'No shortage of liquidity in Indian equities'

Summary: With markets recovering but valuations drawing mixed views, fund manager Sonam Udasi believes the rally is rooted in improving earnings, not excess exuberance. In this interview, he explains why liquidity remains strong, how investors are becoming more selective and why active management still has an edge in a maturing market.

The market may have bounced back after the sharp correction earlier this year, but questions about valuations still linger. For Sonam Udasi, the market is neither overheated nor in a bubble. The Senior Fund Manager at Tata Mutual Fund points out that both the Nifty and Nifty 500 are trading only 5–6 per cent above their long-term averages.

With over Rs 15,400 crore across five funds under his watch, Udasi has seen sentiment swing sharply before. This time, though, he believes the improving earnings trajectory, helped by GST cuts and strong domestic liquidity, offers genuine support.

In this conversation, Udasi discusses why earnings recovery, not exuberance, is driving the latest rally, how investors have become more selective in chasing growth, and why active management still holds an edge in a market learning to separate the best from the rest.

Markets have staged quite a comeback since the mid-year correction, though they’re still shy of earlier peaks. Do you see this rebound as the start of a durable phase, or are we once again in a zone where valuations have raced ahead of earnings?

If we step back a bit, from October last year to February, we had a massive correction. Valuations corrected, and foreign institutional investors (FIIs) pulled out in a big way. Then policymakers did a 360-degree turn to tackle this. We saw liquidity improving, taxation reprieve, and the focus on growth was back. So, all policymakers, whether government or monetary, were on the same page that we need growth back. That’s where market sentiment started to improve a little.

Even as we speak today, valuations of both the Nifty and Nifty 500 are about 5-6 per cent above their long-term 10-year average, on both a trailing and a forward basis. So, it’s not as if we are super expensive or in a bubble. There are always pockets that are overzealous and others where nobody wants to touch. I wouldn’t say we are a very expensive market, but neither are we cheap.

What we’re waiting for is signs of improvement in the earnings trajectory. In September last year, Nifty 500 earnings de-grew by 1 per cent. There was negative earnings growth, and gross domestic product (GDP) growth was also below 6 per cent around that time. Since then, there’s been a steady recovery in earnings trajectory. For the September quarter, Nifty 500 earnings are not fully out yet, but in June, earnings grew around 10 per cent for the Nifty 500. So, the data is improving incrementally.

The goods and services tax (GST) cut has definitely helped. The low base of earnings in last year’s September and December quarters means we should see positive momentum in both these quarters. That’s one reason for markets to stay somewhat hopeful from a sentiment perspective.

The other factor is that FIIs are still selling, not with the same intensity, but they remain net sellers. I think that’s because they’re uncertain when the US-India tariff deal will go through and at what tariff percentage. After China, we currently have the second-highest tariff rates globally. There’s hope that as we get closer to a deal, FII negativity will fade.

There’s definite liquidity support within India, which is helping sustain this sentiment. Valuations are slightly above average, but things are looking up as the data continues to improve and FII selling cools off once a deal materialises. That’s the current market context. If either of these two factors were to fade, we could face some pressure ahead.

Mid- and small-cap stocks recovered sharply after their correction earlier this year. Is this bounce-back rooted in fundamentals, or are we witnessing a return of retail exuberance?

I think that as a pack, when we talk about the Nifty 500 in the June quarter, the segment that did the heaviest lifting in terms of earnings growth was the mid-cap segment. Large caps did slightly less, and small caps were the weakest. So, mid caps as a bucket performed relatively better in the earnings growth trajectory. I would say that some of this recovery is definitely earnings-led.

After the cool-off from October to February, most of the small-cap space, especially outside the mutual fund industry, had seen froth driven largely by private participants and high-net-worth individuals (HNIs). I think they’ve now become far more cautious about how they allocate money.

If you look at market breadth, it’s not as if there’s widespread exuberance. When data supports a stock or theme, it tends to get re-rated. If the data isn’t strong, or earnings or revenue momentum is missing, the rally fizzles out fairly quickly. That’s actually a very healthy sign as it shows that market participants have become much more careful about how they view opportunities and allocate capital.

Growth and momentum themes have continued to lead, while value funds have lagged. Why has this divergence lasted so long, and what typically brings markets back in line with fundamentals?

Typically, over the last 20–25 years, markets have moved in roughly four-year cycles. In each cycle, value goes through a one-to-one-and-a-half-year phase where nobody cares for it, and the same happens with small caps. For example, post-Covid, for about a year, no one wanted to touch small cap or value categories. Yet, that turned out to be the most explosive phase for both, as they performed extremely well once recovery began.

When things improve, the first movers are usually at the top end of the market, where visibility is high. Once that plays out, the next leg usually comes from value and small caps. Today, we are almost at that inflexion point again. Nifty and Nifty 500 P/E multiples are not excessively high. As they normalise further and earnings visibility strengthens, especially after the September and December quarters, sentiment improvement is likely to be broad-based.

The key difference between now and a year ago is sentiment. For sentiment to recover, earnings need to improve, which they are, albeit slowly. Some external clarity, such as a tariff deal, would also help.

There is no shortage of liquidity in Indian equities. Domestic investment continues, and there’s no overt leverage in the system, whether in banks, corporates, or the central government balance sheet. Most large industries operate with a debt-to-equity ratio of 0.4 times or less, providing a substantial cushion against external shocks. So, this isn’t a bad setup. We’re simply waiting for earnings momentum to strengthen.

The GST cuts would also have improved affordability in the system, allowing consumers to spend more. We’ll soon see which sectors benefit from that; those will drive both sentiment and earnings momentum forward.

To put this into perspective, in September 2022, Nifty 500 earnings were down 2 per cent. After that, the trajectory moved to 6 per cent, then 9 per cent and eventually 52 per cent growth. So, the earnings trajectory is pretty volatile. In India, once the system aligns toward growth, earnings follow. And as that trajectory improves, the market will start looking fundamentally attractive.

There’s a recent IPO from a leading eyewear retailer that saw heavy bidding from large institutional investors despite demanding valuations. Yet, you chose to stay away from it. What drove that restraint?

While I manage the Value fund, I also run a Consumer fund, where the trailing P/E is the exact opposite, somewhere around 45-50 times. We evaluate everything across all our funds. The Tata Value fund mandate allows for owning higher P/E stocks if the opportunity size justifies it. For instance, we have a small exposure to quick commerce because we see the size of the opportunity and its long-term growth runway.

In this case, however, we felt the eyewear category was too small a consumer segment to warrant such a steep multiple. We looked at the total addressable market, the pace of growth and the scalability, and decided it wasn’t compelling enough at that price point. Maybe others will be proven right, but we took a more conservative view.

So it wasn’t entirely about valuations? Because we’ve seen the company’s valuation going up from around Rs 7,000 crore to Rs 70,000 crore in the matter of a few months.

Valuation was indeed the key factor. Had it come at a lower valuation, we could have been interested. It’s a decent business; they’ve built a solid backend and executed very well, but that’s part of what’s already priced in.

Let’s talk about what value even means today. In a market where many quality companies trade at over 40 times earnings, how do you define value now? Is P/E still a useful lens, or do you rely more on cash-flow strength and capital discipline?

For us, P/E is really the starting point because that’s how the fund’s framework is designed. For example, if I run a screener for stocks trading below the Sensex P/E, out of about 8,000 listed companies, I’ll probably get around 2,500 names. Next, the step is to identify which sectors are likely to grow faster than the Nifty 500. Within that, we evaluate return on equity (ROE) and return on capital (ROC).

That’s just the beginning. We then fine-tune further, how often has the promoter raised capital? How frequently have investors been diluted? Is the company part of an index? How liquid is the stock? These are the finer points we consider before adding weights.

The top holdings in our fund are based not just on earnings trajectory but also on liquidity. Our approach is simple: growth must be better than the Nifty 500, the companies must be cheaper, and they should offer sufficient liquidity. When all these align, we build larger positions. This process has worked well for us historically.

The value category has also seen the rise of many passive options — Nifty 500 Value 50, Nifty 200 Value 30 and others — each with a portfolio of 20–30 stocks. How do you view these index-based value funds as part of an investor’s core portfolio compared to actively managed ones?

I’d say this is not just for value, but for any category — active versus passive. India is still an emerging market with a per capita income of about $3,000. Our capital markets are developing, and while we now have more sectors and themes to play, there is still a long way to cover.

As long as that’s the case, active funds will continue to offer an edge, especially when the cycle turns. Active managers can better identify which stocks and themes to play and in what concentration. That ability to adapt remains a big advantage in a dynamic, evolving market like ours.

Also read: 'Mid and small caps 30-50% pricier than historical averages'