Midcaps, smallcaps too hot; investors should have a large-cap tilt right now, says Varun Fatehpuria of Daulat Finvest | Mint
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Business News/ Markets / Stock Markets/  Midcaps, smallcaps too hot; investors should have a large-cap tilt right now, says Varun Fatehpuria of Daulat Finvest
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Midcaps, smallcaps too hot; investors should have a large-cap tilt right now, says Varun Fatehpuria of Daulat Finvest

Valuations of mid and small-cap segments are at a premium and it is tough to see these premiums being maintained in Samvat 2080, according to Varun Fatehpuria, Founder & CEO of Daulat Finvest Private Limited.

Varun Fatehpuria, Founder & CEO of Daulat Finvest Private Limited (Daulat Finvest Private Limited)Premium
Varun Fatehpuria, Founder & CEO of Daulat Finvest Private Limited (Daulat Finvest Private Limited)

Varun Fatehpuria, Founder & CEO of Daulat Finvest Private Limited says mid and small-cap segments have had a dream run this year but their valuations are at premium. He believes it is tough to see these premiums being maintained in Samvat 2080. In an interview with Mint, Fatehpuria shared his views on markets and sectors he is positive about. Edited excerpts:

Please share your short and medium-term outlook for the market. What factors can keep the Street busy next year?

The immediate short-term hang on the market right now is the course of the Israel-Hamas war. 

The geopolitical instability in West Asia will have a bearing on the crude prices which will impact India’s energy purchases. 

As the situation evolves, this is a risk that investors need to be mindful of. 

Investors should also be cognizant of global recessionary fears caused by monetary tightening undertaken by central banks all across the world. 

Companies and sectors like IT and ITeS with significant foreign earnings are already seeing some softness in demand from their Western clients. 

On the domestic macro front, India remains a structural story with a strong domestic demand base. 

We remain one of the few countries to have demonstrated resilient growth. 

Markets are also expecting political stability and have already priced in a favourable general election outcome in 2024. 

All of this is reflected in the broader market valuation – India continues to remain one of the most expensive markets globally. 

Any re-rating in the short-to-medium term can also have an impact on investor’s returns on the downside.

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How should retail investors invest in the current market environment? Should they trim their exposure to equities?

A lot of retail investors in the market today are sitting on mid-to-high teen returns earned over the past four to five years. 

This can therefore allow a recency bias to creep in leading investors to extrapolate from a very favourable investing environment. 

We have been a big proponent of asset-allocation-driven investing. This can be a difficult thing to follow in a strong bull/bear market, but this is exactly when it is needed the most. 

If your equity allocation has drifted too far away from its original intended allocation, it is a good time to take some money off the table and deploy it into other asset classes like debt. 

Given the current interest rate environment where we are close to peak, it is an opportune time to invest in fixed-income securities like bonds/NCDs and lock in the high available yields.

Mid and small-caps outperformed the benchmarks Nifty 50 and Sensex significantly in Samvat 2079. Can they sustain this momentum in Samvat 2080?

I think it’s fair to say that the mid/small-cap segment has had somewhat of a dream run this year. 

Part of it is driven by the euphoria of retail investors who have collectively poured over 50,000 crore into these funds in the calendar year 2023. 

Research has shown that when the three-year returns of mid/small-cap are over 30 per cent, then the forward returns tend to be significantly lower. 

Thus investors need to be mindful when investing in mid/small-cap companies. At the same time, there will always be individual stocks to select from, as a whole the segment has run way ahead of itself. 

From a valuation perspective, Nifty Smallcap 250 is currently trading at 19 times one-year forward PE (price-to-earnings ratio) representing a 21 per cent premium to its longer-term average of 15.7 times. 

Nifty Midcap 150, on the other hand, is at a 6 per cent premium trading at 24.8 times one-year forward PE compared to its longer-term average of 23.5 times. 

Therefore, objectively, it is tough to see these premiums being maintained in Samvat 2080. The segment will eventually need either a price or a time correction to make it attractive again.

Also Read: Not the whole mid, smallcap segment is expensive; positive about realty sector, says Mihir Vora of TRUST Mutual Fund

Should one prioritise large caps over mid and small caps? Do you think large caps have some valuation comfort?

We are strongly advocating for investors to have a large-cap bias in their portfolios. 

Since October 2021 when Nifty 50 scaled its all-time highs, the index has grown at 4-5 per cent per annum while the index constituents have grown their EPS (earnings per share) by 12.6 per cent. 

This is also reflected in the valuations where the Nifty 50 is currently trading at a 4 per cent discount at 17.7 times one-year forward PE compared to its historical average of 18.4 times. 

As we all know, entry valuations/prices are essential for longer-term returns. 

And the current large-cap valuation levels can provide a good opportunity for investors to generate attractive risk-adjusted returns in the future.

Also Read: Can Nifty 50 top 21,000 with a pre-election rally ahead of General Election 2024?

PSU and defence stocks have been hogging the limelight in the recent past. Why are they witnessing sharp gains? Is there more steam left in these segments?

PSU/defence stocks have suddenly become an investor darling this year. However, it is important to look at it from a broader perspective. 

If we look at PSU specifically, the index is only crossing the highs it last made in 2008. 

While across the board, PSU companies have become a lot more attractive from a business performance and governance point of view, the bias of a government-run company continues to remain an overhang on them and that is reflected in the valuation discount these firms continue to trade at. 

Defence stocks also seem to have run past their course and it is difficult to justify the valuations a lot of them are currently at. 

Mostly, they have appreciated on account of mere order book numbers and the narrative of ‘Make In India’. 

We usually advise investors to avoid partaking in ‘hot’ or ‘trending’ sectors/funds solely on the basis that by the time an investor invests a lot of the trend has already played out and is priced into the stocks. 

We have seen such cycles play out with other sectors like tech/infra/IT in the past two decades.

Which sectors can give healthy returns in the next one to two years? What are the pockets of opportunities right now?

The Indian BFSI sector is in its best shape than it has ever been. NPA ratios are at a decadal low of 0.6 per cent. 

Deposit-taking institutions like banks are experiencing robust deposit and credit growth, especially on the retail side. 

They have also been able to significantly boost their capital adequacy ratios after Covid-19. 

Due to the interest rate environment, banks with a strong CASA base have the opportunity to improve their NIMs which saw some compression previously. 

Another sector that we are bullish on from a valuation perspective is IT/ITeS. 

Especially, large-cap IT companies today are available at much more attractive prices than two years ago. 

There will be some discomfort in the Street until we have a clearer picture of the US/European economies, but we believe that companies with strong balance sheets and robust cash flows will be able to tide over this situation.

Also Read: General Elections 2024 next big trigger for markets; can't say interest rates have peaked, says Dikshit Mittal of LIC MF

What could be an ideal portfolio in the current market situation? Please explain to us the importance of asset allocation in the current market environment.

Asset allocation informs over 90 per cent of an individual investor’s overall portfolio returns. No two lowly correlated asset classes perform similarly in a given market environment. 

In the current market, the focus should be on constructing multi-asset portfolios across domestic/international equities, fixed income and gold. 

An aggressive investor with an over five-year investment horizon can have a 60-70 per cent allocation to domestic/international equities, about 20 per cent allocation to fixed income given its relative attractiveness due to high yields right now and 3-5 per cent to gold which provides an effective hedge against volatile markets. 

Within domestic equities, investors should have a large-cap tilt right now due to higher entry valuations in mid/small-cap.

Read all market-related news here

Disclaimer: The views and recommendations above are those of individual analysts, experts and broking companies, not of Mint. We advise investors to check with certified experts before making any investment decisions.

 

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Published: 17 Nov 2023, 12:22 PM IST
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