Largecaps look ripe on valuations, but flows hold back: Krishna Sanghavi

Mahindra Manulife MF's Krishna Sangahvi says largecap valuations look attractive, but cautious domestic investors and uncertain foreign flows remain key challenges.

Largecap valuations have turned attractive after the market correction. Still, a revival in foreign investor flows remains

 uncertain amid currency risks and continued capital flight from emerging markets (EMs), says Krishna Sanghavi, chief investment officer — equity, Mahindra Manulife Mutual Fund (MF). In an interaction with Abhishek Kumar in Mumbai, he discusses his sectoral preferences, mid and smallcap valuations, and shortening market cycles. Edited excerpts: 

Oil prices have remained elevated for several months now. To what extent do you think Indian equities already price in these risks? 

We believe this needs to be viewed from the perspective of two different sets of investors — domestic and global. From the perspective of domestic investors, a significant part of the risk is probably already priced in. Oil prices have remained elevated for more than six months, so the macroeconomic impact of higher energy prices has already been factored into market expectations to some extent. 

The situation is somewhat different for global investors. For them, it is not just about the impact of higher oil prices on the Indian economy but also about currency movements and returns in dollar terms. Arguably, the bigger impact of the current situation has been felt through the currency. 

There is also a broader EM angle. India is not the only market seeing foreign investor outflows. A sizeable amount of global capital has moved towards US markets over the past several quarters, while the EM basket has come under pressure. 

Largecaps have corrected the most since the flare-up in West Asia. Has the segment turned attractive? 

From a valuation perspective, largecaps look attractive as a basket. However, flows remain a challenge. If global investors remain cautious about EMs, foreign portfolio investor selling will continue to weigh on India. This creates a meaningful near-term headwind for largecaps, even when valuations look reasonable. 

Interestingly, domestic investors are also becoming somewhat more cautious about largecaps, while continuing to allocate relatively more capital to mid and smallcaps.

 Are continued strong domestic flows into mid and smallcap stocks raising valuation concerns? 

It is difficult to take a blanket view on mid and smallcaps because there is considerable dispersion within these segments. Midcaps are somewhat different. The universe is much more restricted, and the limited number of eligible companies can itself create a valuation premium when flows are strong. 

In smallcaps, one important development is the widening of the investable universe. Once you move beyond the top 250 stocks, the number of potential opportunities expands. However, rich valuations mean investors need to look much further ahead. Many smallcap companies are now talking about their growth plans for 2030-31 and beyond. Investing in this segment, therefore, increasingly requires a longer investment horizon rather than a focus solely on the next 18-24 months. 

From a sectoral perspective, where do you see the strongest opportunities in India? 

India remains a growth economy, with nominal growth potentially in the 10-11 per cent range, offering opportunities across several sectors. The challenge is increasingly about valuations and timing rather than simply identifying sectors with growth potential. 

One structural theme that stands out is manufacturing. The post-pandemic global environment has encouraged companies and countries to diversify their supply chains. India could potentially benefit from this shift. 

The government’s efforts to expand its network of free trade agreements and promote import substitution also support the domestic manufacturing ecosystem.The caveat is that market cycles have become much shorter. A sector can move sharply once the market starts recognising the theme, but the resulting valuation cycle can also run its course quickly. 

How do you manage portfolios in such an environment? 

The core approach remains to focus on companies whose underlying business models and earnings trajectories are intact and whose governance is not a concern. A portfolio need not exit a company completely simply because its stock has become expensive. Instead, valuations can be managed through position sizing. 

The other important factor is sector rotation. Even if a company’s fundamentals remain strong, global sector allocations may change, creating opportunities elsewhere. Portfolio management, therefore, increasingly requires tracking both company-level earnings dynamics and the broader market’s changing preferences. 

This is particularly important because sector cycles are now much shorter. A sector may deliver its returns over a relatively compressed period and then enter a phase of time correction rather than necessarily undergoing a sharp price correction.