ETMarkets Smart Talk: Want to build a portfolio? Look in small & midcap space: Arvind Kothari

After 3 consecutive months of losses do you think we could see some green in July as some of the headwinds seem to be slowing down? What is your view on markets in the short to medium term?
Easing down of commodity prices in India, reduction in FII selling, good monsoon are some of the factors that are adding optimism in the market while uncertainty regarding the US Fed interest rate policy, growth slowdown in major economies globally, risk of high crude oil prices are resisting any uptrend in the market and not giving a clear picture of how the markets can look in short and medium term.

It’s time for micro investing during difficult macros. In the current scenario, we can say that the risk-to-reward ratio has become favourable for long term investors in India. Why do we say this?

Firstly, a huge amount of fiscal stimulus was given globally during the pandemic. Hence, the reaction to such steep actions will be tough to navigate when it leads to difficult macro times.

In India, the stimulus was in the form of government policies rather than direct injection of liquidity. The impact shouldn’t be as severe as in the west.

The counteractive policies of the government took the form of imposition of customs duties, the successful launch of the PLI scheme, focus on renewable sectors and import substitution policies to revive the capex cycle driving capital formation and leading to a higher multiplier effect.

The government is trying to manage near-term headwinds to keep up the long-term growth intact. Overall, the outlook for India looks positive.

In the current times, one can find immense opportunities in the small-mid cap space that can be a huge beneficiary as profit growth can be really high.

What is your take on the rupee?
The rupee is trading near 80 levels but is it becoming weaker? Are the fundamentals of the Indian economy dwindling too? The answer is no.

The dollar is definitely getting stronger. Analysis of past one year’s data (July-21-22) shows the Euro has depreciated by 15.29% and the yen has depreciated by 26% whereas the Indian rupee has depreciated only 7.37%.

The global headwinds and the hike in interest rates in the US is leading to higher investments in the US leading to appreciation of the dollar.

But what is also happening is that the RBI is constantly intervening to not let the rupee breach a certain level by selling dollars.

We will have to see whether our exports become uncompetitive considering other currencies have depreciated a lot more. Also, oil prices are increasing, leading to a widening of our current account deficit.

FIIs seem to be on a selling spree though the quantum has come down. Is a global realignment happening or are there other reasons for FII selloff?

The outflow started in October, 2021 when the index also hit a record high. But, domestic investors have absorbed more than 80% of FII selling.

There can be multiple reasons which lead to FII selloff in the Indian equity market: Higher interest rates in the US to tame down inflation and consequently stronger dollar leads to churning down of portfolio from emerging to developed countries by the FIIs.

Depreciation of foreign currency, in this case INR, could also be one of the reasons for getting money off the table. Valuation is also the trigger for FII to book profits as they were reasonably high in India compared to other markets like China and Korea.

Emerging countries like Sri Lanka and Pakistan are in dire straits. An FII exit from emerging markets could mean outflows from India too even if the country’s growth rate looks resilient.

It feels like we are in a perfect storm – Sri Lankan crisis, Ukraine-Russia war, rupee depreciation, FII selloff, and not to forget boiling crude.
Every time there is a steep correction in the market due to any global event, there would be too many variables impacting the market.

While these global events are ebbing major economies but Indian economy sits stronger than ever despite all the cannons firing all at once.

It is definitely an opportune time to invest in India when the companies are available at reasonable valuations. Unlike the previous times, Indian corporate balance sheet is healthy.

The major thrust of the government is to revive the capital expenditure cycle and begin a virtuous investment cycle by crowding in private capex.

Insights from visiting various exhibitions and interacting with varied Indian entrepreneurs highlight how imports of raw materials/machineries in selective industries have reduced and domestic sourcing has increased wherever possible.

Confluence of factors are emerging to make the Indian economy resilient globally. We’re a volume-based story where penetration of many products is still low compared to the world average.

Of course, the market returns trajectory would not be the same as what we’ve seen in the last 2-3 years, but such markets offer selective opportunities that can create good returns in the long term.

What would be your advice to an investor whose portfolio is down 40% in value and only has laggards? How should one manage such a situation?
The first rule of investing is that one should know where one is investing. An idea can be borrowed but not conviction. Every investor has a different investing process. This helps the investor to navigate through the downcycle prudently.

Ours is research-based investing. Learning while unlearning is important in equity markets. Here, firstly analyse why the portfolio is down. Is it because of an adverse stock selection or allocation approach?

If the former is an issue, there are two ways to deal with this. If the share price is down due to corrections in the market and earnings predictions are stable, one should hold.

Patience and courage make a huge difference in long term in building a strong portfolio. Without courage, it is not possible to have higher allocation in a stock and stick to a company without any fear if the price has fallen or not moving.

If one thinks that an investment thesis isn’t expected to play out on account of externalities or some mistake in analysis, one should not think much before selling too.

Going by the recent data, SIP culture will only pick momentum in the near future. What can a 20-year SIP of more than Rs 1,000 do to your overall corpus?
Doing simple math and being optimistic on the Indian economy, it’s fair to assume a compounding rate of 14%.

The total amount at maturity would be somewhere around Rs 10,76,000 that’s a whopping return of 4.5X on investments if one invests Rs, 1000 per month for 20 years. The earlier one starts, the better it is.

If someone in their 20s wants to create the portfolio, should they bet on small & midcaps as Nifty50 companies are already matured in their businesses and growth models? What is the right way to look at the asset allocation mix?
People in their 20s are in a stage where they build capital and have the ability to take comparatively higher risk. Depending on one’s risk appetite, one should definitely invest in midcap companies as growth and scalability comes inherent to them.

The law of large numbers is quite apt here. Some of these mid-cap companies have all the potential features to become largecaps. For instance,

was trading at around Rs. 8 during 2001 and went up 20X to Rs. 160 in 2011. But it didn’t stop here.

It grew its sales with 12%+ CAGR over the last 10 years and became 10X in the last 10 years. So that’s more than 200X over the last 20 years. Today, Pidilite is a large cap company with market cap of over Rs. 120,000 crore.

So, maybe not everything small runs big, but everything big does start small. Keep in mind, here, higher returns come with relatively higher risk. Hence, it requires higher investment horizon.

Identifying stocks is the first thing but allocation will make a huge lot of difference in generating returns. Our allocation strategy is more inclined toward taking concentrated bets comprising 15- 20 stocks.

Our strategy is to divide the portfolio into three pies- high growth companies, emerging giants and cyclical companies to create alpha.

Sometimes, the allocation to a company can increase to 10 per cent only when we have a strong conviction. We research to do the groundwork to identify emerging trends rather than just focusing on financials which talk about the past business performance.

Also, sometimes we adopt a basket approach while taking exposure in a particular sector till we’re able to identify those who will emerge as a market leader or benefit the most from any particular emerging trend. Recently, we followed this approach while allocating to the textile sector.

Which industry/sector are you most bullish on and why?
We have been spending a lot of time researching how export volumes have picked up after the pandemic and with China +1 strategy in play. This has really driven profitability in various sectors.

We think that India can witness a large capex cycle and the perception is based on the structural reforms like PLI boost, government initiatives, de-risking of supply chain, high energy costs in the western world.

Insights reveal how imports of raw materials have reduced and domestic sourcing has increased wherever possible.

Also, capital goods companies are showing a healthy order book at a time when government policy of export duty on steel translating to reduction in steel prices in the home market would help these steel consuming companies in a significant way.

Indian engineering components exports grew by 37% when compared to 2019 and grew to $ 111 billion in 2022, a rise of 50% from 2021 levels. Numbers do give a lot of perspective. The major thrust of the government during the last two years have been to revive capital expenditure cycle.

The rise in capital expenditure helps to crowd in private investment. The virtuous cycle of investments begins in the economy. Overall, till date, the earning season has been fantastic where few companies have shown good sales growth, maintained or improved margins.

Some companies did show margin pressure too. The focus should be on companies that exhibit pricing power. This is also the time when global companies in the developed economies are incurring margin pressure.

We believe Indian manufacturing will be the best quality asset to own across the globe as an asset class.

(Disclaimer: Recommendations, suggestions, views, and opinions given by the experts are their own. These do not represent the views of Economic Times)