Slight Slowdown In Mid, Small-Cap Inflows: Aditya Birla Sun Life AMC CIO
Caution is advised regarding the broader breadth of the market as there is an anticipation of a slight weakening, he says.
A slight slowdown in the inflow of money in the mid and small-cap segments is being observed, with some flows being redirected towards large-cap and flexi-cap categories, according to Mahesh Patil of Aditya Birla Sun Life AMC.
However, overall flows in the SMIDs are deemed decent and a major drawdown in these flows is unlikely to be seen. Decent growth in the mid and the small-cap space on the domestic side is anticipated, the chief investment officer told NDTV Profit's Niraj Shah in an interview on Monday.
Patil pointed out that the markets experienced a certain degree of correction phase in the last couple of months. However, optimism persists, with an expectation of continued upward momentum and the likelihood of reaching new highs. "A mild consolidation or correction is what we are expecting," he said.
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Valuations in the broader market are slightly elevated. Yet, when considering the Nifty, the earnings growth observed in the last two–three years aligns with the returns, according to Patil.
The markets have received some support and rebounded. Caution is advised regarding the broader breadth of the market as there is an anticipation of a slight weakening, he said. "This is a sideways correction and not a deep correction."
He underscored that continued growth is anticipated to be rewarded by the market, especially as interest rates have reached their peak, prompting a continued search for growth opportunities.
In the medium term, a positive outlook is held for the automobile sector, particularly four-wheelers. Optimism is also expressed regarding the telecom sector, Patil said. "We maintain a constructive stance on private banks as they offer a good margin of safety."
Watch The Full Conversation Here:
Edited Excerpts From The Interview:
We hit new highs today as well amid all the talk of higher valuations, growth concerns, and so on and so forth, which have existed for the last couple of months. Are you surprised by this up move or were you always constructive?
Mahesh Patil: I think you're right. The markets, I mean, there was some amount of correction phase in the last couple of months.
While we were still positive on the market and we are still positive on the market and we think that the market will continue to scale new highs in this calendar year, our view was more on the large-cap space of the Nifty. We didn't see Nifty correcting much because while the valuations in the broader market is slightly ahead, but if we look at the Nifty, the earnings growth seen there in the last 2-3 years is in line with the kind of returns that you've seen. If you look at the last three-year Nifty CAGR returns and the earnings there, they are in line or returns are slightly higher.
So I think, the large-cap space is only marginally expensive. Overall the outlook, there going forward into this fiscal year as we go in, is fairly decent. The strong earnings growth that we saw in last 2-3 years is likely to moderate, but still will be in the double digits or the low teens also.
So I think, given that the market would continue to do well. Obviously, having run so much last year, especially in the mid-cap and small-cap space, there was a need for some correction and that's what we were getting into that phase. But I think, the market seems to have now again taken some support and bounced back from those levels.
Having said that, I think one would still be cautious a bit in the broader breath of the market because that is likely to slightly weaken as we move forward because the money flow which was coming in the mid-cap and small-cap space could probably slow down a bit. Global markets have also been climbing the wall of worry, you can say, despite concerns about U.S. recession, slowdown in growth, global markets are strong, but if at all, we see some weakness over there, I think you will see our markets also possibly reacting to that. But by and large, I think we've remained constructive on the market. Still, we don't see any major big draw downs in the market. A mild correction or a consolidation phase is what I think one should expect in the near term.
Mahesh, I heard you say that the flows toward the small caps, mid caps may go down a little bit? Are you seeing signs of that? Could that lead to a corrective move or would you reckon the small caps can you know, time correct, if you will?
Mahesh Patil: So I think, there has been only a slight slowdown in terms of the inflows in the mid and small-cap market. We are seeing some tilt towards the large-cap and flexi-cap category, but still I think the overall flows in the mid cap has been fairly decent. So it's not likely that you will see a major kind of a drawdown or sell-off in the small and mid-cap space.
You're right to say that this is not a 2018 kind of scenario when we saw a sharp correction in the mid caps and there was earnings impact also. I think this time around, the only difference is that the earnings growth is still fairly good and we think that the mid and small caps also will continue to show reasonably good earnings growth.
A lot of the sectors, where the mid and small caps on the domestic side, I think should see decent growth. Even sectors, which have seen some slowdown in the consumer discretionary side or consumer side I think that could also improve going forward. So in this scenario, I will say that there is overvaluation in certain pockets in the mid and small caps that needs to be some correction. You might see a time correction or even a mild correction over there. But when someone with a longer term view, with a five-year view, I think mid and small cap can still do reasonably well and can possibly on a risk-adjusted basis give similar returns.
So I think, it's more of a consolidation, a sideways correction, or a mild correction rather than a deep correction that we should expect in the mid and small caps. And again, the flows there don’t really turn anything negative. They only moderate it down in terms of the large flows. The skewness that we saw last year, I think, is likely to slow down.
Would you be constructive on large private banks at the current scenario, not from a weightages perspective, but purely from an earnings and evaluation perspective or would you want to distribute that money into other assets if the weightage issues would not hold you back?
Mahesh Patil: So, if your question is whether we are positive on the bank sector, if that's what you're driving at, I would say that to some extent, I think clearly the large private banks have underperformed relatively vis-a-vis the broader market. And clearly, that's one space where I would say the valuations are more reasonable. Again, if you compare vis-a-vis some of their historical value they will be closer to that or in some other cases even slightly lower than that. And the overall outlook of the sector also is fairly steady. I mean, credit growth could slow down a bit because deposit growth is still a bit of a challenge. But overall, ROEs are fairly healthy.
So I would say that some of the large private banks look interesting to us at this point in time where the risk-reward ratio looks reasonably good and this is a time when we don't want to chase momentum. Last year, we chased momentum, high growth or even to some extent, market rewarded risk taking. I think, going forward, one should be slightly cautious. We need to kind of curtail risk in the portfolio and to that extent, I think some of the large private banks provide that opportunity where there is a reasonable margin of safety and possibly steady growth. I mean, it cannot be really exciting, but we don't see any kind of a concern on the asset quality, which could really impair the earnings outlook. I think it could be kind of a contra or counter-cyclical call, which we can take on the private banks.
Are you constructive on PSU banks at the current valuations from say, one-two-three-year perspective?
Mahesh Patil: I think the PSU banks definitely last year have significantly outperformed the private banks. Again, as you rightly said there was a valuation catch up, which was there.
Obviously, the earnings growth also was fairly strong. I mean, they've benefited from not only NIM expansion, but also significantly lower costs and to some extent also recoveries from the earlier written off loans. So that led to very strong earnings growth and that will definitely moderate down in this fiscal year, in FY25, where the whole benefit of lower credit cost is there in the base now.
So we think that now, incrementally, even the rerating that we've seen in the PSU banks they are under kind of valuation because that has also got corrected. So it will be now be more stock specific. Now we'll see it from here on. I mean, as I said, we still remain constructive on few PSU banks, which are fairly well-capitalised—that is the most important thing—and which can continue to exhibit reasonably good asset quality, and obviously, a strong deposit franchise.
As I said, the large underperformance or the large valuation gap between private banks and the PSU banks is behind us. Now, it will be more driven by individual banks—be it private banks or PSU banks—66how they deliver on the earnings side, asset quality side, credit growth side. I think that will determine the kind of relative outperformance over there.
So, to sum it up, I would say that macro trade in PSU banks is probably behind us. We will be more stock-specific going forward.
There was a Nomura note today, as well as a CITI note today, all of which talk about a likely current account deficit surplus number for quarter four, and while it may not extend into FY25, it may still remain within a 1% number in terms of a deficit.
How enthused are you with such a development, considering that just 10-11 years ago, we've looked at numbers which are abysmal, so to say? What are the implications of this from an investing perspective?
Mahesh Patil: I think, clearly, a couple of things that have happened, structurally I think which is leading to a kind of reasonably lower CAD number.
See, one way is obviously there is a domestic slowdown, your growth slows down, your imports slow down, your CAD number goes down. But that's not a healthy way, one is not too enthused by that.
But I think what we've seen is that the reduction in CAD is primarily driven by on the services exports side, we've seen a very strong growth. Again, it's not only the IT services, which have slightly slowed down. But the other services like, for example, the outsourcing work, which is being done in the other industries. There are a lot of global competence centres being opened up in India by global MNCs. They are trying to outsource their backoffice or back-end operations from India, which has seen a very strong (boost). In fact that amount will, in the next couple of years—2-3 years—equal what we've seen in the IT services. That really provides a strong kind of support to reduce the CAD.
Also, we are now embarking on a journey where we are trying to reduce our dependence on imports, specially in the whole electronic side and consumer durable side, which has been kind of increasing steadily, trying to really now start domestic manufacturing. It's still early days but, I think, structurally that would bring down the pressure on the trade deficit side.
So I think these are the couple of factors which can be structurally positive for keeping the CAD under control. Also, on the export side, while there has been some step-up by the government trying to increase exports, and the whole China Plus One, but in a weak, global, kind of a demand scenario, I think that's not really helping at the margin.
But I think over a longer term, I think net exports from India can improve if we're able to get traction in a few sectors where we're trying to display some of the supply chain which we were importing from China.
I think that is really good from a macro standpoint from an India perspective, which reduces the macro risk for foreign investors investing into India and that's what we've been observing—that the volatility on India in terms of the various parameters... So, I think these things are good from a structural macro long-term stability.
For investors, when they look at India, they would probably look at the rupee depreciation which normally is around 3% and in the past, it would probably be lower. It could also make a case for the risk premium—what normally India would require—that will come down. So that means the multiples, when macro stability is there, I think your risk premiums go down I think will mean that India will continue to trade at higher multiples compared to its historical average.
Mahesh, I come to you on this dichotomy wherein there's this belief that value will see buying and we're seeing the market not necessarily shying away from giving premium multiples to businesses which are poised for strong earnings growth in the next 2-3 years.
In newer areas like defence, aerospace, green hydrogen, wind energy, etc. How constructive are you on companies which are growing strong, but are priced to perfection on FY24-25 earnings?
Mahesh Patil: So I think, there has always been this kind of a tussle between say growth and value in the last two years.
We have seen the value stocks do well. Significantly, there was a good amount of re-rating that has happened over there. On the other side, even companies that have delivered strong growth or the outlook is good, I think they also continue to do well where the traditional growth stocks, which were there, let's say, in the retailing sector and other sectors where we've seen the growth have also got impacted. They have seen some amount of correction.
So you are talking about the whole challenge between growth and value. I think the markets will continue to reward growth going forward. The big large value trade in the market has played out, I mean, at least the rerating of some of the value stocks.
I think, going forward, as interest rates have peaked out, as the interest rate correction happens, I think the market will start looking at growth.
Where's it that you have the highest conviction over the course of the next 12 months—something that has the highest weightage on your portfolio and you are comfortable with that weightage?
Mahesh Patil: I think in the medium term, we are positive in say sectors like, for example, automobile, especially the four-wheelers. While the stocks have run up, I think we see a reasonably decent volume growth and margin improvement over there.
We are constructive on the private banks, where we think that the large underperformance last year provides a good margin of safety over there. Also, in discretionary sectors like for example, aviation then on the consumer discretionary side where we have seen a slight slow down last year especially in consumer durables, I think we are getting more constructive there as we move forward.
There we think that the valuation correction that happened is a good opportunity to play from a slightly longer term perspective.
We are also positive on the telecom sector, where we haven’t seen any kind of price increase but post-elections, there is room for prices to move up and that will continue to drive earnings growth over there.
Apart from that other sectors which have been underperformers in the last year, say for chemicals because of the slowdown and the inventory built up in the system, I think, going forward as the inventory correction takes place, one can see improvement in terms of volume numbers and a lot of companies have set up capacities in the last couple of years which could start to now deliver.
So these are some of the sectors where we would be positive in our portfolios, or overweight at this point in time.
Apart from that even the industrials and the capital goods sector, especially in the power side is where we've seen good demand drivers from a slightly medium to long-term perspective and that's also an area that we are constructive on.
We're on the cusp of the earnings. IT will kick-start this piece. People are a bit confused because the numbers from Accenture, etc., don't look that great. The hope is that if the U.S. economy and European economy start to show green shoots, then order flows will start trickling in. Are you looking at it as a glass half full or glass half empty?
Mahesh Patil: I think, IT is a sector where even a slight change in expectations or guidance has a larger impact on the stock prices and it's a fairly well-researched sector in that sense.
But I would still look at this sector as a glass half full because while in the near term, there are some challenges, the bulk of the downgrade is behind us in this sector.
I think, going forward from here, it is just a matter of time, probably one or two quarters by when you will see at least growth numbers starting to look better than that of last year. We still believe, that structurally, the spend on IT and the spend over digital will only increase. The whole discretionary spend, which has been cut in the back of the slowdown, will slowly start to come up.
I think the IT companies, especially the larger ones and which are fairly well-positioned and able to execute well, they should be able to see a recovery, at least in the second half of this fiscal year.
So while the valuations there are not exactly cheap compared to the historical, that is why we might not see a higher return but I would say this is a sector which one would want to buy in the dips, if at all there is a correction because there is a slightly weak macro on the U.S. side.
