive for now. Maybe 8-10 months back, smallcaps were quite attractively valued and we saw a rally. Yes, we did launch our fund almost at the right time in December 22. So yes, smallcaps which are undervalued have now caught up. Maybe the RBI pause was one of the triggers which drove it. For now, it looks like flows are driving the rally much faster than what one possibly can think of from a pure fundamental catch-up. That is where largecaps look attractive and we need not worry because not all smallcaps are bad. We are always bound to find good companies catching up with the economic growth phase of their own and coming to markets for good value creation.We have also seen a spate of big block deals – which have come in QIPs – by founders and PE guys. One section of the market is nworrying that this is probably a sign that the institutional guys see the market right for selling and the retail is actually buying via mutual funds. Is that a sign of worry or not really?
There are two parts of it. One, let us look at the broad principle of market economy. There is always going to be a demand and supply combination. There is a demand for good companies to buy from and there is a supply of existing investors who want to sell. In some times, those investors happen to be promoters but in majority of the time, they are actually institutional investors or individual investors in whichever shape and form.
So, do not really worry too much about it as long as you know the name of the company in terms of the governance and business models. Valuations are reasonably comfortable and acceptable. The pure supply of some shares by a promoter or a private equity investor is not worrisome. More worrisome is perhaps the valuation. In a way, the market matches demand supply. If there is more demand for shares from investors, supply does come in which is a nice way of getting some sort of price discovery mechanism being right because if there is a high degree of ownership by promoters in some cases, you do not really have a right discovery of price.
I believe it is all good actually to let this happen. The quality of the chosen company, the valuation does matter to markets and from an institutional investor’s perspective, that is what we will be focused at in terms of buying the right set of businesses and valuation combination.How is your smallcap fund doing?
We launched our smallcap fund somewhere in end November and we started investing from mid-December. The fund is doing pretty good in terms of its own path for value creation and the market has been pretty benign and favourable for smallcap investors, especially in the last six months because the RBI pause was a nice trigger. We have historically seen smallcaps doing reasonably well when monetary policy is conducive because the majority of smallcap companies have a nice worry in terms of interest cost to sales ratio. So when the RBI policy is on the conducive side or is expected to move to a conducive side, these companies have a nice growth path. Over and above the normal business growth which comes from the top line, interest does help you at below EBITDA level.
So, yes, the smallcaps have done well for us and we do expect a similar thing. Only thing one needs to worry about is valuations on an individual set of sectors or stocks and that is where we believe broadly the valuations are normalised now but yes always find those pockets of growth for investors.
How are you looking at the cycle right now, especially the intersection of the macro cycle, the business cycle and the market cycle we are in right now? How should retail investors approach this issue?
Yes, it is a nice combination. Macro overlay partly comes from geopolitics in terms of how maybe oil price moves, how China plus fund strategy moves, how offshoring plans for the big importers in the world play out. So that is one piece. They are looking for some country which can step up to take an incremental 5-10-15% market share which is pretty good for some countries like India. That is the macro piece in place.
Look at the economic cycle. Clearly we are growing, maybe relative growth can always improve with some support from global customers. That is what our story actually is. Exports are a story for India. We will be able to provide a lot of goods to the world having done on the services side. That is again the macro drop of the economy. The only other nice part about markets really is that markets have a very nice interchange between sectors in terms of valuation multiples and one very intriguing part which all of us as investors have learnt is that the same one rupee of profit earned by different sectors has different market implications from wealth creation.
Some sectors are inherently traded at low valuations in terms of 10-15 PE which we are used to pay and that is most of it. There are some sectors with stocks where multiples go as high as 50-70-80. So, that is a nice interplay between economic growth which plays out and the market cycle because market cycle gets that perspective of valuation multiples which can create a lot of wealth or perhaps can take away some part of wealth depending on which sectors do well.
That intersection is pretty good for India broadly on every front. The only caveat should be that one needs to respect valuation because over time you learn that once you respect valuation, the market ends up respecting your investment style and your portfolio outcomes.
You also are planning a business cycle fund. What will the philosophy of that be?
We are in the midst of the business cycle fund in the sense that today we are going to close the fund in the initial NFO period. The broad philosophy is like this, in a growth economy like India, every sector is going to take its own chance to have a higher profit growth cycle relative to each other.
So let us look at it this way, almost every sector earns its own share of profits but when those profits are seen on an incremental basis, one sees a nice split, a nice market share being gained by certain sectors on an incremental basis and by default lost by somebody on an incremental basis. As an illustration, when metal companies do well, metal producers end up making a far better share of profits on an incremental basis while the metal consumers end up taking that hit and to an extent the profit pool keeps on shifting.
A similar example happens to be on the interest rate cycle side when interest rates rise in an economy, banks being the lender, typically get a far better share of the incremental profit pool versus the borrowers. Our idea is simple. The economic cycle does play on the incremental market share of profits in the economy. On the market cycle side of it, which says that every rupee has a different valuation implications across sectors, if one is able to evaluate how the profit growth participation is going to be going ahead and evaluate vis-à-vis the market implications from a valuation multiple, one can have a portfolio construct which can keep on alternating across sectors. Since India is growing, every sector is going to grow, all we look into, measure and monitor is a valuation multiple from a market side perspective.
