WF: There seems to be a lot of nervousness in the market, and the persisting weakness in the broader market is now beginning to show up in the index heavyweights as well. How do you read the market now and how do you see it shaping up over the next 12-18 months?

Lalit: Until about late 2018, we had been maintaining that market valuations were on the higher side. Relative attractiveness of the equity asset class drew domestic savings flow into the market largely through the mutual fund route. As this flow continued to sustain and fed somewhat on its own momentum, it propped up sentiment and valuations up until mid-2018. Some derating happened towards the end of the previous year and this is reflected in large parts of the market but may not be fully reflected in the index due to skewed representation. Hence while some parts of markets are currently attractive, at a headline level one can only say that the markets are no longer expensive. With earnings being elusive, the road ahead continues to be bumpy but there are bottom-up names, which show healthy promise from a 5-7 year perspective.

WF: While mid and small caps have corrected substantially in the last 12 months and therefore appear attractive to some, others believe they have only come down from premium to par vs large caps and not yet at a discount – meaning not yet time to go overweight in that space. What is your take on this debate?

Lalit: There cannot be a one size fits all answer here because the mid and small cap space covers a very heterogeneous cross-section of businesses. That said after last year’s sharp underperformance, midcaps are now at a slight discount to large caps. History suggests that serious money has been made when small and mid-cap stocks start quoting at a discount to large caps. That said, timing the market for sectors or segments is fraught with uncertainty and even the most successful of investors have not been able to do it consistently. Midcaps create wealth over long periods but they are also volatile in the short term, hence one needs to balance the desire for long-term return with the shorter-term risks when allocating to the segment.

WF: Which sectors do you see creating significant wealth over the next 3 years and why?

Lalit: Data shows that for most part Indian markets have worked bottom up rather than top down. Even if you look at the current outperformers within the index, there is no strong sector-linkage. There are however themes which seem to attract investor attention and till recently it was consumption growth. With earnings growth eluding some of the popular names even in this theme, it may be time for the markets to look elsewhere. Two areas which look interesting are the rural intervention story and the investment cycle. The first is clearly triggered by the transfer of economic power from the rural poor to the urban rich in recent times. A process driven largely by a secular improvement in farm yields, higher output and hence lower agri-prices, fragmenting farm land and lack of alternative rural employment avenues. Governments irrespective of party colour will probably try to restore parity by taxing the urban rich and doling the same out to the rural poor. Companies catering to this trend should do well in terms of business volumes and profit growth. The second theme is that India has not experienced a capex cycle since 2008. While consumption has been rising there has not been any significant addition to manufacturing capacity. If one looks at the breakdown of PAT to GDP by sector, it is apparent that some of the companies that benefitted greatly in the investment upcycle period 2003-2008 have done badly from 2008 onwards. Some of these sectors such as infrastructure, utilities and capital goods are linked closely to the investment cycle. They have large fixed costs and should benefit significantly when investment demand comes back as their high operating leverage begins to play out fuelling accelerated profit growth.

WF: In your Long Term Equity Fund (ELSS), do you adopt a flexicap approach? What is your strategy on cap sizes and how have weights across cap sizes moved in the last 12 months?

Lalit: This fund was initially positioned as an ELSS-product for the first-time investor into equities who was participating for the tax benefit and given this stance it maintained a lower risk profile by having a larger share of large caps, between 70-75% as opposed to the much lower exposure held by the peergroup. In the future we expect to be in in line with the category narrative at 40-60% in largecaps and 60-40% in mid & small caps, which provides flexibility within a range depending on how valuations are placed in these two broad buckets. In the last twelve months, we have used the midcap correction to lower exposure to the largecap segment from 64% to about 58%.

WF: What are some of the key sector/stock calls you have taken over the last 12 months, amidst all the volatility that we have seen in equity markets?

Lalit: We are broadly in the range of the sector weights in the benchmark and focus on bottom up stock picking for the fund. Over the last 12 months we have increased weights in financial services, consumer goods and automobiles, while reducing weight slightly in energy and services.

WF: Your Long Term Equity Fund is currently positioned in the 3rd quartile of performance over 1 and 3 years. What steps are you taking to enhance fund performance?

Lalit: As at end- January 2019, the fund has posted a second quartile performance on a one-year basis. Previously, in the era of sharp valuation expansion in midcap stocks (from late-2013 to mid-2018), the fund though having a lower risk portfolio, lagged peers in performance due to its significant large-cap orientation.

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