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As volatility continues in the stock market amid the ongoing Russia-Ukraine crisis, Kotak mutual fund’s top fund manager believes that equity investors, who are in for the long-haul, should not worry as the recent volatility can be beneficial for the long-term as investors will be able to enter the market at a lower valuation.

In an interaction with Livemint, Harsha Upadhyaya, President & Chief Investment Officer - Equity, Kotak Mahindra Asset Management (AMC) further explained why he thinks large-cap exposure or a combination of large, mid, and small-cap is better at this point of time.

Edited excerpts:

Looking at the recent high volatility in equity markets, what kind of equity funds do you suggest for investors with a lower risk appetite?

I would say that large cap exposure is still better, because while the earnings growth scenario is likely to play out for the entire Indian corporate world. So, the volatility in those earnings or volatility in the stock prices could be lower in case of large established businesses. Thus, investors who do not want to take higher amount of risk can look at that.

But, for those investors, who can afford to take higher risk can also look at exposure to mid and small caps or a combination of mid small and large cap equity funds because we do believe that over the next three or say five years, when our economy is expected to come back to reasonable strength in terms of growth, there will be opportunities even in mid and small cap segment, although the volatility could be higher. But eventually, those segments should also give reasonably good returns.

Also read: Zerodha co-founder's advice to investors: Wait, don't buy this dip yet

So, depending on your risk profile, you can choose just the large cap funds or a combination of large, mid and small-cap funds at this point of time.

If the Ukraine conflict prolongs, even if at a lower scale, what could be the impact on Indian equity markets? What risk-reward an investor should be aware of while investing at current levels?

See, monetary policies across the globe was changing before this Russia-Ukraine conflict affected the markets. Now as far as the conflict is concerned, it could also be a short term impact, we really do not know how it plays out. But, I think the central issue for the markets is still our monetary policies changing globally. I think because this is a chain that's happening after many many years and we are just at the beginning of the new interest rate cycle. So as we all know, as interest rates move up, it will have a negative impact on profitability of corporates. But, it may not be so high for Indian corporates, because Indian interest rates even now are at much lower rate compared to previous several years and also the leveraging has been very, very strong.

As far as another impact is concerned that's about compression in equity valuations, whenever interest rates in the economy goes up. That is something that we need to keep in mind. We really do not know how interest rates will play out and how the compression on equity valuations will happen in terms of timing. But it's fair to say that a further rewriting of the markets, especially when it’s given that the earnings growth is broadly in line with expectations and very unlikely to exceed expectations. And also the fact that interest rates are likely to go up means that the re-rating chances are less and the markets could consolidate either sideways or with some downward movement at least in the immediate term.

Also read: Calm before the storm? What Morgan Stanley's Ridham Desai says on stock market correction

So on net net, I think equity investors who are investing for longer term should not really worry. In fact, whatever volatility you see now is actually can be beneficial for long term investors because you will be able to enter at a lower valuations over a period of time. Anyways, equities should not be invested for the short term. So what happens in the short term is very, very difficult to predict.

Do you expect the US Fed to reduce the pace of monetary tightening due to the Ukraine crisis?

It’s too early to say one way or the other. Definitely, they will consider the geopolitical situation now, but at least in the immediate term, the inflation has risen even more. Right from the levels that we were seeing pre conflict, the levels have gone higher. What impact it will have on the growth is yet to be seen. But I'm sure the monetary decision makers will see the impact on growth as well inflation and then calibrate their interest rate decisions. Nevertheless, the interest rate increases are definitely on the cards, which only the extent of interest rate increase is something that will be decided depending on geopolitical events, I guess.

Looking at the recent market volatility, what is your suggestion to the investors?

We always advise investors who come into equity to expect some volatility. I understand that middle of 2020 to 2021 there was a one way market movement, which was essentially, as markets were rebounding from lower levels post-COVID. And those sort of markets are very uncommon when markets give super normal returns without much volatility. In fact, this was one of the longest periods where markets went up consistently without even a meaningful 10 per cent correction, that has clearly changed and also as we discussed, many of the macro parameters are also changing. So in that context, it will be very difficult to put a number in terms of a market valuation will stabilize or market levels will stabilize. It's fair to say that in terms of expectations, investors should have more moderate return expectations as compared to last week years.

Any particular sector or sectors that you believe may outperform others in short to medium term?

See, we don't construct a portfolio just based on what we see in the very short term. So to that extent, we try to make a portfolio which is fully diversified. When some of the cyclical sectors both technical and weak recovery momentum gathers speed, we should be able to see at least some positive surprises from the earnings front. And that should lead to some sort of reading and performance in some of the other segments like IT and FMCG, for example, valuations look quite rich and doesn't leave much room for further appreciation in terms of valuation. And also, these are steady sectors in terms of earnings growth, very unlikely that we will see very different positive surprises from those sectors. So to that extent, the possibility of re-rating in valuations exists in cyclical pocket of the economy. And that's where, I mean, if you look at our portfolios, that tilt is more towards the cyclical basket.

Amid selloff in global equity markets, should investors look at adding US stocks in portfolio?

Yeah, international equity markets have also corrected, but I won't go to the extent of saying that they have become attractive as there has been selloff pressure across global bourses in recent sessions. So, nobody can rule out further downside or further consolidation in equities, not just in India, but even globally. Having said that, global equities will definitely give you diversification benefit in the portfolio. There are various benefits for example, if rupee were to depreciate, then the international exposure is more beneficial. 

You could also take exposure to some of the themes which are not available in India for example, many of the industry segments may not be available in the domestic context, but there may be international companies, which are operating in that segment, which are profitable, which are reasonable in terms of valuations, etc. So, that exposure is also possible. So, I would say that every investor wants diversification should look at international exposure as well.

In the recent selloff, a good number of stocks have become available at attractive valuations. Any particular stock selection strategy that you would like to suggest?

You will have to do proper due diligence in terms of where that business is headed, what are the valuations and how the competitive landscape is going to pan out over the next few years, etc, those kind of analysis will have to be done. And then depending on your risk tolerance, and what do you believe is the fair valuation, you will have to take a call, which not very easy for every investor to do that. And that's where I think, if you choose mutual funds, you will be able to get the benefit of professional research and fund management team. And also your risk will be a lot more diversified. Because even with a small sum of let's say 5000, you will be able to get a basket of stocks prove the fund. Whereas if you were to individually build a portfolio and build a portfolio with good diversification, it would need much larger sum.

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