“Midcaps and smallcaps will always remain an attractive investment opportunity. They do present challenges, like liquidity. Investing in some of these smallcaps is similar to venturing into VC-backed companies – they exhibit very strong growth,” says Punita Kumar Sinha of Pacific Paradigm Advisors. Edited excerpts:
ET Now: Tell us how clear and present you see the danger of a sharp correction in the midcaps at this point, compared to the large caps. Why do midcap valuations look as extended as this report indicates?
Punita Kumar Sinha: First of all, I believe India is undergoing a structural change as an economy. When India’s GDP per capita rises, which I anticipate will happen exponentially, we cannot just limit ourselves to large cap names because there are only about 200-300 of them. Some of these midcaps will inevitably become large caps, so that universe has to expand. However, the entirety of India’s story isn’t reflected in just these 300 companies. Thus, midcaps and small caps will always remain an attractive investment opportunity. They do present challenges, like liquidity. Investing in some of these small caps is similar to venturing into VC-backed companies – they exhibit very strong growth. Hence, investors find these opportunities quite appealing, anticipating that these companies will experience exponential growth.
ET Now: Which investors find the midcap universe interesting? The Jefferies note mentions that FIIs aren’t as overweight on India as expected. Why do you think that is, especially since the current upsurge is primarily driven by domestic investments? If midcaps are promising, would that be the area they’re most interested in?
Sudip Bandyopadhyay: There are two aspects to understand here. First, the correction we observed in midcap seems overdone primarily because, if you consider the index, 75% weightage is on large caps and 25% covers numerous midcaps. When there’s a transition to large cap, even a minor shift impacts the midcaps considerably due to this weight structure. Secondly, yes, some midcap stocks did appear overvalued, and a degree of correction was probably due. However, it’s essential to note that not all midcaps were overpriced, and not all needed adjustment. Also, many large cap stocks appeared attractive compared to mid and small cap valuations just a few weeks ago. Changes were certainly needed. Another pivotal element to understand is the evolving market conditions in the US, particularly with rising oil prices and potential US Fed hikes.
ET Now: Considering the emerging macro data from the US, including inflation trends, expected Fed actions, the dollar’s trajectory, oil prices, and the recent spike in US bond yields, how do you see foreign fund flows moving now?
Punita Kumar Sinha: Foreign fund flows have been gravitating towards India, primarily from many emerging market funds where China’s weightage has diminished considerably. I recently spoke with a sell-side strategist in the US who revealed that several hedge funds have significantly reduced their weight in Hong Kong and China, redirecting much of that capital to India. This shift is energizing the Indian market. While the technicals of mid and small caps indicate they’re overbought, the long-term narrative suggests significant growth opportunities for patient investors. As for the US macro situation, factors such as rising oil prices and imminent elections in various countries pointed to increased risk levels. However, the markets largely disregarded these risks over the past few months. If China enacts enough stimulus, we might witness some funds returning there. But, looking at valuations and technicals, a market correction would likely be beneficial.
ET Now: Global cues seem unfavorable currently, especially with recent developments in Europe and ECB rate hikes. Yet, India continues to project bullish sentiments. How robust do you believe our fundamentals are currently? And can you comment on the correlation between capex cycles, corporate growth, credit growth in our financial sector, and the market’s upward trajectory post the August consolidation?
Sudip Bandyopadhyay: Two crucial factors stand out. The global rise in oil prices poses a challenge for India. However, the ongoing hesitance about China among global investors balances it out. With the impressive GDP growth that India is showcasing, foreign investments will naturally be attracted to the country. Another significant trend is the financialisation of savings. Previously, a significant portion of Indian savings was tied up in unproductive assets like gold. Now, more funds are entering the market, both directly and through mutual funds and insurance. This influx is just the beginning. As more Indian capital gets channeled into the Indian capital market, its health and vigor will be maintained. While FII selling might occur, domestic investors and institutions are not only absorbing this but also propelling the market upwards. Thus, despite short-term volatility, the long-term outlook for Indian markets remains positive.ET Now: Given the shift in foreign investments into Indian markets, how do these significant foreign institutions view asset allocation, especially considering China’s substantial role in the emerging market index and the exodus from passively managed funds to circumvent China? Could you also shed light on this from a sectoral perspective?
Punita Kumar Sinha: To add to Sudip’s points, during the 90s, foreign investors predominantly drove the Indian market due to a dearth of domestic capital. Now, the Indian market is much more reliant on domestic capital. Due to capital controls in India, mutual funds and investors can’t invest overseas. This constraint provides a solid foundation for Indian equities, possibly the reason why they often trade at a premium compared to other countries. From an allocation standpoint, US investors have the flexibility to invest anywhere. Many have also ventured into money market funds, fetching them around 4.5-5%, a rate higher than recent years. As risks rise, funds might transition from risky assets to more stable ones, possibly affecting flows into emerging markets. Nonetheless, from a value perspective, other markets still hold more promise than the US.