More inclined towards large caps over mid, small-caps: Mahesh Patil of Aditya Birla Sun Life MF

People who invested in midcap or smallcap stocks and mutual funds in 2023 would be an extremely happy lot.

And why not? The BSE midcap and small-cap indices accelerated 46 per cent and 48 per cent respectively last year, way more than the 19 per cent gains in the benchmark Sensex. But, this year things could turn out differently, with one of the top fund managers pointing out that large caps were looking more favourable now from a valuation perspective.

"If you look at the price performance in the large caps, bulk of it is explained by the earnings growth. But, in the mid and small-cap, lot of price-to-equity (PE) re-rating has also happened. We think that could see some mean reversion. So, this is the year where the risk-reward in large caps looks much better than the mid and small-caps," said Mahesh Patil, chief investment officer at Aditya Birla Sun Life Mutual Fund.

The fund house noted that large cap valuations are just 5 per cent premium to their historical average, indicating that valuations are still reasonable. On the other hand, the strong rally last year has pushed valuations of midcaps and small-caps above the historical average, thereby warranting caution in the near term, it feels.

However, the fund house remains structurally positive on the mid and small-cap space over the medium-to-long term, with the Indian economy expected to do well.

"India kind of looks to be in a Goldilock zone where we are seeing sustainable growth, inflation is likely to come down, commodity prices, especially oil, that is likely to be lower," said Patil.

While thus far the revival in GDP has been driven by a huge capital expenditure push by the government, private sector capex is also likely to see a recovery going ahead.

Consumption, especially in rural markets, has been sluggish. This year, with the overall improvement of the economy, inflation coming down and the general elections around the corner, Patil feels real wages could go up and lead to a pickup in consumption, albeit with a lag.

The ruling BJP won in three of the four state assembly elections held recently, which boosted investor sentiment and drove stock markets to fresh highs. The election results have raised expectations that the BJP will win for the third time in the general elections this year, ensuring policy continuity. As such this year, many countries, including the United States will go to polls.

Will the markets react negatively if the elections spring a surprise contrary to expectations?

According to Patil, a look at the history shows, that the market reacts initially depending on the election outcome, but after that, it reverts to underlying trends in the economy and earnings.

"After the recent state elections, expectations have built up that there will be stability in the policy. If the election results disappoint, there may be some reaction short-term, but it won't change the overall course of the market," he said.

A big rebound in foreign investment flows was a major driver of the market rally in 2023. Foreign portfolio investors pumped in Rs 1.71 lakh crore in Indian equity markets last year, versus outflows of Rs 1.21 lakh crore in 2022. While foreign fund flows have been strong, domestic fund flows, especially via mutual funds, too have been rising each month. In 2023, equity mutual funds saw inflows of more than Rs 1.60 lakh crore. Total mutual fund assets under managements have crossed Rs 50 lakh crore for the first time, according to the Association of Mutual Funds of India. Contributions via systematic investment plans (SIP) also hit a record Rs 17,610 crore in December.

Patil believes these changes are structural in nature and sees scope of this growing considerably in coming years.
"The financialisation of savings that has happened post demonetisation has only accelerated and we see the move towards risk assets will continue. Currently, the total ownership of equity as a percentage of savings, which is around 2.5 per cent can double," said Patil.

Last year, a broad swathe of stocks across many sectors did well. But, this year, investors may have to look at a more stock-specific approach, he noted.

The fund house remains positive on banking and financial sector, domestic manufacturing and the whole capex recovery, discretionary consumption and digital/ tech themes.

With the inflation easing, it is expected that global central banks will start cutting interest rates this year. In India, however, Aditya Birla Sun Life MF sees headline policy rates remaining unchanged for much of 2024, with a possibility of a shallow rate easing cycle at the end of the year, unless economic growth slows to below 6 per cent.

The fund house expects Nifty earnings to grow in the low-to-mid-teens range on a compounded basis over the next three years.

Equity is expected to deliver around 10-15 per cent returns this year, fixed income around 8-9 per cent and gold around 5-10 per cent.