Narrow market breadth great for alpha seekers
Head of Equities
HSBC Global Asset Management India
WF: What are your key takeaways from the Interim Budget and the RBI policy? Do you see these as key drivers for markets or non-events?
Neelotpal: We think both were very significant. The Interim Budget had a number of populist announcements, while at the same time, managing some level of fiscal discipline, though lower than originally planned. The key issue is farmer distress and how to alleviate it and the second was the tax breaks for the middle class – all measures in both aspects will help boost consumption, which is positive. On the RBI policy front, which a neutral stance was expected, the rate cut was a positive surprise. This should also help drive consumption.
WF: What is your outlook for equities for the coming fiscal year? What do you see as the key drivers and detractors?
Neelotpal: Clearly the upcoming general elections are weighing on markets. But what has been seen from past elections is that election results cause only temporary volatility – markets settle down post the event and then focus on underlying fundamentals.
So our belief is that 2019 is going to be a year of two halves – first half being dominated by election oriented discussions and potentially heightened volatility and second half being driven by fundamentals.
Volatility caused by the NBFC scare in recent months is also perhaps behind us now, with RBI proactively stepping in to ensure sufficient liquidity through OMOs and other NBFC specific policy decisions.
As we move into 2HY19, one factor that can influence markets beyond just fundamentals is the global context – decisions by the US Fed on interest rate hikes and progress or otherwise on trade talks between US and China. These can potentially cause some volatility if they don’t pan out the way global markets would like them to.
But overall, we believe as we move forward in 2019, it will be more of fundamentals and less of extraneous factors that will drive markets.
WF: Some experts worry that the narrow market breadth of 2018 is continuing in 2019 as well, with only a handful of stocks holding up headline index numbers while the broad market continues to languish. Is this a worrying signal for you? How do you manage diversified portfolios when market breadth turns narrow?
Neelotpal: You are absolutely right on the narrow breadth of the market. In 2018, while Nifty delivered a positive performance, the midcap index was down 13% and small cap index down 23%. Even within Nifty, the Nifty equally weighted index performance was 9% below the market cap weighted index – indicating just how narrow this market has been.
What this has however done is to throw up many good investment opportunities in the broader market. This is a good time for alpha seeking bottom up stock pickers to go hunting in the broad market. Ultimately, markets are always mean reverting, as we will see a mean reversion here too – where broad market will outperform and index heavyweights may lag. We saw that in 2017, then we saw index heavyweights take the lead in 2018 – our sense is post elections, we may see market leadership rotating once again in favour of broader markets.
WF: In terms of the SEBI classification of funds, how different is the asset allocation mix of the Large and Mid Cap category from the Large Cap category?
Neelotpal: In large cap funds, at least 80% of portfolio has to be in large cap stocks – which is the top 100 companies by market cap. Likewise for mid cap funds, at least 80% has to be in mid cap stocks – which are stocks ranked 101 to 250 by market cap.
The large and mid cap category, in contrast, mandates at least 35% in large cap and 35% in mid cap, with the balance 30% to be allocated at the discretion of the fund manager across large and mid caps or even small caps to the extent he sees merit. So as you can see, there is a lot more flexibility to the fund manager compared with the mandates of large cap funds and mid cap funds.
WF: What would be the investment rationale for a fund in the large and mid cap space, when we have separate categories for large cap and mid cap?
Neelotpal: Flexibility to participate across market caps is the biggest advantage of this category. I have already talked about opportunities in the broader market today – these can be effectively captured by a fund in the large and mid cap category. Also, for any growing economy like India, there are always opportunities to spot companies with strong growth potential and ride their growth from mid cap status to large cap status. A fund with some flexibility in its mandate can seize such opportunities.
WF: Large caps have posted a flat 1 year return while midcaps have seen a sizeable correction. Is it time therefore for mid caps to outperform large caps in the coming 12-18 months?
Neelotpal: Mean reversion, as I mentioned, is a fact of life – the only question is the timing of such mean reversions. In the last 12 months, falling currency, rising crude oil prices and hardening interest rates acted as margin headwinds for small and mid cap companies. With all three now stabilizing, these headwinds have subsided, allowing for normalization of operating margins. We believe earnings momentum in small and mid caps will be aided by these factors, which can then enable them to bounce back well.
WF: Which sectors/themes do you see creating significant wealth over the next 3 years?
Neelotpal: We are positive on corporate lenders who have strong liability franchises. There are a number of banks and high quality NBFCs who we believe have managed their NPA cycles better and who are poised to grow market share in the coming years.
Consumer discretionary is the second space we are very optimistic about from a 3 year horizon. They have seen margin compression on account of higher energy costs, currency depreciation and higher interest rates. With all these now stabilizing, there is room for margin expansion – and with consumption being boosted by recent policy initiatives, demand should be healthy. Sectors in this space include home improvement, autos, auto ancillaries etc.
As I mentioned, the broad market is now offering many bottom up stock ideas across several sectors – it’s a good time for alpha seekers to go out and invest.
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