Look at large caps, hybrids and multi-asset funds in current market: Nippon India MF CIO

For Sailesh Raj Bhan, one principle has remained constant through market cycles: don't overpay for growth. "Your starting price determines longer-term actual investing returns," emphasises the Chief Investment Officer (CIO) for Equity Investments at Nippon India Mutual Fund, drawing from his nearly two-and-a-half decades of experience.

Overseeing assets worth around Rs 83,000 crore across three funds, including the five-star rated large-cap and multi-cap funds, Bhan avoids taking blind risks that might seem appealing during bull markets but fail to enhance returns over time. His focus remains on purchasing growth companies at reasonable prices.

In this interview, Bhan explains his investment philosophy, how mid and small caps still carry inflated valuations and the importance of asset allocation for investors. Below is the edited transcript of our discussion.

You've spent over two decades navigating the ups and downs of the equity markets. If you could go back in time, what would you tell your younger self about investing, and what would your younger self be surprised to learn about you today?

That is an interesting question. My simple response is that you should embrace volatility, as it ultimately determines the type of returns you will earn. Instead of being caught on the wrong side of volatility over a market cycle, one should take advantage of it. Equities allow you to position yourself well in different market conditions and take advantage of extreme price fluctuations.

Over the years, how has your investment philosophy evolved to manage large equity assets spread across diverse funds? Are there any principles you swear by that haven't changed?

When you start managing money, you adjust and tune yourself to reality. I think a few core principles don't change with time, and one for us has been to not overpay for growth. Be careful about what you're paying for because your starting price determines longer-term actual investing returns.

The second step is to understand your risks; taking blind risks only intensifies the challenge. It looks appealing in a bull market but does not enhance returns over time. As a philosophy, we have always focused on purchasing growth companies with our underlying framework of buying at a reasonable price. We don't like to overpay for growth disproportionately. A few principles like this have allowed us to live through different cycles and capture market returns. As discussed before, I think if there is a single tool that can enhance your returns, it is volatility. The market fluctuates, testing your conviction, but the results can be very good if you understand the investment and industry.

Has your investing framework and strategy remained the same or evolved depending on the market dynamics?

The core framework has remained the same because, at the end of the day, we are doing two things—choosing good businesses and paying for that business. In that sense, the fundamental framework has remained the same. However, the extent to which you can include cyclicals in your portfolio has changed.

For example, when you look at cyclical investing, it can go through large cycles, and our idea is to choose the leaders there because you don't want to add one more layer of risk to fragile balance sheets. So, those kinds of nuances do come about over time. But what lies at the core is buying businesses at sensible prices and thinking medium- to long-term in everything you do.

Geopolitics, domestic slowdowns, market corrections—the current landscape isn't for the faint-hearted. What's your outlook on the Indian equity market in this perfect storm?

The market has done exceedingly well in the last three to four years. Even if we look at the previous 12 months, it doesn't appear cheap. Since the starting valuations are high, it won't be an effortless market for investors.

But our case is that there are still areas of opportunity. The first is the domestic slowdown we've seen in the last two quarters, which presented challenges due to the elections and extreme weather conditions in many regions. This impacted the growth. Further, we have been sitting on very high margins from last year. The combination has hurt, but we think earnings, which were weak in the first half, should improve. The entire investment cycle is in front of us. Global growth, which has faced some challenges in the last two to three years, is now in a better space. So, I think overall earnings recovery should get better. But it will not be immediate from where we stand today because it's a journey. I believe that change is what markets will look forward to, and if you can get the earning cycle right, I think you will get the markets right from a medium-term point of view.

Do you see the recent market corrections as a much-needed reality check, or are we still walking on thin ice with valuations?

I think the single biggest thing that has happened positively for investors has been the recent correction. The kind of euphoria that was being built in many segments of the market was unrealistic. When we meet investors, we observe that they have unrealistic expectations for returns due to the positive performance of the last three years. The expectations are very high for what they can earn from stock markets, and I don't think that's possible. Due to this correction, people can reassess where they invest, how much risk they are willing to take and whether they want alternatives to equities, since you can allocate to hybrids and other asset classes. I think the recent correction has at least given investors time to rethink the risk they are taking.

The bull market has resulted in a significant misallocation of capital, with investors flinging money at any stock, leading to the excesses. We must understand that it required $15-20 billion of selling from the foreign institutional investors in the large-cap stocks to have that excess go away. That kind of selling has not happened in mid and small caps, so excesses still remain in both these segments. Some collateral corrections have happened, but we have yet to see attractive prices in mid- and small-cap components. But large caps appear to be sensibly priced for at least earning led kind of returns for investors.

What is the ideal strategy for the investors at this juncture?

It's challenging to time the market, and investors should follow their asset allocation. Over the past three years, the extreme performances in certain market segments, such as mid and small caps, have dramatically shifted the weights within the portfolio. In fact, large-cap ownership in most portfolios should have come down dramatically, and we can sense it from the flows that come into mutual funds, which have been much less on the large-cap side in the last three years versus what has been in the mid- and small-cap side. So, I think it's more a question of getting the asset allocation right regarding where you want to put it and where you stand today. An incorrect allocation for a different market yields inferior results. Therefore, today's simple approach suggests investing in large caps with incremental capital is a sensible strategy.

Investing in hybrids and multi-asset funds in the current market environment may be a reasonable risk-reward strategy. Because of their successes, I think these are the three spaces to be in and a time to reassess whether you have overallocated to small and mid caps. While their outperformance would have benefited you, leading to a higher than-usual overall allocation to mid and small caps, this may be the time to rebalance that. If investors have long term leverage commitments like home loans, some of the fantastic returns of equities of the last three or four years can be booked to reduce leverage, which is outside the system. So, it becomes very good for an investor's portfolio from a long-term risk-reward perspective.

Also read: Markets not cheap, expect slightly lower returns over the medium term: DSP MF's Vice President