Edited excerpts from a chat with Rupesh Patel, Senior Fund Manager – Equity Investments, Nippon India Mutual Fund:
Three decades and 22% CAGR! That means massive returns from the midcap fund. When you look back, what do you think worked in your favour? What has been your secret sauce?
It has been a long journey, and every member of the existing and past fund management team and research team has contributed to creating this stellar track record. Having said that, the core philosophy of portfolio construction has not changed. I believe, focusing on well-researched bottom-up stock ideas, being aware of valuations and keeping a balance between high conviction bets and diversification are some of the factors that have worked for the fund.
As one of India’s oldest mid-cap funds, how have you recalibrated your investment framework to stay relevant across changing market cycles and investor behavior?
One thing that has remained consistent across time periods is our focus on bottom up stock ideas for constructing the portfolio resulting in participation across multiple growing profit pools. This can be seen as an endorsement of the idea that buying right businesses at right valuations is key for long term success in equity markets.
How do you interpret the current midcap rally? Is it an earnings-driven expansion or liquidity-led overreach?
If we look at the last 3 years’ earnings CAGR, midcap as a category has reported superior earnings growth as compared to broader markets and going ahead as well, the outlook on midcap companies earnings growth continues to remain healthier. Hence, earnings driven expansion is a bigger contributing factor for the performance. Further, many midcap companies are a play on some unique and fast growing profit pools that will keep their valuations high based on near term earnings.
From a valuation standpoint, where do you see the risk-reward balance tilting as we step into Samvat 2082?
Markets have remained flat during the last one year, whereas earnings have grown at single digit. That makes the market relatively better poised in terms of valuations as compared to where they were about a year back. At the same time as compared to other global markets, India has significantly underperformed over the last one year resulting in India’s valuation premium correcting meaningfully. Having said that though, absolute valuations are still not cheap, the outlook on earnings growth seems to be improving. We believe with accommodative fiscal and monetary policies, continued positive view on capex, improving outlook for demand recovery, markets are well poised to deliver on earnings growth.
The fund follows a GARP (Growth at Reasonable Price) philosophy. How are you defining “reasonable” in this market? The valuations have moderated from last year’s peak and now the Street is expecting earnings growth to revive in next 1-2 quarters.
Valuation is a construct that gets influenced by a number of factors that include outlook on growth, interest rates, overall macro stability and earnings growth in the foreseeable future. For benchmark driven investors like us, it is important to be cognizant of factors that can drive valuations for its index constituents. Having said that, being a bottom up investor, all our positions are reflective of relative risk reward within our investment universe. There is no single metric to evaluate relative attractiveness of one over another. However, on a broad basis longevity of earnings, corporate governance, capital efficiency and valuations are some of the metrics we use to pick one over another. Some of them may be businesses that appear expensive in the near term, however, the size of opportunity and their ability to maintain earnings growth at a reasonable rate over the long term make them attractive. In some other instances, it may be that the businesses are facing temporary headwinds or are in a cyclical industry where the valuations at which they are available where they are in the cycle become important deciding factors.
You’ve maintained overweight positions in financials and consumer-facing sectors. What’s the underlying conviction behind these allocations, and are there any early signs of rotation you’re watching?
Our OW stance on financials is on account of our exposure to lenders as well as other beneficiaries of financialization of savings like Insurance companies, asset management companies etc.
On the lending side, most of our exposure is to well capitalized lenders where asset quality is largely expected to hold, Return on Asset/ Return on Equity remains healthy and valuations are reasonable in the context of the overall market.
We believe companies in consumer discretionary categories will benefit from near term drivers like expected bottoming out of demand and longer term drivers like favourable demographics, growth in per capita income and trend on premiumization playing out.
With India’s manufacturing and capex cycle gaining momentum, how are you positioning for potential beneficiaries within mid-caps?
We have exposure to companies that are likely to benefit from India’s focus on manufacturing revival and pick up in capex momentum across multiple sectors. Accordingly, our exposure to companies in sectors like defence, power utilities, equipment manufacturers, EMS and other engineering products makes our portfolio well positioned across multiple profit pools to gain from these trends playing out.
Looking ahead, what’s your market outlook from this Diwali to the next — are we in for sector rotation, a leadership change, or an earnings-led melt-up?
After 13 months of consolidation, the risk reward is much better. Earnings are likely to sharply recover from 2HFY26 onwards driven by recent fiscal and monetary stimulus. Earnings recovery is likely to become broad based which bodes well for the broader market. Consumption is likely to lead to an earnings recovery. Investors with reasonable return expectations may not be disappointed.
If you have to start afresh for Samvat 2082, how would you go about allocating Rs 10 lakh to equities, gold, silver and debt?
Considering the improving outlook for earnings growth, moderated valuations and relative underperformance of Indian equities as compared to most of global markets, Equities will get substantially higher allocation. I will keep some exposure to gold and silver as a hedge against the risk of any large dislocation in global financial markets and currency devaluations. Debt exposure would be largely for liquidity purposes and be minimal.