Investors should look at large-cap stocks

Focus on large caps and ensure that the portfolio is balanced, mutual fund managers tell Joydeep Ghosh and Sanjay Kumar Singh.

S Naren, executive director and chief investment officer, ICICI Prudential Asset Management, has a simple advice for retail investors: "Often, in a rising market, investors tend to overlook asset allocation and go overweight on equities. This is one mistake every investor should avoid."

Naren should know.

In the past year, retail investors have become aggressive on equities. In August, mutual fund (MF) houses collected a net Rs 21,875 crore in their equity schemes, the highest ever.

The numbers have been growing steadily. In the past year, equity funds have collected as much as Rs 2.2 lakh crore, the most among all MF categories.

Says Nilesh Shah, managing director, Kotak Mutual Fund: "Equity flows have been rising in MFs, as investors are hopeful the good macroeconomic fundamentals will be converted into earnings growth."

Such buoyancy is seen only when the markets are rising sharply. Most of the top collections, six out of 10, have happened in 2017 till August.

What is interesting is that in January 2008, MF houses collected Rs 12,782 crore. That month, the Sensex peaked at 20,873 points, before crashing by the end of the month. By the end of 2008, the Sensex had tested 8,000.

Are fund managers worried? Not too much, still.

"At this juncture, inflow is not a massive problem. Inflow as a percentage of assets under management (AUM) is more important than absolute flow. If it is within a manageable level of five-six per cent, then it is okay. In a Rs 6-lakh crore industry (equities), if you are getting Rs 20,000 crore-plus, that is still manageable," says Gopal Agrawal, chief investment officer, Tata Mutual Fund.

He adds it is only in the balanced fund category that inflows may be disproportionately high at present.

Naren says over the past two years, steady inflows into equities have been largely through Systematic Investment Plans or SIPs (the industry's SIP inflows stood at Rs 4,947 crore as of July 2017), and managing this is not a concern.

Are investment options becoming hard to find?

It is a tricky situation for fund managers as well.

"Deploying cash at higher valuation levels is an issue. We have to be prudent about where we invest. One needs to avoid the momentum ideas and those that look hot at this point of time," says Anand Radhakrishnan, chief investment officer for Franklin Equity-India, Franklin Templeton Asset Management.

There is a need to strike a balance between growth and valuation.

Radhakrishnan gives an example: A couple of years ago, the banking sector, especially public sector banks, was not too keen to lend. But, there was a need for someone to cater to the credit needs in the consumption part of the economy. Also, after demonetisation, many who borrowed from informal sources earlier had moved towards formal sources of credit.

Consequently, non-banking financial companies (NBFCs) took up the slack, thereby gaining market share at the expense of banks. However, if one bets on these stocks, one has to remember that in chasing growth, some NBFCs could be underwriting poor-quality business.

"Investors should only pay a reasonable price for growth. If some part of the market has turned expensive, one has to look at alternatives instead of getting pressurised into buying something at an unreasonable price," says Radhakrishnan.

Private sector banks, he points out, are growing at 15-20 per cent annually, and trading at less than four times their price-to-book value.

According to Agrawal, valuations are high in pockets. Value is still available in segments such as corporate lenders (banks), pharmaceuticals, oil and gas, etc. Moreover, new sectors are emerging, such as insurance.

Many sectors, such as consumer discretionary and retail lenders (banks), are structural growth stories, where you can adopt a buy and hold strategy.

The good news, according to Agrawal, is that a lot of fund raising through initial public offers, follow-on offers and others routes is taking place. "The supply of paper is also good," says Agrawal.

By doing the due diligence, fund managers are still able to find new stocks they can invest in for the long term.

Says Jinesh Gopani, senior fund manager, Axis Mutual Fund: "Foreign institutional investors are selling and therefore the volumes are good. A problem can only arise if a considerable portion of the inflow is hot money and would be redeemed in the short term."

What should investors do?

Naren believes that as valuations have risen sharply, investors should look at large-cap stocks. Historically, it has been seen that in the last phase of a market rally, pure large-cap names stand to gain, as was seen in 1998-1999 and 2006-2007 in India.

Jyotivardhan Jaipuria, managing director, Veda Investment Managers, believes investors should temper their expectations as valuations are no longer cheap and markets will be volatile in the near term, with the possibility of both price and time correction.

"The earnings cycle is still at a low point and the long-awaited revival in earnings will drive returns for equity investors over the next two to three years. Investors should use corrections to buy. Equity returns will be lower than those seen over the past three years. However, equities will still beat other asset classes in the next three years," says Jaipuria.

Adds Naren: "SIPs remain apt for the long term. Those investors who are looking for opportunities for lump sum investing could consider dynamic asset allocation schemes."