Look at largecap, midcap & smallcap through same prism: Navneet Munot

In the last few years, we have been at the trough of the investment cycle. We were in a cyclical slowdown. Over the next three-five years, the rally is going to be more broad-based than what we have seen in the last few years, says Navneet Munot, CIO, SBI Mutual Fund. Excerpts from an interview with Nikunj Dalmia of ETNOW.

How do you see markets moving globally as we start a new year and a new decade? Globally, market rally has been facilitated by cheap money? Where do you see it going from here?
Globally, the cheap money has been facilitated by the central banks. Central banks globally have followed an extraordinarily accommodative policy running negative interest rates at several parts of the world. The total balance sheet of US Fed, ECB, Bank of Japan, Bank of England and maybe a Swiss National Bank was like $3-3.5 trillion, that is today more than $15 trillion. . A lot of private debt has become a public debt because it is residing in the central banks’ balance sheet.

Money becomes cheaper when you are discounting your cash flows at a zero or a much lower rate and then you put the equity risk premium. The valuations in the equity market can go up as has happened in some or the other markets. In case of the US, another interesting trend is the rise of some of those great companies in the digital space. Facebook, Amazon, Alphabet, Microsoft and some of these companies have done extraordinarily well over the last several years and in the US particularly.

That is why there are strong returns on capital by these companies to the shareholders. The buybacks plus dividend payouts in the last 10 years would have been more than $5 trillion which is more than 20-25% of the market cap.


Lower interest rates and loose monetary policy have played a very large role in the way stock prices or asset prices have gone higher and more than earnings, PE multiples have got re-rated?
The earnings growth in some of these markets have been very good. In fact, when you look at the returns of Sensex, Nifty and some of the other indices, there are sets of companies which have delivered extraordinarily good return even in a growth environment which has been lower than the long-term average. Maybe there are new business models, maybe there are managements who have been able to deliver or find ways of growing profitably during this period.

Interest rates are going to be the biggest part of this jigsaw puzzle. Interest rates have come down less in India but globally, the decline has been nothing short of a precipitous. Interest rates cannot go down more than this. The 10-year paper in 1999 was at 6.4. We are starting the decade at 1.92. World’s most traded instrument has taken a knock of more than 4% or 400 bps. If interest rates do not continue to decline at the same rate, what happens to equity returns?
Globally, investors have to moderate their return expectations going forward. You will have a very limited amount of re-rating of the market. Returns have to be driven by the normalised earnings growth. Also keep one thing in mind about the US markets. Their profit margins are close to at an all-time high. There is a re-rating of the market and profit margins which are already at an all-time high. Whether that can sustain is something that we need to watch out for.

You cannot get further support from the monetary policy that is for sure. My view is that from here on, fiscal policies are likely to play a bigger role. Maybe Germany will start. It will be done by several other developed markets where fiscal policy will play a bigger role in building new sustainable infrastructure.

Look at climate change, look at the condition of infrastructure in developed countries. A huge amount of investment can take place. And how will this be funded? Pension funds are investing in richly valued equities and extremely richly valued bonds today. If you can provide them a 20-30-40 year good quality infrastructure asset and deliver a high single digit return, they will be very happy.


In China, thanks to big investments in the last several years, a lot of capacity has got created in terms of building an infrastructure that can be utilised by several countries. My view is that capex cycle may come back over the next 10 years in the world. This will be a good quality growth even for the equity market not driven so much by cheap money but more by delivering growth which creates jobs and which in turn improves productivity and ensures sustainable growth.

It is said that mean reversion is the biggest truism in capitalism and market investors like you who have seen decades and decades of market cycles would admit to it. Where do you think mean revision is due in this market? Where could price wise or time wise correction take place or perhaps both?
We have seen that around 1999, 2000, IT and consumer companies were trading at higher valuations and we saw a mean reversion in the PE ratio in the valuation over the next several years. We keep having this debate internally in our office every day that several of the high quality businesses with higher certainty of growth, great management and very good governance, are trading at very richly valued premium.
But we have also seen that markets often under-estimate the longevity of growth and the ability of these management to keep re-inventing themselves and identifying new markets, new territories, new products, new ways of doing business and new ways of expanding their mode. You would like to remain invested in some of those managements, even if the valuations are slightly higher. Having said that, there are a lot of other businesses which today are not in favour simply because the economic growth is at 4.5%.

Over the last few years, we have been at the trough of the investment cycle. We were in a cyclical slowdown. We have seen huge challenges in corporate lending. We have seen sector level challenges in telecom. Several of them are on the cusp of a revival and over the next three-five years, the rally is going to be more broad-based than what we have seen in the last few years.

2015 to 2018 was dominated by smallcap stocks but now the focus is on largecap or mega cap stocks. Every time, there is a displacement in the economy, the big players become bigger and that is where the dominant share moves. If we are going through an economic displacement and slowdown, the big players will become even bigger. Why should one focus on small and midcap stocks?
First of all, I do not think an investment philosophy depends on the market capitalisation of the company. There is largecap, midcap and smallcap. One looks at the company from the same prism. As I mentioned earlier, you look for a good business, good management and a reasonable valuation that does not change. What happens in case of mid and smallcaps is that the universe is very large, your opportunity of bottom fishing is much larger because you have top 100 companies that are largecap, next 150 in midcap and everything else is smallcap.

Let me give you an example. Bajaj Finance has been doing well for the last few years. 10 years back, it would have been a smallcap, which became a midcap which became a largecap. Today, it is a mega cap stock. Some of the stocks that have done so well for us were smallcaps earlier. They have become largecaps in the last 10 years. I do not see any reason for the next 10 years to be any different.

One has to look at a business regardless of whether it is a largecap or a midcap or a smallcap today. The equity universe is very large and maybe out of those couple of hundred stocks, if you identify five, then the universe is very large.

I also want to mention one thing; Over the last several years, markets have always been paying a premium for the right reason to size and stability. To me, disruptions are underway both locally as well as globally. It is equally important that you look at the nimbleness and agility of the management.

If a large company has got nimbleness and agility, it will continue to do well. But history is littered with several examples where with size has come complacency and with success, a lot of complacency. One has to look at whether the management is complacent or paranoid enough to keep re-inventing themselves.

Could you identify two or three trends which will continue and two or three trends which are small but can become big? Your views on clear winners and future winners.
The runway of growth in India is very long over the next several years. Just because the economy has not done well in the last one or two years and the overall number of companies that have done well have shrunk, it does not mean that this trend is likely to continue. The trend can change, growth can become more broad based. A year or two back, there were hardly any insurance companies or asset management companies that were in the listed space. Even NBFCs and HFCs are struggling. Some of the biggest wealth creators have been in that space. I am giving these examples to showcase the growth potential across all sectors.

You talked about the consumption and the higher valuation of several companies in that space but there are so many niche areas where the total size of opportunity is large relative to what it is today as India grows from a $2.5-3 trillion to a $5 trillion economy.

If we are able to pull millions of people out of poverty to a consuming middle class and part of the middle class to an upper middle class with an ability to consume various products, then you are going to create several categories. Who would have thought 10 years back that an innerwear company will have a market cap of a couple of billion dollars?