Large-caps, financials, IT: Axis MF's Devalkar on where he sees opportunity

We remain constructive on the financial sector, particularly on high-quality private sector banks, said Shreyash Devalkar of Axis MF.

Despite the steep outperformance by small and midcap stocks, Shreyash Devalkar, Head – Equity, Axis Mutual Fund, believes that the most rewarding strategy in the current environment lies in combining high-quality large caps with select names from the broader market. In an email interview with Saloni Goel, he added that "future returns are likely to depend increasingly on earnings delivery rather than valuation expansion alone". Alongside, he also explained the underperformance in Axis MF's largecap fund, his preference for financials and why he remains underweight on IT. Edited excerpts: 

 

Inflation headwinds and central bank rate hikes have become major concerns. Do you expect the markets to trend lower from here?  

Inflation and interest rates are important variables, but they need to be viewed in the context of the broader macro environment. The real question for markets is not just where inflation settles, but whether corporate earnings can continue to grow despite higher input costs and tighter financial conditions. 

 

A sustained rise in crude oil and commodity prices can create pressure on India through inflation, margins, the currency and fiscal balances. However, markets have already adjusted to some of these concerns. Valuations, particularly in large caps, have become relatively more reasonable after a period of underperformance, improving the risk-reward balance for long-term investors.

 

In a constructive environment where inflation moderates, crude remains manageable, policy tightening is gradual and domestic demand stays resilient, earnings growth can continue and support markets. On the other hand, a combination of persistently high oil prices, aggressive rate hikes, currency pressure and earnings downgrades could lead to further volatility and market corrections. Our focus is, therefore, not on making binary market calls but on owning businesses with strong balance sheets, pricing power, resilient cash flows and attractive valuations that can navigate a range of macro-outcomes while continuing to compound earnings over time. 

 

Axis large-cap fund has underperformed other equity large-cap schemes on a 1-, 3-, and 5-year basis. What's behind this, and what could flip it?  

Our investment philosophy has historically focused on quality businesses with strong governance standards, sustainable growth prospects and earnings visibility. We have also focused on investing in large cap companies, hence fund had minimal mid/small cap exposure. While this approach remains central to how we invest, markets over the last few years have rewarded a broader set of factors, including cyclical opportunities, where our participation was relatively lower. In a large-cap universe, even a few stock-specific and sector allocation differences can have a significant impact on relative returns. 

 

Over the period, the portfolio has evolved in line with changing market dynamics while remaining anchored to our long-term investment framework. We have retained our emphasis on quality but become more valuation-conscious, rebalancing the portfolio towards areas where the risk-reward is more attractive. This has included increasing exposure to sectors such as financials, healthcare, capital goods, automobiles and select domestic demand themes, while reducing allocations to segments getting disrupted. We are also working towards greater portfolio differentiation through sharper stock selection and conviction-based positioning. Ultimately, a combination of better stock picking, disciplined portfolio construction and with earnings delivery, will drive performance.

 

Financials have historically been an important part of large-cap funds. What are some of your high-conviction bets from the sector?  

We remain constructive on the financial sector, particularly on high-quality private sector banks that have demonstrated the ability to navigate multiple credit cycles while consistently gaining market share. The banking sector is emerging from a phase of balance sheet repair with stronger capital positions, healthier asset quality and improving operating efficiency. As economic activity strengthens and credit demand broadens, well-managed banks with strong liability franchises and disciplined underwriting standards are well placed to compound earnings over the medium term.

 

Beyond banks, we also see opportunities in select non-bank financial companies that have developed niche lending capabilities and strong distribution networks. We currently have a favourable view on select financial sector opportunities because they are direct beneficiaries of India's structural growth, increasing financialisation of savings and expanding credit penetration. 

 

Do you expect the mid & small-cap outperformance to sustain over large-caps? 

Mid and small caps have enjoyed a prolonged period of outperformance, driven by strong earnings growth, expanding market opportunities and significant valuation re-rating. Many of the themes that led the post-pandemic rally, such as manufacturing, capital goods, defence, healthcare and domestic consumption, were more heavily represented in the SMID universe, allowing these companies to benefit disproportionately from India's growth cycle. However, as markets mature and valuations become richer, future returns are likely to depend increasingly on earnings delivery rather than valuation expansion alone. 

 

That is why we believe the debate should not be framed as large caps versus mid and small caps. The opportunity set today is broader. Large caps are entering this phase with relatively more reasonable valuations, stronger balance sheets, better earnings visibility and greater resilience to global uncertainties. At the same time, domestic macro indicators such as nominal GDP growth, credit growth and consumption trends remain supportive, which could widen the earnings opportunity for large-cap companies as well. 

 

Historically, phases of strong outperformance by any one market-cap segment have eventually moderated. Therefore, rather than making an aggressive market-cap call, we believe a balanced approach that combines high-quality large caps with selective small-cap & mid-cap opportunities is likely to be the most rewarding strategy in the current environment. 

 

Can IT emerge as a contrarian bet?  

The business is getting challenged due to deflationary trends accelerated by AI. We remain underweight on sector. Valuations may drive opportunities from a risk-reward perspective. After a prolonged period of relative underperformance, valuations across several technology companies have become more reasonable, even as the long-term drivers of digital transformation, cloud adoption and AI-led technology spending may drive growth. A relatively weaker rupee can also provide a tailwind to export-oriented sectors such as IT supporting earnings, although currency movements alone are not a sufficient investment case. 

 

That said, we would be selective rather than broadly bullish on the sector. Near-term demand visibility remains linked to global growth, enterprise technology budgets and the pace at which AI investments translate into large-scale spending. We prefer companies with strong client relationships, differentiated capabilities, healthy cash flows and the ability to benefit from evolving technology trends. If global demand stabilises and technology spending improves, IT could emerge as a meaningful contrarian opportunity, but we believe stock selection will matter far more than a broad sector call. 

 

How much average cash are you sitting on across portfolios?  

We generally stay substantially invested and do not use cash as a major tool for making short-term market calls. Cash at the individual scheme level is usually held for liquidity management, flows and the gradual deployment of capital into identified opportunities.  

 

Has generating alpha become even tougher in the current market? Where do you see opportunities?  

Observation from trends across markets both in developed markets and ours, generating alpha has become more challenging as markets have become more efficient. Today, performance is increasingly determined by earnings delivery, competitive positioning and business quality rather than liquidity alone. As a result, stock selection and valuation discipline have become far more important. 

 

That said, we continue to see meaningful opportunities. Our focus remains on identifying companies where earnings potential is not fully reflected in valuations, particularly in areas such as financials, manufacturing, capital goods, healthcare, automobiles and select consumption themes. In this environment, alpha is likely to come less from market timing and more from disciplined research, conviction-led portfolio construction with high active share and effective capital allocation.   ALSO READ: Transrail Lighting shares zoom 12%  |   NSE IPO allotment expected today 

 Disclaimer: Views and outlook shared belong to the respective brokerages/analysts and are not endorsed by Business Standard. Readers' discretion is advised.