The views expressed here are of Anil Sarin, chief investment officer of the global asset management business at the Edelweiss Group.
The CNX Midcap index has fallen 29% from its intermediate top of August 5, 2015. Despite that fall, it is still delivering roughly 10% positive returns over the previous 12 months. This is better than the performance of the NIFTY which has delivered negative 0.6% returns over the previous 12 months.
When we compare the performance over longer periods of time, mid-cap stocks deliver slightly higher returns than large caps. This follows a pattern - during bear markets, mid caps fall more than large caps. And in a bull market they rise faster. In other words, mid caps are more volatile, but they usually deliver higher returns to compensate for higher volatility.
In the current volatile environment, there are creeping doubts about the sustenance of the bull market itself. However, we feel this is a temporary dip and the bull market will continue, for the following reasons:
- India provides growth in a world starved of growth.
Unlike most other emerging markets India has relatively lower dependence on exports. So it is expected to suffer less from the ongoing slowdown in global trade. Moreover, sectors like infrastructure, defence and railways provide ample scope for growth that is completely delinked from global conditions. As such the recessionary trends of the world will have lesser impact on India, and global investors will continue to favour India.
- Asset allocation towards Emerging Markets (EM).
There is a fear that global investors will shun EM as an asset class. But it is our understanding that the proportion of capital committed to EM (or for that matter any other asset class) changes only very slowly over time. What changes is the inter-se allocation within emerging markets. Since India is a net beneficiary of the commodity price collapse, and is also among the better managed among emerging markets, it stands benefit from such a re-allocation.
- Preference for financial assets.
Within India, real assets like gold and real estate are gradually losing their charm and most retail investors increasingly prefer to invest in financial assets. This is quite evident in the rapid growth of bank deposits, as well as in the increasing assets of mutual funds.
This trend is consistent with the experience of all developed economies where the share of financial assets rises in line with the level of development. For the next few years, real estate and gold are not expected to outperform, and this will provide supply of funds for equity markets.
- The government’s rising preference for equity market investing.
The NDA administration has already permitted provident funds to invest up to 5% of their assets into the equity market and there is expectation of this figure rising further in times to come.
- India’s twin windfall gains.
Thanks to a sharp fall in the price of oil and gold, India’s export bill has been cut substantially. This is resulting in a temporary windfall.
Secondly, due to fall in prices agricultural commodities, the government has very little pressure to increase minimum support prices of food crops. This is resulting in a second windfall.
We like the fact the government is using these twin windfalls to shore-up infrastructure spending and also to repair the broken balance sheets of public sector banks. Once these two sectors start performing well, Indian economy will enter a period of sustained GDP growth.
These bullish arguments work equally well for both large and mid caps. Within this overall positive scenario, a portfolio of well chosen bottom-up stocks should perform much better than the average index. We have discovered that over the longer term, bottom-up stock picking works much better than market-cap based investing. This was so even when the investment was made at the levels near the peak of the previous bull market top (early 2008).
For an investor who entered the market in early 2008 (the previous bull market top) the overall equity market index delivered a total return of roughly 60% till April 2015. The top performing mutual funds delivered a 160% return over the same time period. But there were more than 115 stocks that went up at least 10 times from the previous bull market top.
This just goes to show that over the longer term equity markets delivers superior returns (remember capital gains are currently tax free in India). And it further goes to show that bottom up stock picking can deliver significantly higher returns than the broader market.
As such we remain sanguine about investing in mid caps at the current levels.
