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Midcaps are costlier than largecaps in all sectors: S Naren, ICICI Pru MF

ET Bureau|
Updated: Sep 27, 2018, 09.07 AM IST


  • We are positive on power, deposit-taking banks & exports & manufacturing.
  • Periodic corrections like this give us time to accumulate above stocks.
  • Market has not fully priced in all the risks.
The markets are fully valued, with large caps better placed than mid or small-caps. Power, exports, manufacturing, and strong deposittaking banks are good investments themes, S Naren, CIO, ICICI Prudential Mutual Fund, tells ET in an interview.

Edited excerpts:

After the sharp correction in the markets after the IL&FS fiasco, where do we stand on valuations?

Our view is that the markets are fully valued. Having said that, largecaps appear less valued than small caps and midcaps. If you look at the global environment, interest rates in the US are going up and crude oil is also rising. I don’t think we are in an environment like 2013. But once the current volatile phase is over in the next one or two years, things will be good after that.

Crude oil prices are on the rise and are well past the $80 per barrel mark. Are you worried?

There is lot of worry about crude prices in the near term, say, three to six months because of two reasons. One, Iran sanctions and other, in US there are many places, they can’t transfer the oil produced. I don’t think the market has fully priced in all these risks, but it doesn’t mean that the market will fall in a straight line…. we have a fund called Balanced Advantage Fund and if you look at the August-end portfolio, we are at 32% equity weightage. The range for that product is 30% to 80% and we are at the lower end of the product. That means equities are fully priced.

Which sectors you are most bullish on in such an environment?

We’ve been positive on power. The reason being that in the past 10 years, you have had virtually no new companies coming up. Half the existing companies have exited. There is a very good consolidation in a product whose demand goes up 5-6% each year. Even renewable funding has tightened today. The ability to create new capacity in power is coming down. That’s one sector we clearly like.

Second, when interest rates go up significantly, the significant gainers are strong deposit-taking banks. The strong deposit-taking banks were all stuck with the NPL problem, but if you have a fantastic deposit engine today, then you get money in CASA, the margins you make today are much higher than what they were two years ago when bulk rates were much lower. That’s the second area where clearly things are improving.

Third theme we like is anything to do with exports and manufacturing. Simply because one year ago the rupee was at 64, today it is at 73. When that’s the case, imports are 15% costlier, for anything you manufacture. That’s a big benefit to every manufacturer.

The 10-year benchmark has moved to 8.1%. Do you think that interest rates will continue to go up? Is there a possibility of a rate hike in the upcoming policy meet?

Crude prices continue to rise and are past the $80 per barrel mark. If crude oil prices continue to go up, the 10-year will continue to go up. If you believe crude prices will go back to 70, then debt yields will go down. When crude and US 10-year is going up, then Indian bond yields are bound to go up. There is a possibility of a rate hike.

The government has not cut taxes on petrol and diesel. They continue to go up, in line with the rise in crude prices this time. Yet stock prices of oil marketing companies have corrected sharply?

The government has handled it very well in terms of policies so far but the market has its own set of worries. I attended a conference where the finance minister said that until non-oil taxes go up significantly, there is no choice for us as a country but to have oil taxes. It’s absolutely right. If you look at it, the government has been committed to controlling the fiscal deficit which has come down significantly. Current account has only deteriorated recently and that’s substantial because oil went up and in electronics, ‘Make in India’ hasn’t worked so far. So, I would say that the government has handled things well but there are fears. Investors fear that in the period ahead of the elections, oil marketing companies will not have marketing margins. The market is worried; it can last for maybe 3-4, or even 6 months.

There has been a lot of volatility in bank stocks. Is the worst is over there?

If you see our portfolio, we have increased exposure to the strong deposit-taking banks, the retail-cum-corporate banks. That segment we have increased our allocations over the past year. We think strong deposit taking is a massive benefit in this environment with crude oil prices going up. Periodic corrections like this give us time to accumulate such stocks.

You were very early to pick the trend that large caps will outperform the midcaps, which eventually happened. So now we see a lot of midcap/small caps are down 25-50%. Will that trend reverse and when?

People want cycles to restart very quickly. Past experiences mean that cycles take time, for example, TMT theme 1997-99 didn’t come back for a long time and infra theme between 2004 and 2008…I would say that there was only a mini-theme later. If you look at small caps and midcaps, there was a big boom between 2002 and 2006 and the next boom started only in 2014. People forget that there were big gaps in between. Due to that, our view is that it will take some time.

Look at midcap valuations today. Still midcaps are more expensive than largecaps in every sector, then why would I take midcaps in a rising interest-rate scenario? Rising rates affect the bigger companies lesser than midcaps as they borrow much lesser than the smaller companies. Why should I pay higher PE ratios for companies that are more vulnerable?

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