Why Anand Shah is overweight in mid & smallcaps

Anand Shah, Head- PMS & AIF Investments, ICICI Prudential AMC, “says a 10% market correction is a typical occurrence in the investment arena, marking a period of sustained volatility. Investors must adopt a long-term perspective as the market no longer offers short-term bargains. Despite the market’s current lack of affordability, selective stock picking based on earnings remains a viable strategy. Moving forward, emphasis on strategic stock selection will be crucial amidst ongoing market unpredictability.”

The question on everyone’s mind is how much more pain do we go through? How much of the damage is already in the price? It got triggered by small and midcaps but seems like now it is spreading through to the largecaps too?

Anand Shah: To be very honest we are seeing the pain from a very short-term point of view but if you look a little long term, from two- to three-year perspective, the market had a phenomenal rally in the backdrop of the challenging times that we saw during the pandemic and since then we have seen a very sharp recovery in overall earnings for the corporate India as a whole and that did give confidence for markets to move up.

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To be very honest, this is part and parcel of any market that every now and then markets would correct. We have done some work and if you ask me, over the last 34 years whatever data tells us that there are 107 times that market has corrected more than 10%.

So, the 10% correction in the market is generally part and parcel of the game. The volatility is going to stay, it is going to be here and investors will have to have a long-term view from here, we cannot say that the market is very cheap and you can actually come in for a very short term, those days are behind us.

We have come a long way over the last three years where the market is not cheap anymore. The earnings allow us to do stock picking and pick some companies with a lot of comfort even today, but overall, from here on, stock picking will be key and the general market will remain choppy.

You would not recommend making market cap distinctions, would you because many believe that smallcaps are going to be extremely volatile from here onwards and it makes sense to have a larger allocation to largecaps as that is where safety is?

Anand Shah: At this juncture, we are not taking even a market call on largecaps. There is enough distinction between the companies where there is a growth and value is still there and there are companies which are very richly priced and still the growth is missing. So to that extent, we have seen this change in trend where the consumer facing businesses which are very richly priced and struggling with the growth versus manufacturing, manufacturing allied businesses which is coming out of a decade, decade and half of a challenging period is actually delivering good on the earnings growth front.

At the same time, when I take this argument to the midcaps and smallcaps, that market is much wider. So, unlike the largecaps, which is a small number of sectors and small number of companies, the midcap and smallcap is much wider, the bottom-up stock picking and the heterogeneity, the difference between the growth and the earnings among the various sub-segments of midcap and smallcap is that much higher.

So, the midcaps and smallcaps also remain slightly overweight in our flexicap portfolios purely because we are more overweight manufacturing and manufacturing allied businesses in general. And when I go and check for these businesses, there are very few in largecaps and mostly they sit in the mid and smallcaps. So, by virtue of our positive outlook on this side of the business or the economy, makes us on a bottom-up basis, a lot more overweight in mid and smallcaps versus the index.

I was referring to the manufacturing design services company. They are not traditional technology. Their clientele is completely high-tech manufacturing companies, some of them are even going towards defence. Do you have some of these kinds of technology companies, but catering to manufacturing design, defence design, all of that?

Anand Shah: Indeed, there is a lot of focus and especially in PLI, there is a lot of focus to get the next technology manufacturing in. Obviously, from a maturity perspective, from the visibility perspective, these are all emerging businesses and to that extent, we will have to see a few more quarters of their performance, their business before a large position can be built.

However, within the manufacturing piece, the old economy, the traditional manufacturing, steel, aluminium, textiles, auto ancillaries, and even in capital goods and industrial products, we have seen the history of 10, 15, 20 years and we have seen that during the 2004-2007 cycle where we have some data to look back to and saying what sort of growth they delivered, what sort of operating leverage they delivered and to that extent, picking those businesses are easier today.

I have no doubt in my mind that in the coming years, we will see more emerging businesses. The key word here is they are emerging businesses and to that extent it will take some time before they become mainstream stocks in the institutional portfolios.

Where are you placed on wires and cables part of the power value chain? Some of them got corrected pretty sharply in the last two-three months, but it is an important part of the power value chain. Do you have it?

Anand Shah: Actually, there is one big play on the Indian economy that will remain real estate, urbanisation from rural to urban India. Providing housing is a big play and that will be the big driver of GDP, big driver of public capex in the sense there is a government capex, there is a private capex, and there is also the household capex and large part of household capex comes in housing. We are long on home builders.

Very clearly, that is the play where RERA has been a significant driver of consolidation, significant driver of the lesser competition, the pricing has inched up and to that extent, that is our first play. The ancillary plays to the housing growth remains be it paint, be it cable and wires, be it white goods and these all, to be very honest, had a good time from 2010 to 2020. B2C businesses had a lot going for them, given China was exporting deflation and the raw material prices were not inching up.

Do you have Tata Power in your portfolio? I am sure you would not talk about stocks, but private sector, large power companies such as Tata Power.

Anand Shah: Our portfolios have both manufacturing and manufacturing allied in a big way. A big part of our manufacturer-allied portfolio is the power value chain. Power value chain includes power generation, distribution, T&D and so on and so forth and that is one of the, again, big driver of our portfolios.

We have been overweight the entire chain of the power because if the manufacturing has to pick up, if the economy has to move to $5-10 trillion, there is no denying that we will need more power. We have heard that there is going to be a need to even add thermal power which otherwise was supposed to be a sunset industry. So, yes, that is the entire value chain we own.

Where within largecap specifically and I am going to draw your attention particularly to largecap banks because they somewhat have not quite matched up to what the streets anticipation was at least at the start of the year. Where within that pocket do you find value? Also, is it time now to see some participation from the largecap cluster, the banking pack that is?

Anand Shah: Indeed, we own a lot of traditional corporate banks which had a lot of NPA challenges during 2015 to 2020. Those are the banks which are also today the big beneficiary of recoveries we are getting. So, we own that. Having said that, there are two challenges today. Obviously, the liquidity is quite tight and to that extent, deposit accretion has been a challenge for the industry. They are not able to grow deposits as rapidly.

But the other bigger challenge is also the loan growth and that has been anaemic for a while and that reflects in the improving balance sheet of corporate India. Corporate India has deleveraged, good cash flows especially in the capex cycle, the private sector capex companies which otherwise would have led to the credit growth rate for the banking industry, that is still deleveraging, that is still putting the cash flows in reducing debt rather than putting up new capex.

As we move forward and as capacity utilisation goes up and China plus one plays out, we will need to start a new private sector capex and that is where the bank will have opportunities to lend gainfully in both power as well as in the private sector capex. The key trigger for banking is at some point of time, RBI would be comfortable with inflation and the global challenges and that is when the liquidity eases and that is when the banking should actually grow.

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