Largecaps merit a relook after prolonged underperformance: Harsha Upadhyaya

Kotak MF's Harsha Upadhyaya favours banking, manufacturing and healthcare, while remaining cautious on IT and advising investors against aggressive mid- and small-cap bets

The pickup in earnings growth in the largecap space has expanded the opportunity set in the equity market, says Harsha Upadhyaya, chief investment officer (CIO) – equity, Kotak Mahindra Mutual Fund. In an in-person interview with Abhishek Kumar in Mumbai, Upadhyaya discusses the improving earnings outlook and his preference for banking stocks but reservations against IT shares. Edited excerpts:

 How are you approaching the market as the West Asia conflict enters its sixth month? 

We don’t take tactical positions on such an event as it is never easy to predict the outcome. The focus is always on finding sectors and companies that can do well on a long-term basis. So, we maintain a diversified portfolio and wherever we feel there is more risk because of external developments, we may not take positions there. Otherwise, the long-term approach continues. The one positive aspect of such event-led volatility is that it provides an opportunity to buy some of the companies we like at better valuations. 

Largecaps have underperformed small and midcaps for some time. Do you see the earnings recovery changing the relative attractiveness of these segments?

 

Largecaps look quite interesting. Their valuations had been on the lower side compared to their own history and now earnings have also picked up. In FY25 and FY26, Nifty’s earnings growth was less than 3 per cent and below 6 per cent, respectively. From that very muted earnings trajectory, we have seen almost 17.6 per cent growth for the Nifty in Q1 FY27. 

For the last two years, there was limited choice, as only a few companies were delivering strong earnings growth, largely concentrated in the mid and smallcap space. That led investors to favour these segments despite their valuations. If the largecap earnings recovery continues, some incremental flows could shift from mid and smallcaps to largecaps. 

How confident are you on the sustainability of earnings recovery? 

This is the first quarter where we have seen largecaps delivering decent numbers, while mid and smallcaps continued to deliver reasonably strong numbers. They have managed to deliver good numbers in a quarter that was expected to be impacted by all the issues surrounding West Asia. 

There is hope that the conflict will eventually end. If that happens, this earnings trajectory should continue. We have also had two years of earnings consolidation, and the cyclical recovery in earnings growth should provide further support. So, while it is too early to say that the recovery is firmly established, the underlying conditions are becoming more supportive. 

Small and midcaps have continued to perform strongly. Do you think the momentum is sustainable, or are valuations becoming a concern again? 

Definitely, valuations are on the higher side. Midcaps are at a premium of low double-digits compared with the 10-year average, while the smallcap index may be more than 20 per cent higher than its long-term average. Investors should avoid aggressive positioning in mid and smallcaps. At this point, investors should have some largecap exposure because the se­gment has underperformed for quite a long time and earnings are now improving. 

Which sectors and themes are you currently positive on? 

We are positive on banking and financial services, manufacturing, pharma and healthcare services. 

What has been holding back private banks? 

Private banks were trading at fairly high valuations when their underperformance began. They were at a significant premium to public sector banks (PSBs) as well as their own history. The cycle turned in favour of PSBs as they earned valuation rerating on the back of strong earnings growth. Private banks, on the other hand, saw a derating. 

We also saw 125 basis points (bps) of interest-rate cuts in the last cycle. Whe­never interest rates go down, there is pressure on net interest margins (NIMs), especially for private banks, as they can­not mobilise deposits as easily as PSBs. At the same time, credit growth was not very strong over the last two years. 

Now, the latest credit growth number is around 19 per cent and it is unlikely that interest rates will fall much further. There may be a long pause or perhaps slightly higher rates, which means there should not be further pressure on NIMs. The constraints private banks had on deposits should also reduce. We believe earnings growth for private banks should pick up. 

What is your view on IT after the recent correction? Has the improvement in valuations made the sector more attractive? 

We will continue to be very selective on IT. There are clouds on the horizon, as we do not know how artificial intelligence (AI) will impact these businesses. Business growth in most IT verticals has been largely muted. If you look at the past few quarters, the results show that there is hardly any growth, and there could potentially be some impact on margins from AI. Valuations have come off meaningfully, but so have earnings numbers for the sector. So, we have been underweight and selective.

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