4 themes this midcap fund manager is betting on in first half of the year

“The overall mood is still a bit on the cautious side, But from the bottom-up driver standpoint and from a medium to long term standpoint, the view is still positive and the flows are a reflection of the same. Increase in inflows into midcap and smallcap funds tells me that the medium term outlook on equities or Indian equities continues to be very robust,” says Trideep Bhattacharya, CIO, Edelweiss Mutual Fund

The AMFI data has thrown up a mixed bag of numbers but one thing that stands out is that smallcap and midcap inflows are at record levels. Smallcap inflows have gone to Rs 2,245 crore in December as compared to 137 in November and similarly, we have seen record high numbers in midcap funds – Rs 1,962 crore for December and Rs 1,176 crore in November. What is your view on these kinds of numbers and this trend for investors?
The way I read it is that investors’ confidence in Indian equity markets, particularly from a medium term standpoint, is growing. Generally, when investors look to invest in markets, they first test waters with largecap or largecap-oriented funds and when the risk appetite tends to be little bit higher or their confidence in the economy tends to be a little higher and the outlook tends to be longer, we generally see the inflows into midcaps and smallcaps, particularly the midcap category grow over time.

I read this as a sign of increasing confidence of retail investors in Indian economy and the mutual fund market being the foster child of that, we are seeing the benefit of the same though I think the overall mood is still a bit on the cautious side, But from the bottom-up driver standpoint and from a medium to long term standpoint, the view is still positive and the flows are a reflection of the same.

ET Now: The entire inflow into equity has gone up three-folds but if we compare it with October numbers. there is a dip of around 21-22%. A lot of reports suggest that the second half of 2022 is where the inflation has started pinching the investors. That can either lead them to stop SIPs or maybe reduce the amount that they are putting into a particular fund. Looking at reduced inflows compared to October numbers, do you see this going down further in a couple of quarters?

Trideep Bhattacharya: I read the overall inflow number as a little bit soft. The overall inflow number is a reflection of investors’ appetite for equities, not just in India but globally with regards to what they hear and see in the form of headlines. When one sees too many recession and Covid related headlines coming out of China, one cannot help but be a little more cautious or careful and that is why we are seeing a little bit of money moving in the side lines, particularly because markets have done well.

We said at the beginning 2022 that this would be a tale of two halves, where we expected the first half to be fairly volatile/down and the second half to be reasonably robust and we saw pretty much the same script flowing through with Nifty down about 15% in the first half and 19-20% in the second half.

But the fact of the matter is that in the second half, investors saw good bit of returns come through which is why some bit of profit taking is reflected in the numbers that you quoted and the fact that inflows on a relative basis are still more sanguine in mid and smallcaps tells me that the medium term outlook on equities or Indian equities continues to be very robust.

Although these are month on month numbers, a lot of trend spotting is evident from these numbers. Even flexicap category and index funds have seen outflows. Looking at this particular trend, how are you able to gauge the 2023 start when it comes to investment in equity mutual funds?
Our theme for 2022 was a tale of two halves. Our theme for 2023 is that we will probably face recessionary conditions before a rebound. In other words, in the first half, not just in India, but globally, if one were to summarise the equity market environment, in which we will have to play around, it will probably be recessionary conditions about whether you look at the United States, Europe and how China evolves overtime.

As we get towards the back half of the year, where we see the economy bottoming out to a certain extent, inflation peaking out, growth numbers stabilising and probably better conditions from a news flow or from a headline standpoint. We should be prepared for a reasonably volatile first half followed by rebound or a positive back half of the year.

Do you think a weakening rupee is going to be the main factor behind this volatility that we are talking about? Fiscal deficit and trade deficit are a problem that is cropping up for us?
While that would be one of the main things that we are seeing, it could be one of the stumbling blocks for the market.

Over the last six months, equity markets globally have seen 500 bps rise in interest rates whether it is the United States or more generally cost of capital globally. The impact of the same in the economies to various degrees is yet to be felt. In the first half of the calendar year 2023, we will see some of the impact of the rate increases flow through the economic growth or economy in general and that is what we are mindful of as in the first three to six months of 2023.

We are not necessarily saying that the world will get into a recession; may be certain countries, certain geographies will but in general, we will see a bit of growth moderation, particularly in the first half of the year as a result of rate increases that we have seen in the back half of CY2022.

Talking about fresh investments,I really want to know the sectors that you are bullish on in the first six months. What are the sectors which despite this volatility on your radar are going to perform very well? If investors want to go bullish on these sectors, can they try it out?
Having been a proponent of long-term investing, from a sectoral allocation standpoint or thematic standpoint, I would not look at six months in isolation, but use these six months as an investment opportunity in tranches.

All I am trying to say is that in the volatile first half, one should invest in tranches and there are four or five themes that I would be bullish on investing in from a 3-year perspective.

The first theme in that context that I would like to talk about is after a decade or so, we are seeing good semblance of capex cycle coming through in India and we will see the private sector driven capex cycle come out over the next two to three years. The investor should use the first three to six months to position themselves accordingly for this to play out, that is number one.

Second, after almost four to five years of clean up, whether it is with regards to asset quality or liquidity, the banking sector is looking set for better growth rates and better profitability given that overall the asset quality fears have receded. The second theme would be positive on lending financials overall from a two to three years perspective.

The third theme that I would like to highlight is basically idiosyncratic country specific themes like indigenisation of defence. That in my opinion, is close to a decadal theme, which will play out with regards to companies that we can lay our hands on.

Coming to the fourth theme, beneficiaries of China plus one theme have now moved on to Europe plus one theme. These are very specific to India but could benefit the Indian manufacturing sector and the allied companies could see a meaningful spurt in growth rates over the medium term. Those would be a few areas I would be positive on, particularly, if I see volatility in markets.

After a very long period of underperformance and may be negative returns, some kind of a relief is coming up in the midcap and smallcap sector. Should investors actually book their profits because they are seeing this underperformance for a very long time and now if they are getting any profit on their portfolio, should they just wind it up and diversify themselves in some other category? Or should one just stay put in midcaps and invest more?
Overall, this is a relatively tough question to answer, particularly from a short-term standpoint because we expect the market to be quite volatile. In that context, I would suspect that all types of funds have generally spot on asset allocation and overall for midcap investors with five to 10 years’ time frame of investing, should probably stay put in the fund because in the next five to 10 years, the bottom-up drivers will play out and would be positive for Indian equities over that time frame.

In that context, particularly in the mid and smallcap categories in the first three to six months of the year, if they are under invested, take advantage of some of the volatility that we might see during this course to add to the overall exposure. If investors are overexposed or if certain set of investors are over exposed to midcaps as a category, they could consider profit taking from a short term standpoint.

But generally midcap investing would encourage viewers to take a reasonably long-term view of five to 10 years. So, over a 5-10 year period, one should stay put rather than run away from it.

Your flagship scheme which is going on for almost 15 or more years. When you sit down to plan a strategy with your team of fund managers, how do you plan to beat the volatility in the midcap space? What are the sectors in midcap space that you are banking on?
Over the last 15 years, the midcap fund has generated close to 18% CAGR. A disclaimer is future returns may not be similar to previous returns but a 15-year time frame is a reasonably long period to give the investors a bit of gauge as to what kind of returns people have seen in the past in that context so that is the starting point.

Generally one of the scare factors with regards to midcap funds is the volatility. The way we at Edelweiss take care of volatility is not just to focus on the short term which is the next three to six months but we in the portfolios where we see potential earnings upgrade come through from the next two to three years standpoint. Generally what we have found is that by putting an anchor around a three-year horizon the outlook tends to be more stable, the view tends to be more sanguine and you know to give a better opportunity to investors to actually play or benefit from the same.

The other thing to keep in mind, particularly from a midcap investing standpoint is that midcap as a category is basically full of successful smallcaps and aspiring largecaps. In many ways, the entire market cap spectrum captures the sweet spot of the listed space quite nicely and hence from that perspective, industrials or capital goods or financials or for that matter defence or China plus one, are some of the areas that we are positive on in our funds keeping in the medium term in mind which I just highlighted and also we think that quite a few companies in India from a bottom up perspective are in the right spot to benefit from this over the medium term.


Talking about individual financial portfolios, is it the time to actually look into each and every investment that you have in your portfolio, see the risk reward ratio and then move on with it or maybe stick to it? Is this the time when you need to re-evaluate every investment instrument that you have, looking at the volatility and the uncertainty that is getting predicted?
Investors should do this on a periodic basis, but a few guiding principles might come in handy. The first thing to keep in mind is the point that I highlighted that the near term looks like a little volatile recession before rebound in 2023, maybe the first three to six months and use this as a time for volatility and that is one thing to keep in mind.

The second thing to keep in mind from an asset allocation standpoint is that while inflation will come down sometime in the first three to six months we have entered from a medium term standpoint inflationary environment, this is different from what we have been used to over the last 10 years and generally in inflationary environment as an asset class equities and gold which should be part of investors’ portfolios who are looking to do asset allocation.

The percentages can differ and based on the investors’ appetite and what not, those would be some of the guiding principles that I would need as they evaluate their asset allocation and investments at this point in time.