Free run of midcaps over; multicap funds ideal now: Gopal Agrawal, Tata Mutual Fund

There should be earnings growth of 10-12% for our premium valuations to be justified, says Gopal Agrawal, chief investment officer (equities) at Tata Mutual Fund. In an interview to Prashant Mahesh, Agrawal says the free run on midcaps is almost over and returns from here on should be in the range of 10-12%.

Edited excerpts:

Sensex is up 22.4% since the start of the year and is trading at a PE of 24.12, a significant premium to its long-term average. Can these high valuations sustain?

The market is expecting structural improvement and lower inflation in the economy. For markets to sustain this valuation, the most important thing is that inflation and interest rate should be benign and there should be some earnings growth of 10-12%. The recent reforms measures by the government, in particular GST, will help to curtail fiscal deficit and improve tax collection, all of which is positive. The biggest worry is on earnings recovery. From the base this year, we should have 7%
earnings growth. And there should be 20% earnings growth next year, and if we get to get there, I think premium valuations can sustain.

Earnings growth has been slow to come by. Analysts have been revising earnings growth estimates downward every year. When can earnings growth catch up?

The earnings growth on aggregate basis was not coming primarily due to two reasons. One is NPA recognition in the banking system, and second is lower commodity prices for last fiscal. What has changed is that commodity prices have recovered and global recovery is far more sustainable, which will help earnings to move upwards. In terms of banking system NPA, I can tell you that fresh NPA formation is coming down. The only thing is that banks are recognising NPAs of the past. So, by first quarter of 2019, the worst in terms of NPA recognition will be over. We will have much favourable base for 2019, where we expect 20% growth on an aggregate basis.

Investors have made handsome returns over the past three years, especially in mid- and small-cap stocks. What returns should investors expect going ahead?

The free run on midcaps is almost over. The ideal pocket at this juncture is multicap funds. You should give more space to fund managers to pick and choose stocks. While returns in the past have been phenomenal, returns from here on should track nominal GDP growth, which will be in the range of 10-12%.

Its been more than three months since GST was rolled out. Have things stabilised?

We are seeing some signs of stabilisation already in the system. After first two months, where manufacturing growth was on negative, we are now seeing positive manufacturing growth for last month, which gives us confidence that things are now turning out to be normal. The government is also proactive in recognising the problem and helping corporates by making relevant changes. So, the worst is behind us.

What would be your approach to stock picking? What themes or sectors attract you?

I am very positive on the consumerism theme in India, which is a broad theme from where any discretionary spend, lender to the consumer, both are my favourites. There is lot of cherry-picking due to stabilisation in global growth and that is also supportive. We will pick up infrastructure-related stocks, be it road construction or power T&D stocks. Pharma has corrected materially. We have used this opportunity to go overweight on the sector, and we expect things to improve in this sector over time. IT companies are moderate growth sectors but they generate significant cashflows, which will protect the downside of the portfolio and cushion the portfolio in bad times.

Does geopolitical tension between North Korea and the US worry you?

I am not worried about such things. What is serious for the world market are the protectionist measures taken by various governments, which can have some impact on export growth. The way currency-related tensions are there is quite evident, which means many governments want to protect their industry.

Since August, we have seen FIIs selling, while retail investors are buying through mutual funds. What do you make of this?

FIIs were running significantly overweight on India and underweight on Brazil and China. With recovery in global growth, they have moved some money to Brazil and China. This is why they have sold from India, North Korea and Taiwan. This is a global reallocation of portfolios. They are looking at success of GST, banking NPA cycle to come to an end and earnings recovery to happen. These three things are on their watchlist and once there is visibility, they will be back again.