'India in a favourable position despite elevated valuations'

Summary: Amid the Indian equity market’s high valuations, we caught up with Mahindra Manulife Mutual Fund’s fund manager to understand her views. The conversation also touches on her investing strategy and key lessons from her fund’s recent underperformance.

Valuations across the market look stretched, especially in the mid-cap space. That has left many investors wondering whether the rally has run its course or if Indian equities still have some fuel left. To get a perspective, we spoke with Kirti Dalvi, Fund Manager at Mahindra Manulife Mutual Fund.

Dalvi, who co-manages the Mahindra Manulife Mid Cap Fund, admits to being cautious in such an environment. At the same time, she remains optimistic about the Indian economy and market. In her view, India is among the most attractive economies right now, backed by a mix of domestic and macroeconomic factors that are driving high growth with relatively low volatility. As a result, valuations will naturally remain inflated.

In this interview, Dalvi also breaks down her investment philosophy, how she is identifying opportunities in an expensive market and the lessons learned from her mid-cap fund’s recent underperformance.

Valuations across the market look stretched after the strong rally of the past few years. How do you see the market from here? Does the high starting point make you cautious, or do you still find reasons to stay constructive?

I agree that valuations are currently elevated, not only in India but also in several global markets. Does that make me cautious? Of course, yes, on a few stocks or sectors trading at high valuations, where the rally has already happened. But I would also like to add that we should generally remain cautious when making investment decisions, regardless of the market phase.

That said, my constructive view hasn't changed, despite the significant outperformance we've seen over the last year or so, particularly in the mid-cap space. If we step back and look at the broader factors, India is currently in a favourable position. We have seen double-digit nominal GDP growth, a well-functioning democracy, positive demographics, stable policy reforms, improved infrastructure (both digital and physical) and most importantly, a rising entrepreneurial class.

Add to this some supportive tailwinds, such as lower oil prices leading to lower inflation and structurally lower interest rates, and we have strong catalysts for growth. The confluence of these domestic and macroeconomic factors makes India one of the most attractive economies globally and hence markets, albeit with valuations that are built into growth.

We're also on the cusp of a major energy transition. The credit-to-GDP ratio is expected to rise as financial penetration improves, and the share of manufacturing in India's GDP is likely to expand significantly. All of these point to high growth with relatively low volatility. In such an environment, especially with falling interest rates, higher valuations and elevated P/Es are natural.

So, despite elevated starting valuations, given India's growth potential, I remain very constructive on the economy and market.

Regarding your investment philosophy and style, would you describe it as more bottom-up stock picking, or do you also bring in top-down themes when building portfolios? Could you elaborate on your investment style and strategy?

My approach is primarily bottom-up stock picking. When you aggregate those stock-level decisions, it may naturally lead to sectoral overweights or underweights. Top-down themes, on the other hand, are primarily useful for scanning broader, sustainable business opportunities. Macro factors are certainly important, but within the attractive sector, selecting the right company is crucial to delivering better performance.

Regarding my investment style, I prefer companies with leadership in their respective sectors and those that possess differentiated advantages, such as niche technology, cost leadership, product scalability or a diversified distribution network. I also examine turnaround candidates with a strong potential to generate higher cash flows, particularly where structural shifts in the business model or management changes create new growth opportunities.

Evaluating all these factors helps me build a portfolio that is both robust and forward-looking.

In the current environment, where everything looks expensive, what is your process for finding businesses that are still worth adding to the portfolio?

In expensive markets, the differentiating factors become even more critical. First, you need to be convinced about the company's overall business theme. Then comes the assessment of the relative competitive advantage the company enjoys compared to its peers, and how much of its growth is already priced in at current valuations.

The most critical factor in such environments is the downside risk. Whenever I build an investment hypothesis, I start with the fundamental question: Why am I investing in this company? That hypothesis has to hold true not just at entry, but also as you monitor existing positions. If the original rationale begins to change, you need to reassess.

With mid-cap companies in particular, they are often in a high-growth phase, making it essential to strike the right balance between potential returns and inherent risks. This balance, along with continuous evaluation of your investment thesis, is what helps mitigate downside risk in a high-valuation environment.

When it comes to high P/E businesses, what conditions around growth, visibility, cash flows or balance sheet strength make you comfortable taking that call?

Firstly, if you are paying for a high P/E, it ideally must be backed by high growth and strong visibility; these are non-negotiable factors. But what is equally important is the sustainability of that growth and the timeframe over which it is visible. Are we talking about two years, five years or 10 years? Because while the long-term story for many companies may look good, what really matters is how visible and sustainable the growth is in the near to medium term.

I also closely examine relative valuations, both in comparison to peers and against the company's own historical track record during similar growth phases. Has the company experienced cyclical periods before, and how were its shares valued during those periods? That comparison gives useful context.

Another key factor is whether the levers of growth are intact or undergoing change. Often, when a new concept or technology emerges, the first movers enjoy higher valuations. But as the idea gets replicated and competition intensifies, those benefits diminish. Just because one player enjoyed high multiples in the past doesn't mean similar valuations will automatically flow to second-tier or third-tier companies, unless they bring something truly niche or differentiated. So, I evaluate these businesses fundamentally first, and only then justify their valuations.

Once you invest, how do you determine if a company's valuations have become too far ahead of its fundamentals? And at what point do you start trimming positions in the portfolio?

For me, it always comes back to the original investment hypothesis: Why did I initially invest in the company? If my thesis is based on an 18-24 month view, then the decision to trim or exit would only arise if there is a structural negative change in the company or sector that impacts earnings, or if governance standards deteriorate in a way that alters the parameters I initially relied on.

Another situation is when the returns I had expected to play out over a longer horizon get front-loaded and are achieved too quickly. In such a case, valuations may become stretched even though nothing fundamental about the company has changed, which could justify reducing exposure partially.

Otherwise, if the core thesis remains intact, earnings visibility is strong and the company continues to deliver in line with expectations, there is no need to exit simply because the stock has appreciated in the short term.

Your mid-cap fund has had a strong long-term track record; however, the past year has been relatively weaker. Which specific calls did not play out as expected, and what lessons have you drawn from that experience?

I joined Mahindra Manulife in November 2024, so it has been approximately 8-9 months.

First, I must give credit to my predecessors; they have done a phenomenal job of delivering strong returns over the years. Between March 2023 and November 2024, the mid- and small-cap segments experienced significant inflows, attracting substantial investor participation. The supply of liquidity created high demand for mid- and small-cap companies, pushing their valuations higher.

Over the last year and a half, while some companies delivered strong growth, others saw earnings that didn't quite match the optimism, leading to corrections. Additionally, investor flows into these categories moderated, further impacting performance.

In terms of stock-specific calls, an overweight on consumer durables, for example, didn't play out as expected. Factors such as the weaker summer season affected these businesses cyclically, although I believe the fundamentals of those companies remain strong.

From a portfolio management perspective, some corrective steps were taken. For positions where I remained confident, I increased the weights so that they could contribute more meaningfully to performance. On the other hand, small positions that didn't move the needle were exited, either because they weren't adding value or because I had become less positive on those stocks. So, it has been about streamlining and focusing on positions that can make a real impact.

Of course, global factors and volatility play their role, and it takes time for actions to fully reflect in performance. However, as fund managers, our job is to continuously monitor the portfolio, adapt and make necessary adjustments. We cannot afford to be rigid; we must remain flexible and humble enough to accept reality and act accordingly. That is how we navigate volatility and strive to deliver consistent returns.

We've also noticed that, apart from the core long-term positions, the mid-cap fund sometimes takes tactical bets. What percentage of the portfolio is allocated to these positions, and how do you determine such allocations?

Generally, my investment horizon is 18-24 months, so I don't really classify positions as short-term tactical bets. What may appear tactical is usually a function of relative valuations.

At specific points, some companies present compelling opportunities simply because their valuations become very attractive compared to their growth prospects. In such cases, we may take exposure, but it is not with the intention of making quick, opportunistic returns.

So, I wouldn't call these short-term trades. They are part of the same disciplined investment approach, focusing on growth, sustainability and value. The core philosophy remains unchanged.

In periods of underperformance, do you prefer holding on to your conviction bets, or do you make active changes in the portfolio to regain momentum?

For me, the philosophy is always to remain a long-term investor and focus on sustainable, investable returns. I don't believe in chasing momentum simply because a stock is moving. If I have conviction, I stay with it.

As I mentioned earlier, some stock calls may not play out immediately due to cyclical factors, but that doesn't mean the underlying investment philosophy for those companies has changed.

Risk management, in such cases, is addressed at the portfolio-construction level through adjustments in weightages rather than by abandoning a conviction stock. Unless my original investment hypothesis has fundamentally changed, I don't exit or add new positions to capture short-term returns. My approach isn't about trying to make quick gains in a short timeframe; it is about staying invested in businesses that I believe can deliver long-term results.

Regarding sectoral bets, industrials and financials are currently your largest exposures. What makes you positive about these sectors? And within them, what type of businesses do you typically prefer, and which ones do you avoid?

If we look at FY25, it was a year marked by slower growth rates, tight liquidity, over-leveraged customers leading to stress in unsecured loans and a stricter regulatory regime. But in the future, we are seeing very different conditions emerge. A benign interest rate environment, comfortable liquidity and cleaner balance sheets are setting the stage for healthier growth. There is also a faster resolution of regulatory and compliance issues. We believe a liquidity-backed environment is likely to support growth in the second half of FY26.

The retail, SME and MSME segments are expected to be key growth drivers. In our view, credit costs will remain at relatively low levels. While the pain in unsecured loans has been visible, recent regulatory steps should provide strong support for both banks and NBFCs. Among private banks, profitability has always been strong, but what's particularly noteworthy today is the turnaround in PSU banks. Their balance sheets are in the best shape in over a decade, with ROE in the mid-teens range.

Given this strong economic backdrop, valuations in the sector look quite reasonable, which makes us positive. Within the space, our focus remains on identifying the relative opportunities that individual banks or companies offer, rather than treating the entire sector as a monolith.

How closely do you track the benchmark while building your portfolio?

Of course, we are aware of the benchmark. However, it is not a guiding factor in portfolio construction. As a bottom-up stock picker, if I am positive on a stock that already has a sizable weight in the benchmark, I am comfortable going overweight because that is how alpha is generated.

Sector weights do matter to an extent for maintaining balance, but they do not dictate stock selection. If I don't see a positive case for a sector or a company, I don't include it in the portfolio just because it is represented in the benchmark.

What are your non-negotiable rules on position sizing and liquidity, especially when it comes to less liquid mid-cap names?

At Mahindra Manulife, we have internal risk controls in place. For mid-cap stocks, the cap on individual positions is 3.5 per cent, and for small caps, it is 2.5 per cent at the time of investment. If I want to take a position higher than that, CIO concurrence is required. This ensures discipline and risk mitigation across all schemes.

Additionally, liquidity is carefully monitored. We assess overall market depth, including trading and delivery volumes, before allocating. I prefer taking slightly more concentrated positions in names I am confident about. Small token positions do not significantly enhance performance, whereas higher weights on conviction bets can contribute to alpha if the investment thesis is realised.

Lastly, what usually triggers a sell decision for you? Are they due to broken fundamentals, governance concerns or stretched valuations?

I would say it is a combination of all those factors. Selling is often harder than buying, because there is always the dilemma of exiting too early or too late. For me, it begins with the original investment hypothesis. If the structural factors that led me to invest change, whether at the macro, sector or company level, that's a clear trigger to reconsider. Governance concerns are also non-negotiable.

Valuation is another critical aspect. If a stock has delivered strong returns and valuations have risen to levels where future returns are unlikely over the next 18-24 months, it may make sense to trim exposure. Sometimes, if a relative opportunity arises in the same sector at more attractive valuations, I may reallocate capital accordingly.

A complete exit typically occurs only if the original hypothesis no longer holds, governance issues emerge or valuations are so stretched that long-term returns appear unattractive.

Also read: More comfortable with mid caps, followed by large caps: Kotak Mutual Fund's Atul Bhole