Praveen Kumar V.
The equity market rarely trades in the fair value zone for a long period, adding to the investors' dilemma and difficulty in finding their starting point. When the economy expands, the market, boosted by the earnings growth optimism, trades at a sizable premium to their long-term average. This builds a euphoria, which in-turn shakes an investors’ confidence for taking higher risk due to the fear of possible capital erosion in the initial years.
On the other hand, the market trades at a steep discount when it factors-in the uncertainties related to macro environment or shrinking corporate earnings. In the former situation, investors fear being a part of the ‘greater fool’ concept—where an investor buys an overpriced security in a richly valued market, expecting it to touch newer highs. While, in the second situation, the investors feel they may end up buying a falling knife, and that it could be bought later at a lower price, with a lower acquisition cost.
So, what should be the strategy for an investor who intends to reap the benefits from the long-term wealth creation potential of equities? The optimal solution would be to park their money in the large and midcap funds; they can turn defensive in tough times--by investing in most sound large-cap companies, and become opportunistic by raising wager on small-cap and midcap companies--to generate alpha for boosting the overall portfolio return.
The large and mid-cap funds provide a relatively safe vehicle to remain invested in the equity market in different market cycles, with reasonable long-term returns and lesser volatility. The large and midcap funds can invest up to 35-65% in the large-cap stock and similar ratio for midcap. This provides a perfect balance of portfolio, with top 100 stocks in the large-cap space and remaining 150 stocks picked by their market value. This provides a pool of two kinds of the stocks.
First, the large-cap stocks such as HDFC Bank, which grows from large-to-largest and provides a CAGR of 16%, second are the pool of stocks such as HCL Technologies, that become large from midcap with a CAGR of 14%. The underlying thought remains that the stocks chosen in the portfolio should have a growth story attached to it, offering a secular earnings growth trajectory. The perfect blend of large-cap and midcap stocks help in building a portfolio that is powered by strength of the current market leader, and equipped with shares that have the potential to turn into challengers. While investing in the category, it is important to have an investment horizon of atleast three years and above.
The returns expectation from the equities continues to be encouraging in the long-term, with supportive government policy such as product-linked incentive scheme, insolvency and bankruptcy code, consolidation of PSU banks, introduction of GST, land reform and increasing manufacturing share of India by Make in India scheme. The positive impact of these is reflected in several high frequency indicators. The monthly GST collection has reached a record high of Rs 1.49 lakh crore in February 2023, and the passenger vehicle sales clocked-in a record volume of 3.8 million in 2022.
This is further buttressed by the government and private sector capex reaching a record high crore in the current fiscal year. The trend will continue in the next fiscal year too, as the union government continues to step up expenditure on capex, reaching a record high of 3.1% of the GDP in FY24. Being an all-seasons equity fund, the large and midcap funds are likely to be the best beneficiaries of the market cap expansion in India. The market-to-GDP ratio has been in the range of 0.8-1.2.
While there are several offerings in the large and midcap category, ICICI Prudential’s large and midcap fund stand out from the peers, thanks to their unique stock selection approach. The portfolio consists of names which of names which are either structural or cyclical beneficiaries based on either global factors or on local dynamics. The fund has currently allocated 58% in large-caps, 38% in midcap and balance 4% in small-caps. Currently, financials and pharma hold the largest weight in their fund. In terms of performance, over the last two years, the fund has outperformed the benchmark index by 6.3% and is among the consistent performers in the category.
Praveen Kumar V. is partner, Capstone Investments
