Investors should ignore the current negative noise around mid-cap funds and stick to their suggested asset allocations, Rajesh Cheruvu, Chief Investment Officer, WGC Wealth, tells ET Wealth.

What do you make of the current sharp divergence between large caps and mid- and small-caps?

Global risk aversion coupled with concerns around domestic factors like currency volatility, rising crude prices, inflation, interest rates and upcoming elections are some of the drivers influencing investors towards profit booking in mid- and small-caps.

This divergence widened due to stretched valuations over large-caps and looked ahead of fundamentals as well. Adding to the woes were Sebi’s additional surveillance measures, mutual funds realigning portfolio composition and instances of corporate governance issues. These ended up hurting overall sentiments in the mid- and small-cap space. Overall earnings outlook for largecaps look good, causing further skewedness.

How do you expect the corporate earnings trajectory to shape up over the next year?

The consumption space continues to be the predominant driver of ongoing macro recovery, backed by strong demand and increased appetite. As a result, consumption stocks, retail lenders and infrastructure ancillary segments are witnessing healthy volume growth. After three years of lull, IT and pharma too are showing signs of improvement in outlook. With the narrowing gap between WPI and CPI in recent times, it appears the pricing pressures are receding for businesses, which can lead to better realisations. Commodity prices have also started falling from their recent highs and overall interest rates may too top over the next two to three quarters which may strengthen earnings going forward.

Will markets continue to show preference for quality over anything else?

On YTD basis, quality names have stood out and been the market outperformers. Given that broad market valuations are still ahead of fundamentals, participants will find comfort in quality franchises and balance sheets to mitigate disappointment on earnings front. Amid the global backdrop of liquidity getting unwinded and uncertainties surrounding trade war, there is clear risk averseness and FPI outflows reflect that. Likelihood of political uncertainty ahead of elections and fragile macros may further push market participants away from high beta stocks and continue to favour quality.

What investment themes or sectors make for good bets now?

Consumption-oriented themes and segments will continue to be in focus. Recent government moves aimed at uplifting the rural economy and expectation of normal monsoons augurs well for the FMCG space and resultant demand would continue to favour them. The consumer durables segment may see the required uptick with recent GST rate cuts for products in the 28% bracket. Improved productivity and increased profitability of truck operators post GST and new launches are likely to keep up the demand momentum for the auto segment. The government thrust on housing and infrastructure is driving the pick up in volumes of cement and steel producers. Retail and private lenders continue to be in vogue with the increasing market share from PSU banks.

Does the mid-cap segment provide a good hunting ground after the sell-off?

Since 2014, most mid-cap stocks have been trading at a significant premium to their historical averages owing to expectations of healthy earnings outlook. While we haven’t witnessed any meaningful shift in their earnings trajectory, there has been a stark turnaround in sentiments and momentum. Correction of this magnitude has pulled down valuations as well, which does offer an opportunity to pick quality businesses with medium to long-term outlook at reasonable valuations.

Your advice for investors who started SIPs in mid-cap funds over the past year?

We do believe that quality and niche midsized companies have the ability to capitalise on the opportunity by ramping up their size and thus increase earnings propensity over time. Given the favourable fundamental backdrop over the medium to long-term, investors should disregard the intermittent short-term noises and stick to their suggested asset allocation. Considerations on fresh mid-cap allocation or existing ones shall be done in line with overall suitability and asset allocation in a staggered manner or through SIPs.

Are hybrid funds a better way to fight volatility?

Hybrid funds are seen as vehicles to beat volatility or minimise the risks within the portfolio. However, that might not hold true. Equity and debt as an asset classes hold positive correlation, hence in principle they may not be able to mitigate the volatility as perceived by investors. Also, if you look at the risk adjusted returns of balanced funds over large-cap funds, it is not making a compelling case with three-year Treynor ratio of 0.35 against 0.42 of largecap funds. Between 2013-2017, both equity and debt as asset classes gave strong returns, delivering positive returns for most of the successive months. At the same time, schemes have also given monthly dividends and these hybrid funds were wrongly positioned as investment vehicles to meet liquidity requirement and dividends. Post November 2017, we have witnessed negative returns in these hybrid funds since they have been marred by heightened volatility in fixed income and equity markets both.

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