Time to dive aggressively into mid and small caps?

Vinit Sambre

Head of Equities

DSP Investment Managers

  • DSP IM has strengthened and sharpened its equity research team and processes in an effort to enhance fund performance
  • The wait for an elusive broad-based earnings growth momentum continues, and can take shape only when private sector capex revives
  • Vinit believes that while valuations in mid and small caps have become more reasonable, it may not yet be prudent to become aggressive in this space. Any pre-election volatility may however offer opportunities to do so.
  • Three themes Vinit believes will be long term wealth creators include building materials, healthcare and private sector banks

Click here to view DSP IM’s note: Reflections & Resolutions

WF: What steps have you initiated to overcome some of the performance challenges that your equity funds saw in 2018?

Vinit: We started by introspecting on the reasons for our performance challenges. There were some beyond our control – in particular, the hugely polarized nature of 2018 market performance where only a handful of stocks drove the headline number – a factor that impacted almost all funds in the industry. Then there were factors where we saw scope for strengthening ourselves.

We have strengthened our equity research team – 3 experienced analysts have joined us and one more will be joining the team shortly. That will enable us to give adequate internal coverage to our stocks universe. We have also strengthened the research process by getting clear definitions in place for “Strong Buy”, “Buy”, “Hold” etc – which gives clearer actionable input to fund managers.

The third aspect is around strengthening our communication of our philosophy and processes to distributors and investors. The fact is that no fund manager can be top quartile every quarter or every year. All funds experience phases. The need therefore is to articulate our strategy very clearly and amply, to enable investors to understand what we are doing and why. Our experience suggests that with enhanced communication, we get better alignment between fund manager, distributor and investor – which then allows the fund manager to deliver long term wealth creation in a manner that he has highest conviction in. This is an area we have been working on actively, and will continue to do so.

WF: In what ways do you expect an ESG (Environment, Social, Governance) framework to strengthen your research process? Is this more about picking winners or avoiding pitfalls?

Vinit: Out of ESG, the G aspect – Governance – is something that we have always been focused on. Quality of management has always been of paramount importance – evidence of which is being seen in recent times where we are seeing so many large and mid sized business houses experiencing the pitfalls of poor governance.

On the environment and social aspects, we would like this to be a signal from the fund industry to corporates that institutional investors will increasingly focus not just on the bottom line of the business but also on important issues like sustainability – which is where the E and S aspects play a big role. We are getting more conscious about ESG and would like the industry as a whole to also look at this aspect seriously.

WF: Your reflections note talks about multi year mega themes and also acknowledges that these did not really play out in 2018. In a fund industry where Y-o-Y performance is critical to attract flows, how do you try to juggle between structural themes and nearer term investment opportunities?

Vinit: We have 5 equity fund managers and each has his own distinctive style. The structural themes that we laid out are indeed multi-year themes and will continue to be relevant for many years to come. What typically happens is that fund managers tend to draw on these structural themes for their core portfolios. But the tactical portion of each portfolio is driven by respective fund managers based on their nearer term perceptions and convictions.

WF: Your reflections note points out to the continuing disappointment on corporate earnings growth. While we do understand growth will come back in time, do you see evidence on ground that encourages you about a sustainable earnings rebound?

Vinit: This frankly has been a source of continuing disappointment. From 2008, we have been witnessing a prolonged phase of sluggish earnings growth at an overall level. Some pockets have done well, and markets have tended to cluster around them, in the absence of a wider opportunity set, leading to elevated valuations where earnings growth momentum is visible. This has however not yet become a widespread earnings rebound. There seemed to be some green shoots visible in the last 2 quarters, but the recent quarter’s numbers are not particularly encouraging.

We need to see a broad based revival in private capex cycle to gain confidence of a broader and more sustainable earnings rebound. Perhaps once the dust settles after the upcoming General Elections, we might see that panning out.

WF: Is it time to go tactically overweight on mid and small caps post the correction of 2018, or are valuations in this space still a little stretched to warrant such an aggressive posture?

Vinit: Valuations have come off, and have become more reasonable. However, I don’t think one should get aggressive in mid and small caps yet. My sense is that in the run up to the elections, you can have some volatility – and mid and small caps are vulnerable to such volatility. It might be a good idea to stagger your investments in this space over the next 3-4 months and think of more aggressive exposure if heightened volatility gives you opportunities.

WF: If you were to pick 2-3 sectors that you believe will create significant wealth over the next 5 years, which would they be and why?

Vinit: When we talk about a 5 year time frame, first thing to keep in mind is that these sectors may not show any signs of momentum in the near term. If one were to accept that, one sector that we like from a long term perspective is building materials. Growth is slow right now because the real estate sector is going through some challenges. But if you consider the structural demand story, there are significant long term opportunities across the building materials space.

Another space we like is healthcare. The industry has seen its fair share of challenges – regulatory as well as pricing issues in the US. Our sense is that we are in the trough as far as these issues are concerned. The sector has the potential to exhibit linear growth, irrespective of market or economy, in the years ahead.

The third space which is a continuing structural play is private sector banks and well managed NBFCs. We see a structural shift in market share away from PSU banks to private sector banks and well managed NBFCs. That, coupled with the ongoing financialization of savings, will enable better companies in this space which may continue creating wealth over the long term. We are also positive on the consumer discretionary segment in the long term.

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