S Naren, CIO, ICICI Prudential AMC, explains to ET Now that after a six-month correction and not even a 12 or 24-month underperformance, you cant say we have reached the bottom in small and midcaps. Naren, however, says if you had to do SIP investing for 10 years, there is nothing better than small and midcaps.
You have been saying that post this selloff, there would be attractive opportunities in midcaps and smallcaps. How should one be looking at this midcap meltdown?
Is it a meltdown? I do not know. One-year returns are pretty good and that does not tally with a meltdown. Our base was in the period from 2013 to 2016, commodity prices had fallen and interest rates had also fallen. At such times, midcaps and smallcaps are big beneficiaries. Coupled with that, there were huge inflows into midcaps and small cap as a category in mutual funds, AIFs, PMSs, etc.
The result: most of the mid and smallcaps started to have trailing PEs of 40 and 50 and that meant that the mid and smallcaps had become seriously overvalued.
The process of correction of the over-valuation is on and we have learnt from past experiences that as fund managers we want the top-to-bottom of the cycle to happen in six months. But at times it takes five or six years, It is too early to call the bottom at this point of time. We continue to think that relative to largecaps, mid and smallcaps are still pretty unattractive because you have just had a six-month correction and not a three-four year correction.
Are you hinting that this correction in mid and smallcaps is going to last three to four years?
It is not that. Largecaps are so attractive relative to midcaps and small caps at this point of time that if you look at the quantum of money which has come into largecap funds as compared to that in midcaps and small caps, there is scope for relative underperformance from here.
As a matter of principle, over a long period of time, I have looked at annual reports as and when they come in this season but in most companies, even today the trailing PEs of many of the small and midcaps are in the 30-40-50 range. It is not as if after this correction mid and small caps have become cheap. It is not as if the market needs to come down in a straight line. I believe that periodically, there should be good rallies in mid and smallcaps and both mid and smallcaps are clearly todays bag. When we are looking at it, they are very oversold. Thus, there was a scope for a good pullback rally in both mid and smallcaps and we saw it.
But for us to say that after a six-month correction and not even a 12-month underperformance or 24-month underperformance, we have reached the bottom in small and midcaps, is not right. In fact, largecaps have been meaningfully underperforming all the way from 2013 till now. If you look at the four to five year underperformance of midcaps and small caps against largecaps, you will find that largecaps have meaningfully underperformed and the last six months or one year is not an indicator of what has happened in the last five years.
That is why as a house I would say we were about one year early in this call but we held on to the call and now it is working. I believe there is still scope for underperformance of mid and small caps against largecaps.
People ask me what do you do for SIPs over the next five to ten years? We are believers in mid and smallcaps on an SIP basis over the next five to ten years. We think that is the way to go starting now. That is the right way to do long-term investing.
What is the good benchmark to see and assess how much of the bloodbath has already been played through?
Actually the way we look at it is that historically the trailing price to PE of midcaps has been lower than many of the largecap indices and consequently what I would like people to do is to take a stock, look at the trailing PE and then to check in their balance sheet whether the profits are showing up as cash flows or are going into working capital or capex.
If you have trailing PEs of 30 to 40 on most companies or you have most of the earnings going into capex and working capital, I would say there is scope for correction. It is difficult to time the bottom but the top itself was in January. We are actually just four months from the top at this point of time. To me, bottom does not happen four months from the top. Having said that, if you had to do SIP investing for 10 years, there is no better thing than small and midcaps.
As a fund manager, are you beginning to cull out that list where you have seen a fair amount of price and PE damage within the small and midcaps? Are you already starting to nibble over there or do you think right now one should focus on only largecaps because they are the ones which are going to dominate the market in the next few months to come?
We would be trying to nibble in one or two stocks and trying to trim may be slightly more even today. If you look at the quantum of midcaps and smallcaps and the kind of liquidity those stocks have, it is not easy for a big fund to say that we will come out of all the small and midcaps in one day!
But, after this meltdown is there scope for some nibbling to be done in some select midcap and smallcaps? The answer is yes. There are sectors where there have been positive cycles and in wherever there has been a big positive cycle, it is now time for nibbling.
On the other hand, there are sectors where there has been no positive cycles, like banks or real estate. In those cases, I would say that because the super cycle itself has been so negative, the small and midcaps have corrected a lot and therefore there are opportunities in sectors where the cycle has not played out and that is the area where we are looking at nibbling at this point of time.
On the other hand, if we are trying to book profits, there are a number of sectors with a fair amount of big boom like NBFCs, where there is still scope to trim even today. Most of the stocks are 600-700% higher then what they were in 2013.