Why are mid, smallcaps underperforming largecaps? | Economic Times

The selloff in mid and smallcaps was more as a round of profit taking, which is good for the longer term health of the bull market, says Pankaj Murarka, Founder, Renaissance Investment Managers. What is happening in the broader market space? Warning signs were there since last week and to be fair they have not fallen too much from their top or even month to date. But there has been stark underperformance vis-à-vis the largecaps. What explains this?I would count this pretty much normal market behaviour we have seen over the last six months since February. Midcaps and small caps have been outperforming the large cap by a very wide margin and maybe rightly so because the growth recovery and the performance of a lot of these midcap companies has surprised on the upside, coupled with the recovery in the economy. Having said that, in a raging bull market like this, things do get over extended and we see the emergence of some degree of froth which happened in the midcap and small cap space. A shakeout is always good and healthy for the markets. I would think about it more as a round of profit taking which is good for the longer term health of the bull market. So net-net you are saying that there is no reason to panic or worry and this weakness and that this is not going to rub off on the large caps?We have had a parabolic move in the market over the last 15 months from the lows. Even the large cap index Nifty has more than doubled. Even the large cap indices go through a 5-10% correction. It will be pretty healthy because the market also needs to catch its breath. I would not read too much into a sideways move for a period of time or a price correction of 5-10%. Investors with a medium term view have pretty much remained in the bull market which remains pretty strong. The only caveat is that given the low hanging fruits in this bull markets have been taken off, investors should be conscious of investing into good quality companies -- be it midcap or small cap and avoid poor quality companies. So this is a correction that is taking place and is unlikely to be a repeat of what we saw in 2018?Yes I do not see that kind of a thing happening because 2018 was a different environment, where the economy was going through a difficult period and on top of that, we had a mini financial crisis which started with IL&FS default and snowballed into some sort of a financial crisis, spreading across some of the housing finance companies, finally ending with the capitulation of YES Bank. I do not see any of those kinds of things happening. In fact, if anything, the recovery is pretty strong in the economy. Now that different parts of the country are unlocking, I expect to see a strong resurgence in growth in the economy over the second half of this year and hopefully by the end of this year or early next year, probably 70% of India’s population would be vaccinated which effectively should get us herd immunity. Hopefully, next year should be a more normal year. The economy is on an ascending recovery curve unlike 2018 where the economy was on a contraction curve. I do not see anything of that sort happening. It won’t be fair to draw parallel to 2018. Everybody always says look for the quality winners, look for the men among the boys when it comes to the midcaps. How should one do that?Twenty-five-years and I am still learning how to do it. Essentially from our perspective, growth bias investors are looking for companies which can deliver superior growth. But what is equally important is the track record of the management -- whether they have delivered some healthy growth over the last five-ten years and which is why essentially we generally do not invest into IPOs. We are very selective about IPOs because these companies are new and do not have a long enough history of track record. But within the listed universe, there are large numbers of midcaps which have delivered very healthy growth over the last five-ten years and the outlook for growth for them remains pretty strong. On top of that, these companies are generating positive free cash flows and rewarding investors with dividends. These are the four or five filters that we broadly use while trying to identify potential winners within the midcap space. Have you kept completely away from Zomato?We have been early investor into one of the parent companies of Zomato, that is Info Edge and we are very happy with our holding there. We do not have direct investment in Zomato.Would you contemplate that or is it the valuations that are keeping you away?I must admit that the valuations are extremely rich and for an old investor like me, it takes a while to adjust to the new framework of valuation, the way all of these new age or new generation technology companies are being valued. It is not about India, but it is a global phenomenon how these companies are being valued. Investors are taking a slightly much more longer term view on these companies and their growth prospects and trying to value that growth on a much longer timeframe. We are happy to play through as I said with our investee company InfoEdge which is essentially the principal shareholder in Zomato. Having said that, there are many more technology companies which will get listed over the next six to 12 months and I feel pretty excited about this space as a whole because these are companies which undoubtedly will deliver superior growth over the next five, 10, 16 years. I am sure we will find our own stocks which will meet our framework of growth at a reasonable price and we would certainly look forward to investing into those companies. How are you approaching the pharmaceutical pack because according to one school of thought, after Covid, it has topped out?If you really ask me, the medium term view from our fund of view on the pharma sector remains positive. What we are essentially seeing are two or three broad underlying trends in the pharma sector; one still continues to be some degree of price erosion in the US generic space. So one, companies which are focussed on or where the business models are completely dependent on generic markets in the US, are getting impacted by that and I think that is what we saw in Lupin numbers as well. On the other hand, some of the Indian companies like Sun Pharma have made significant investments over the last five or six years in terms of pivoting their business to complex generics and speciality generics and which is where they are enjoying far better pricing power and they are reaping the benefits of that. And finally, I think we have seen some degree of disruption in the domestic healthcare space as well because of the Covid and that started normalising which is why first quarter of this year most of these companies have reported very strong growth in their India business. So I think it is a mix of all of these three and given these companies their business models are very heterogeneous so one cannot draw one single inference from all the results. Having said that, if you ask me about the sector on an aggregate basis I still remain positive from a slightly more medium term perspective. How have you used the numbness in the mid and small cap stocks in the last couple of days to your advantage?I must say not much because we have been fully invested so taking a slightly more medium term to longer term view, we have not been opportunistic enough to use that to our advantage. But we continue to remain invested because of the high conviction in our investee companies. How has your portfolio changed between March and now? In between, the Covid second wave hit us. Have you changed anything significant in the last three, four months in your top three, four holdings?We have tilted our portfolios a bit towards companies which will be beneficiaries of unlocking the economy. Some of these sectors which relate to retail or hospitality have been very badly impacted over the last 18 months because of lockdowns or for that matter even exhibition because theatres are closed and new movies are not being released. I believe that once we achieve complete normalisation and unlock the economy over the next three months, all these sectors will see a very strong resurgence in demand from consumers. From a slightly more medium term perspective, valuations in some of the sectors are attractive as opposed to a lot of other segments of the market where valuations are extremely rich. We have had some tilt in favour of some of these companies within these sectors.