Large caps are shock absorbers to tide volatility: Aditya Khemani, Motilal Oswal AMC

With market trading near its all-time high, many investors are confused about whether to invest in large caps or mid & small caps. To find answers to these questions and help investors in making the most of this crest, Money9 spoke to Aditya Khemani, Fund Manager, Motilal Oswal Asset Management Company. Edited excerpts:

With markets quoting at all-time highs is it a good time to book profits or one must stay invested in equities if so why?

Firstly, I would say that investing is a marathon, not a sprint so be patient and use equity as a tool to reach your financial goals. Markets hitting new highs is part of that journey. Equity markets are ultimately a reflection of the economy and in case the economy does well the markets will do well. Last 4-5 years there has been a lot of speed breakers in the economy starting with demonetization, IL&FS credit crisis, short term impact of GST implementation and finally Covid and it is now reasonable to expect the worst is over and the growth in the coming years to some extent should make up for the lost ground. Hence it looks like we are at the start of a strong earnings period for corporate India. The corporate Profit to GDP ratio which typically is in the range of 5% is currently slightly around 2-2.5% indicating that we are at the cyclical bottom as far as earnings are concerned. Hence as one sees strong corporate earnings growth going forward the markets should also do well. Though market returns should be less than earnings growth as some part of higher earnings growth the market has already factored into its valuation. So an existing investor should just stay invested without getting bothered about day to day volatility.

Off late we have seen a trend where large-caps have outperformed mid & small caps. In fact, in August Nifty outperforms the Midcap/Small-cap index for the first time in CY21. Do you foresee this trend continuing?

No one knows the intensity and the timeframe of the current bull market. One of the traits of an evolving bull market is most parts of the economy participate in it. Hence one sees sector leadership changing as there is price exhaustion in that sector. Also one see at points in time large caps do better but again as there is price exhaustion the mid-caps then take on the mantle of taking the markets higher. So after a very strong rally in the mid/small cap, one saw the Nifty do well in the month of August. It is very difficult to anticipate these shorter-term trend change. But as the economic recovery is getting much more broad-based, one should see both the large caps and midcaps participate. Hence I would not say that there is a trend reversal. For an investor what is important is to draw up a balanced allocation between both the large caps and mid/small caps. I would say in case we have to reach our financial goals on time, the large caps will act as shock absorbers to tide over the volatility in that journey and the midcaps give us speed to reach our financial goals on time.

So which sectors are you betting on across large, mid & small caps? What could be the spoiler of the ongoing party in Dalal Street?

India is a very bottom up market and there is money to be made across sectors. But if I have to choose which sector looks more promising, the first would be financials especially the frontline banks and NBFC’s. Banking is the biggest play in macro recovery. Plus we have seen during Covid, the asset quality of frontline banks turned out to be much better than expectations. Secondly, I would also be very bullish on the domestic healthcare market across the value chain including the domestic-focused pharma cos, hospitals and diagnostic chains. The reason being Covid has made us realize the importance of good health and hence spends on healthcare would increase going ahead.

Markets ultimately will do well in case the profit growth is good for corporate India. So in the last 12 months upmove, some part of that higher earnings growth going ahead is already factored into stock prices. So the key challenge would be to live upto expectations and eventually how the earnings cycle pans out will be key. So I would say keep monitoring the high-frequency data points to gauge the health of the economy and corporate India.

The Nifty is trading at premium valuations when it comes to value it on a price to earnings ratio but when it comes to valuing price to book ratio the valuations seem reasonable as it is quoting at around 3.6 times to price to book ratio driven by cheaper valuations of capital intensive sectors. So what do you make sense out of these it and would it be wise to look at valuations by ‘asset approach’?

Looking at the valuations of the market with a 12-month horizon might not do justice at this juncture because the earnings growth projection for a lot of companies might be depressed due to Covid. So one has to remember the big picture that last 4-5 years there were a lot of disruptions with Covid being the mother of all disruptions. And hence the Corporate Profit/GDP ratio is typically around 4-5-5% on average is currently at 2-2.5%. Hence the earnings base is depressed which is optically showing high PE ratios. So on a macro basis where India looks good relatively on most parameters, one could see a string multiyear earnings growth cycle pan out going ahead similar to the 2004-2008 cycle. Hence one should not see just the PE Ratios but take a much broader view on the direction of the economy and markets.

Q1FY22 earnings were in line with street estimates how do you see Q2FY22 earnings panning out and which sectors will be leading from the front in Q2?

It looks like Metals, IT, Pharma results could be good. Plus banking sector asset quality could be better than expectations as the economy has bounced back strongly the last couple of months. Consumer Discretionary numbers could be a bit weak as again Covid has been an impact at the start of the quarter. But I think investors will again look ahead and forgive weak numbers in sectors that have been impacted by Covid.

Going by what was experienced in August where many IPOs were aggressively priced and listed at a discount. Do you see the same trend to continue or companies coming with IPOs will price them reasonably?

On an overall basis, whenever the secondary markets is hot one would see primary issues come at an expensive valuation. And the retail frenzy has added to the strong listing gains seen in a few issues. But one won’t be able to generalize which companies will price their issue aggressively and which ones will leave money on the table. But yes a few bad listings has made the valuations a bit saner for upcoming issues. But we have to remember IPO’s where there is very strong institutional interest due to a unique business model will still come expensive especially in the digital space.