Expert view: Low rate regime unlikely in next few years; small-cap segment a stock-picker’s paradise, says TRUST MF CIO

Expert view: Mihir Vora, CIO of TRUST Mutual Fund, believes a low-rate regime in the next few years is unlikely as inflation in India and globally is likely to be sticky. Discussing why small-caps have caught investors' attention, Vora says investors have consistently made money in the past four to five years, and it will take a sustained fall for them to lose faith in this segment.

Edited excerpts:

How do you assess Nifty's performance this year? What key factors have driven the market?

It has been a wonderful year so far. Multiple tailwinds have benefited the markets.

Stable inflation, the beginning of global interest rate cuts, upgrades in growth expectations for India and the world, and regime continuity after the Elections provided the perfect backdrop for equity markets to do well.

Domestic investors continued to pour money into equities directly and through mutual funds.

Foreigners were sellers in the first half of the year but became huge buyers in June after the Elections.

Small caps and mid caps outperformed large caps as investor participation was broad-based.

How long do you think the current bull run may continue? Are there some challenges that we should be cautious about?

Fundamental and technical factors support a continuation of the uptrend.

India continues to be the fastest-growing large economy in the world, and domestic and foreign portfolio flows should continue because of this.

The entry of one to two crore new retail investors annually provides a long-term source of funds for the markets.

While everything looks fine, one always needs to look for risks. Most of the risks that I see are global in nature – geopolitics and war, oil prices, high debt levels plus sticky inflation in the Western world and the K-shaped nature of the recovery in India.

Much of investors' confidence could be due to the durability of the Indian economy's growth. How do you see the inflation and growth dynamics evolving?

Absolutely. Investors buy stocks for growth, and India is a growth market.

All the factors driving the India story are long-term and structural in nature. I call them the 7 Ds driving India’s growth – demographics, democracy, deregulation, dynamism, digitisation, (low) debt and diversification of manufacturing away from China.

Inflation is not such a big issue for India now, and we are used to 5 per cent inflation.

Moreover, with 7 per cent GDP growth, these inflation levels are not considered extreme.

Core inflation has gradually decreased in the past year, while headline inflation has been stickier.

However, since interest rates cannot control food and fuel prices, I do not see the risk of the RBI becoming hawkish.

So, the bias of favouring growth over inflation will continue. RBI may take more targeted, micro steps towards specific segments if needed.

The economies of the eurozone and China look weak. Even the US economy does not appear to be in good shape. What does it mean for the Indian economy?

The US economy has performed better than expected, and growth estimates for this year have been upgraded.

While Europe is growing slowly, there have been no downgrades to the expectations.

China is weak, but the government there has shown its intentions to prop up the economy using whatever means required. So, on the whole, we have seen upgrades to the world GDP growth estimates this year.

India is not an export-dependent economy, so we may not be directly impacted by global growth, but trading volumes do tend to go down when there is a slowdown.

So, the impact on India is limited and, in some cases, may even be positive as oil prices go down slowly.

How should retail investors invest in the low-rate regime?

I would not say we will be in a low-rate regime in the next few years.

While rates will be lower than the present, in the next few months, my view is that inflation in India, as well as globally, is likely to be sticky.

This is because global governments and central banks are likely to continue to pursue monetary printing to service their ever-increasing debt, which will create sticky inflation.

In this environment, most asset prices will get inflated – stocks, real estate, gold, etc. Hence, investors should own such assets for capital appreciation and inflation hedging.

What sectors look attractive to you for the medium to long term?

The sectors we like have three broad themes: rising income levels, physical asset creation, and technological disruption.

Rising income levels mean that premium item consumption growth will be higher.

This means segments such as premium vehicles, real estate, jewellery, consumer durables, hotels, and airlines.

This also means segments that cater to financial savings will grow faster—insurance, wealth management, asset management, broking, exchanges, depositories, registrars, etc.

Physical asset creation includes real estate, capital goods, construction, infrastructure, power, defence, and railways.

Technological disruptions include all the new-age companies in the B2B and B2C space, which use technology to create new business models or to disrupt existing ones.

What are your views on emerging themes like AI and renewable energy?

We are positive on both themes and believe India is ahead of many countries.

How can retail investors navigate risk related to investments?

Strategic asset allocation and 3 Ds: diversification, due diligence, and discipline.

Diversify across asset classes and securities with the classes. Do not dilute the quality of your investments –due diligence. Stick to the plan and not get swayed by market volatility – discipline.

Why have small caps caught investors' attention? Why are they rising despite valuation concerns? Could they be a good bet at this juncture?

India is a growth market, and small-cap companies often have the highest growth trajectory within their lifecycle after the high-risk start-up phase.

In the micro-cap or small-cap stage, companies focus primarily on growth, and the length of the growth runway can be very long, offering the potential to become multibaggers.

Moreover, in many high-growth segments, the options are exclusively or predominantly in small-caps or mid-caps. For example, there is no large-cap stock in the hotel sector, consumer durables segment, etc.

There are only two large-cap chemical stocks versus 60 small-cap and two real estate large-cap versus 30 small-cap. Many such sectors have 10 times the number of choices in small-caps versus large-cap.

Moreover, the investable universe of small-caps has significantly expanded. In 2020, the number of small-caps with a market capitalisation of more than ₹2,000 crore was about 220– today, the number is 800, an increase of 4 times.

The largest small-cap used to have a market capitalisation of around ₹7,000 crore—today, it is around ₹30,000 crore.

Moreover, the weight of small and mid-caps in the market has increased from 20 per cent 15 years ago to 40 per cent - they have become too significant to ignore.

Small-caps and mid-caps are about $1 trillion each – quite large, even by global standards.

On valuations, the P/E (price to earnings) ratio of the small-cap index (Nifty Small Cap 250) is similar to that of the large-cap (Nifty 100) index, at around 19-20 times on two-year forward earnings (we have excluded loss-making companies in the aggregates).

However, small-cap earnings growth is projected to be 18 per cent for the next couple of years versus 8-10 per cent for large caps.

So, growth-adjusted valuations are not that expensive for small-caps. Moreover, with a canvas of 800-1,000 stocks, it is inaccurate to generalise and say that small caps are expensive.

Yes, many stocks have become expensive, but not all the 1000 stocks – there is ample scope for stock picking.

These factors make the small-cap segment a stock-picker’s paradise.

Moreover, investors have consistently made money in the past four to five years, and it will take a sustained fall for them to lose faith in this segment.

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Disclaimer: The views and recommendations above are those of the expert, not Mint. We advise investors to consult certified experts before making any investment decisions.