Mid-, small-caps aren't overvalued; see opportunities there: S Naren

After a sharp rally over the past few weeks, the markets seem to be consolidating ahead of the March quarter earnings season. S Naren, executive director and chief investment officer, ICICI Prudential Asset Management, tells Puneet Wadhwa that even though the markets are fully valued, they may not correct. However, there could be volatility in the short term, given the general election. Edited excerpts:

What’s your market outlook ?
 

The markets are no longer cheap, but there are interesting/selective investment opportunities in mid- and small-caps. However, the difference between 18 months ago and now is that the US Federal Reserve (US Fed) is no longer talking about increasing rates. This is a positive development for emerging markets (EMs), including India, as it means that flows from global markets to India can increase, unlike the environment in 2018. Even though the markets are fully valued, they may not correct. There could be volatility in the short-term given the general election.

What are the key risks you foresee?
 

Risks include a spike in oil price (currently approaching $70 a barrel), poor monsoon and how the markets interpret the election outcome. The other concern is lack of investor appetite in fixed income instruments/investing in corporate debt. At a time when corporate bond yields are attractive, we would like to see much more inflows into this segment.

How many rate cuts do you expect from the Reserve Bank of India (RBI) over the next few quarters?
 

The RBI has highlighted the near-term upside risks to food inflation, uncertainty in crude oil prices, and concerns over slowing domestic and global growth. Given this, we believe the next rate cut would be data-dependent as the RBI may want to see these risks play out, including the probability of El Niño effects in 2019 and the Budget to be presented by the next elected government. Hence, a series of rate cut looks challenging as the best of food deflation is behind us.

 What’s your reading of mutual fund flows? 
 

In our opinion, when foreign institutional investors (FIIs) were selling in October 2018, inflows into mutual funds were robust. We see the current slowdown in flows as a healthy development. It is important for Indian mutual funds to get inflows when the markets witness big FII selling, like in October 2018. So, the slight slowdown in flows is not a material factor, in our opinion. In fact, we believe CY19 is the year of SIPs.

What has been your investing strategy thus far in CY19?
 

We have been positive on several sectors that earlier had not done well, such as public sector units (PSUs), metals and corporate financials. We are of the view that the non-performing loan (NPL) cycle has almost come to an end, which is a notable positive for corporate financials. Barring a few quality stocks and mega-caps, we believe the market is not overvalued. PSUs, metals and telecom are the contra bets in our portfolio. Thus far, we have not faced any redemption pressure in any of our equity schemes.  

Will the mid- and the small-cap segments  outperform large-cap peers?
 

Though the markets look fully valued at the current levels, mid- and small-caps are not overvalued unlike the beginning of last year. We believe there are interesting stock specific opportunities available in this space. CY19 is about being stock specific in one’s approach rather than having a market-cap orientation. 

What are your expectations from the upcoming earnings season? 
 

We are positive on the earnings season, particularly on the financial space, a pocket which we believe is likely to deliver an encouraging set of numbers given the low base, NPL cycle being provided for and pick-up in the credit cycle. We expect some of the consumption-oriented sectors to see a slowdown, but given the size of the profit from the financials, the overall earnings are likely to be healthy. We think the capex cycle is likely to recover and see traction over the next three years. Nonetheless, there are specific investment-worthy options in the capex theme across sectors. 

Should one increase allocation to defensives such as the fast moving consumer goods, the pharma and the information technology (IT) sectors?
 

The pharma sector is very attractive from a long-term investment perspective. However, the IT sector remains a defensive play, for which, the future outlook will be determined by how the currency (rupee) moves. We continue to remain negative on the consumer goods space, in the near term.

What’s your view on the auto sector?
 

Our belief is that the consumption sector, which includes auto, is where the earnings will be subject to a downward revision. That said, the best time to invest in any sector is when there is a slowdown. We at ICICI Prudential believe the best long term structural idea facing near term headwinds is the consumption theme. Based on this thought, we have launched ICICI Prudential Bharat Consumption Fund, an open ended equity scheme following consumption theme.