Investors could still hope for decent returns from the Smid (small- and mid-cap) segment for the long term , but the return expectations have to be tempered with benefits of operating leverage already having played out in part and the government capex slowing down, according to Jyotivardhan Jaipuria, founder & managing director of portfolio management services firm Valentis Advisors.
Earnings of large-cap companies could compound at 12% while those of Smids at 17-19% for the next two years, said Jaipuria in an interview. He doesn’t expect oil prices to flare up and upset the apple cart for India despite the current tensions in the Middle East. Edited excerpts:
At the current index valuations within the small- and mid-cap universe which pockets are you finding value in?
In general, valuations are not cheap with the mid-cap index trading at roughly 30x and the small caps at 21x on a one-year forward basis. However, this is a very vast segment and earnings growth is very strong here, which will offset some of the higher valuations. Our focus continues to be on finding companies which fit our three ‘U’s’ philosophy – undervalued, under-owned, undiscovered, and we still find companies which meet this criteria. We are focused on some cheap banks which have under-performed the market. Pharma is another sector where we find lot of interesting opportunities.
In terms of earnings, do you think they will justify valuations going forward? Why?
We think earnings growth will slow relative to the past few years but will still be in double digits. For example, we see earnings growth over next two years for the large-cap companies at 12% CAGR, while it is 17-19% for the mid- and small-cap segment. Earnings growth will be slightly higher than nominal GDP growth as some part of the operating leverage is already seen in the margin expansion over past few years. We would expect better monsoons to help revive consumer demand. But government capex will grow at a slower pace, putting the onus on private capex.
Overall, our message is that there are still returns to be made in the long term but return expectations have to be tempered. Secondly, investors should be ready for some volatility in the markets.
Recent regulations allow for a new asset class where MFs are perceived to be at an advantage to PMS or AIF. How will you cope with the competition?
We tend to focus on our business where we offer three things (a) a more personalized and customized service (b) deep research is our hallmark with a very long-term vision and low portfolio churn. This has helped to drive many multi-bagger stock ideas (c) Unique investment ideas backed by our three ‘U’s philosophy (undervalued, under-owned, undiscovered), which drives superior, risk-adjusted returns. We service much fewer clients than mutual funds but with larger ticket sizes.
From India’s point of view oil is a key commodity to watch, especially if there is an Israeli attack on the Iranian oilfields.
New geopolitical risks seem to be emergent. What impact, if any, do you envision these could have on our markets?
Historically, the market reaction to geopolitical events has been short-lived. Typically, after a couple of weeks of a sharp fall, markets have tended to bounce back. Most conflicts have been localized and we have not seen them spread into any global war. Having said that, from India’s point of view oil is a key commodity to watch, especially if there is an Israeli attack on the Iranian oilfields. Our view is that oil prices are unlikely to flare up on a sustainable basis even if the current tensions continue.
Our nominal GDP will grow at around 10-11%. Do you feel this is good for mid- and small-sized companies?
Yes. We think we have a 10-11% GDP with real GDP growth being in the 6-7% range over next few years. This will help small- and mid-sized companies report a healthy topline. The better companies in this peer set tend to gain market share, which helps them grow faster than the industry.
Are you bullish on AI and renewables? Any exposure there?
At current valuations, we are playing renewables through some stocks that are ancillary to the renewable power capex rather than directly.
What is the mood among high net-worth and family-office clients. There were reports earlier that they were rebalancing portfolios amid record high valuations here–i.e. investing in PE or unlisted space.
The mood continues to be positive on PMS products and equity in general. We are seeing more and more HNIs manage their money more professionally. Our product is a differentiated product, which is positioned at investors looking for superior risk-adjusted returns over the long term. In some sense, we are trying to play companies that are listed and give you liquidity as well as a transparent price but have all the growth and return characteristics of unlisted companies.
Sebi will tighten derivatives framework in phases. Do you think some of the huge inflows there will be diverted to the cash segment?
We think the ultimate objective is to reduce the turnover in the derivatives market where India stands out globally. This will not materially help the secondary market. But overall, by reducing any risk of excessive trading, it will make our equity markets healthier.
If the stimulus leads to a better economic growth in China, it would be positive for global growth.
On China, is there a possibility of FII flows from India being diverted there? Any impact of China’s fiscal and monetary stimulus having impact positive or negative on India?
There are three points we would highlight. First, if the stimulus leads to a better economic growth in China, it would be positive for global growth. Of course, at some point it could lead to inflation fears again if commodity prices remain sustainably high. But we think that is an unlikely scenario. Secondly, in the near term, emerging market money would try to nibble into China and so other countries including India could see some impact. Lastly, the rally in China has led to expansion of multiples there by nearly 25%. This will help lower India’s valuation premium to EM equity and prove beneficial in the longer term for flows to India.
