Just going by the kind of moves that we have been seeing in the markets of late just wanted to understand your outlook on where valuations, how they stack up, and whether or not you believe that consolidation is the way to go at least for the next few months.
Vetri Subramaniam: Hard to predict whether it will consolidate, what it will do, but it is always good to know where you are in terms of valuations because the starting point in terms of valuations typically has a very high probability of indicating what kind of forward returns you can earn and at the current level of valuations I am talking more about the Large Cap Nifty 50 kind of valuations. The market is rich, though I would not categorise it as extremely rich.
In fact, early in November when the markets came down, our asset allocation strategies actually used it as an opportunity to raise equity exposure, but I would just sort of say that at the current valuation level investors should have a fairly muted expectation in terms of their near-term returns let us say over the next one to two years.
But given the allocation and given the movement with the largecap stocks appearing fairly above that fair value, what should be your allocation strategy looking like at this point in time, do you believe that the largecaps still have sufficient potential for an upside or would you like to bet on the mid and the smallcap end and you believe that there is more headroom for an upside from these levels as well?
Vetri Subramaniam: Actually, it is the other way around, the mid and smallcaps in aggregate are actually very richly valued, so much so that I would be very nervous about the kind of expectations that people have from that set of companies in aggregate because midcaps are trading at a massive premium to largecaps and very unusually I would say in the past 20 years I have rarely seen small caps in aggregate trading at a premium to largecaps but that has actually happened and therefore, I would actually argue that the implied expectations that people have from this aggregate set of companies is just too aggressive and which is why actually the largecaps even though they are rich are actually far more comforting in terms of valuations.
In terms of asset allocation, just to be clear, we are sort of in the neutral zone and I am referring to our asset allocation model which we use in strategies like our balanced advantage and our multi-asset allocation fund because those do take asset allocation calls.
Now, this might not be right for any individual investor who has a very different set of financial goals, but just to make the point we are in that neutral zone, the market is not particularly cheap, neither is it nosebleed expensive.
I wonder what the stance is when it comes to earnings because it has been a bit disappointing, cannot take away from that, but do you believe concerns when it comes to the slowdown that we have seen within the consumption space as a whole are likely to linger into the coming quarters?
Vetri Subramaniam: I think that is the guidance we are getting from companies as well and just to step back for a moment again, going into this year what we were always saying is that if you have got a single digit year in terms of single digit nominal GDP growth outcome for the year, then for companies to get margin expansions will be very difficult.
And what we are actually seeing is weakness in revenue growth, single digit nominal GDP growth at the aggregate level, and therefore as a result companies are really struggling in terms of holding on to their margin levels because remember last year’s margins were extremely elevated and therefore I would argue that even the current estimate of 8% earnings growth for 2025 with half the year done and looking much weaker, I think there is a risk that even that 8% growth number might get cut further by the end of this quarter.
But that is interesting to see indeed that the BFSI space has been doing well of late because yes, the stocks have corrected from their highest point, but given the market volatility those stocks are seen to be recovering, some of the sector leaders are also doing pretty well. So, how do you assess the sector’s growth prospects related to the current valuations and also, how do you manage the potential risk in this particular space?
Vetri Subramaniam: Eventually, it is very hard to figure out what will necessarily do well over the next 6 months to 12 months. Our role as fund managers and investors is to identify where do we find the combination of healthy fundamentals, reasonable growth potential, and reasonable valuations.
And when I look at that combination, really one of the only sectors where we think the case is now very strong is in the BFSI segment particularly led by banking, but I would say even insurance is includingly falling into that category.
So, this is an area where we think there is a long runway of growth, credit to GDP including in retail is quite low in India compared to the potential we have for income growth and eventually for credit to grow, so this is the one sector where we think the scope for absolute positive returns is actually quite good over a one- to three-year time frame.
I have felt this way for the last six months. I would still not say that the sector has delivered on that expectation, but there are some headwinds but it is only when you have those headwinds that you get the valuations which are attractive.
So, I would say this is the right sector to which you want to be positioning yourself for a good outcome over the next one to three years.
I wonder what the outlook is on some of these quick commerce players because day after day we are reading the headlines of either a fundraise or somebody coming out with a new offering and the space is really hotting up. Just as a whole maybe quick commerce players, listed names, new-age tech, your take.
Vetri Subramaniam: Well, I do not think there is a simple one size fits all answer to that. We have been investors in some of these companies when they went in for their IPOs. We have held on right from then. We have added to positions in some of these strategies.
We actually run innovation strategy where some of these D2C consumer tech and consumer platform companies are large exposures. There is a good opportunity for many of these innovative businesses to grow over the next decade. But you also got to be cautious when there is too much noise about these companies and there is too much noise flow coming in every day about as you said fundraise or somebody talking about growth.
So, I would be a little concerned right now that maybe there is just too much talk but do not lose sight of the fact that innovation is a great strategy to be investing in over the next five to ten years.
I believe that you have flagged off some concerns related to the valuations all of these capital good and the power utility companies have been holding, so wanted to get a sense that what exactly could be the likely risk for this particular sector and also correct me if I am wrong on your take on given this space, but I also wanted to understand that how are you positioning yourself to navigate these sectors which for now having a lot of investors interest?
Vetri Subramaniam: Easy one is utilities where eventually this is a regulated business so returns in terms of return on capital is healthy but it is in the mid-teen levels. Now, for those kind of businesses where the outlook is in terms of mid-teen ROEs to be paying such a hefty price to book multiple I think is quite debatable. There is excitement about the transition to green energy. But remember in utilities nothing changes in terms of return profile, all that changes is the segment in which they will be investing.
So, I would be wary about the mismatch in utility businesses between their potential return on equity that they would enjoy because as I said this is a regulated business, you cannot be paying the kind of valuation multiples that you are just because there is a green transition happening because that green transition actually involves large amount of investments but not necessarily a change in return profile.
As far as the industrials are concerned, I just think the absolute level of valuations there is quite absurd now and the fact is if you have got a little bit of slowdown on the consumption side, I would not be surprised if with a few quarters lag some of that slowdown gets reflected in the order books of industrial companies as well.
So, I just think that despite the overall positive outlook for investment spending in the economy, the starting point of valuations is just horribly wrong and that is why I am happy to stand back from capital goods.
Any sectors that you believe that right now would be a complete avoid?
Vetri Subramaniam: Yes, I will pretty much talk to what I said which is the capital goods area that is the one that we will avoid just given their crazy sort of valuations and in the midcap and smallcap space as well I would be a lot more cautious. I think the main thing rather than just talking sectors what I would point to is that this is the kind of market environment in which we need to stand back, we need to move away from the narratives that are being sort of told to us, we need to step back from the storytelling that is happening in the market and really start to focus on does this company have cash flow, does this company have a large growth opportunity where they can deploy capital and earn a significant premium to cost of capital.
So, I would say move away from narrative driven investing to a focus on cash flows and return on equity because this is a very dangerous environment when valuations and narratives take over.
