Market valuations have become demanding: IIFL Securities MD R Venkataraman

It has mostly been a one-way street for the markets over the past few weeks, with the Sensex and Nifty hitting fresh all-time highs. R VENKATARAMAN, managing director at IIFL Securities, tells Puneet Wadhwa in an interview that small-caps could outperform their large-cap peers due to a risk-on rally. Edited excerpts:

How should one approach the markets, given the all-time highs? Is this the time to be greedy or fearful?

The Nifty has rallied around 70 per cent from its March 2020 lows. While the recovery was fairly broad-based, the market performance could narrow. Select sectors and companies that have a visibly healthy growth momentum could outperform even if valuations are slightly demanding.

The recent rally has been driven by the improving outlook on the economy and earnings, along with strong foreign institutional investor (FII) participation. Corpor­ate earnings have improved sharply in the second quarter of the fiscal year (Q2FY21) and were better than consensus estimates. The aggregate profit of BSE500 companies (that have announced results thus far in the quarter) rose around 13 per cent year-on-year (YoY) and this has led to earnings upgrades in most sectors.

That said, market valuations have become demanding and margin improvement has been a key driver of earnings growth. This may not be sustainable for all sectors. Hence, bottom-up stock selection would be more important for outperformance. Small-caps could outperform large-caps due to a risk-on rally. They could catch up after nearly three years of underperformance.

What are the key risks — domestic and global — to the market rally that investors should be mindful of?

A spike in infections, in our view, is one of the key risks to the improving outlook on earnings and the economy. The US and Europe are seeing a second wave. Back home, Delhi too is witnessing a rise in cases. Lockdown and social-distancing restrictions can derail the nascent recovery underway. While the economic data of the last couple of months has been promising, it remains to be seen if this momentum sustains after the festive season.

Will the flow into equity as an asset class sustain amid all this uncertainty?

FIIs have invested $17.5 billion in Indian equities in FY21 so far (vs cumulative flows of $11.3 billion in the last five years). However, sustaining the improving growth momentum is important for continued foreign portfolio flows. While domestic flows have slowed in the past few months, systematic investment plan (SIP) accounts continue to rise (around 2.5 million new accounts in FY21 so far) and allocation could rise with improving equity returns. If economic recovery sustains, household income could revive; hence, allocation to financial savings may also rise.

How have your retail and institutional broking businesses fared during the pandemic?

The September quarter has been strong for the investment banking business. We completed our transactions, including Rs 15,000-crore qualified institutional placements (QIPs) of ICICI Bank and Rs 14,000-crore QIPs of HDFC. The deal pipeline has picked up significantly, and is likely to remain robust for the next two quarters. We have won a number of debt and private equity ma­n­dates, which are in adv­anced stages of execution.

What has been your investment strategy since the March 2020 lows?

Sectors like pharma, information technology (IT), and chemicals have outperformed the broa­der market in the rally so far. We expect these sectors to continue to outperform. Also, segments like automobiles, especially tyre, are seeing a recovery after a prolonged slowdown.

Do you see the government’s divestment agenda sail through in FY21? How are you approaching stocks of public-sector companies in the backdrop of that?

Achieving the FY21 disinvestment target of Rs 2.1 trillion is going to be challenging and would depend on the success of planned strategic sale like that of Bharat Petroleum Corporation. So far, the government has raised only Rs 58 billion from disinvestment. Public-sector companies have been struggling to compete with private-sector firms. Also, the overhang of large supply via disinvestment has weighed on stock performance. These challenges are unlikely to fade soon. Therefore, we continue to remain underweight on public-sector firms.

By when do you see the overall corporate earnings normalise and move above pre-Covid-19 levels?

Corporate earnings are expected to edge above pre-Covid-19 levels by the end of FY21. We are currently projecting around 1 per cent YoY growth in FY21 Nifty earnings per share (EPS).

Your interpretation of the measures announced by the government under various Atmanirbhar Bharat packages? Is that what the markets and industry expected?

We would have liked a higher spending plan, but the announcements so far have been well targeted and the government could further intervene with more measures. Also, schemes like the production-linked incentive (PLI) could help boost manufacturing in India.