'Margin of safety looks better on the large-cap side'

Summary: Despite the froth in the Indian equity market, Templeton Global Investment’s Venkatesh Sanjeevi believes that the large-cap space continues to offer reasonable valuations. He discusses the reasons for the same, along with his funds’ stock picks and the themes he’s optimistic about, in this interview.

Equity markets are at record highs, and valuations across segments now demand a far more disciplined eye. In this environment, Venkatesh Sanjeevi, SVP and Portfolio Manager – India Equities at Templeton Global Investments, offers a cycle-aware lens that goes beyond headline multiples to focus on where the real margin of safety lies. In his view, large caps currently present a more balanced risk–reward equation, supported by earnings expectations that are far more reasonable than those baked into mid- and small-cap names.

Sanjeevi, who manages eight schemes at the fund house with a combined asset base of Rs 31,273 crore, including the four-star-rated Franklin India Large Cap Fund, is also of the view that there’s still scope for alpha-generating opportunities in the large-cap space. In this exclusive conversation, he sheds light on his stock-picking framework, the structural themes he is aligned with and why his funds’ portfolios continue to lean into Financials.

Equity markets are at record highs. How are you reading the valuation gap between large caps and the mid- and small-cap space today? Are large caps starting to look more attractive on a relative basis?

We shouldn’t look at valuations in isolation. That said, if you compare large caps with, let’s say, the mid-cap category, the headline multiples of large caps are definitely lower than those of the mid-cap segment. But it’s also true that the growth rate in large caps is probably lower than the typical growth rate of a mid-cap company.

The point I would like to highlight right now is more around the margin of safety. Today, the earnings growth expectations for large caps seem more reasonable to me than those for mid caps. So, if things don’t really work out in terms of growth, there is probably more risk to earnings and multiples on the mid-cap side compared to the large-cap side.

Hence, while valuations are more attractive, I think the more important factor is that the margin of safety looks better on the large-cap side, especially given today’s macro volatility. And so, I think it’s looking more reasonable.

Small caps, on the other hand, are a bit of a different ballgame because it’s a very large universe. The headline multiples may or may not reflect the true picture. What I’m seeing now is that within small caps, given the huge list of companies that are listed and available, there are perhaps more ideas that are more reasonable or more fairly valued, although the headline level could look a bit tricky. But yes, some bottom-up ideas are more visible in the small-cap space.

Given the narrowing opportunities in a fully priced market, does the case for active management in the large-cap space still hold? Where do you see room for an active manager to add value?

This question has come up quite often, and I strongly feel there is still room for an active management strategy, even on the large-cap side. While the mandate is restricted to the top 100 stocks by market cap, there are a few ways to generate alpha. Let me give you a couple of points.

First is the ability to take more active positions. Active positions, both at the sector and stock levels, are quite critical for creating alpha opportunities. For example, in the large-cap fund I manage, we currently have a fairly large active overweight in the IT sector, which is a conscious call based on the view that there is a contrarian opportunity there.

Second is maintaining a healthy, active share. At the portfolio level, we are nearly 50 per cent, which is on the higher side compared to the peer group. We are making a conscious effort to build a high-conviction portfolio. The basic thesis is that if you construct a portfolio backed by high conviction, and you have the right set of stocks in the right position sizes, it becomes possible to create alpha.

Just to illustrate, even within the large-cap universe, take any sector, say, Automobiles. In the last year, the best-performing auto stock is up around 45-50 per cent, while the worst-performing one is down about 25 per cent. So even within the same sector in large caps, if you had picked Stock A, your return would have been 45-50 per cent, while Stock B would have given –25 per cent. A similar dispersion exists across sectors. In Consumer Staples too, one of the best performers is up around 20 per cent, while one of the worst large caps is down 25 per cent. That’s nearly a 50 per cent gap. So, there is always room to generate alpha if you choose the right companies and sectors.

The next important point is the category mandate. Large-cap funds must invest 80 per cent in the top 100 companies by market cap, but the remaining 20 per cent is flexible. We have used that 20 per cent in the past to invest in high-conviction mid-cap names, certain small-cap opportunities and even select international stocks. How a portfolio manager uses this 20 per cent can also meaningfully help in generating alpha.

So, a combination of good stock-picking, strong selection within sectors and effective use of this leeway makes it possible to generate alpha even within the large-cap category.

As you mentioned, in one sector a stock may be up 25–30 per cent, and another may be down 25 per cent. How difficult is it to choose the right stock out of these 100? And what is your process for identifying such stocks within the large-cap segment?

True, that is really the essence of what we are trying to do here. We are trying to develop a sound investment philosophy and implement it with discipline. By doing that consistently, we should be able to generate alpha over time. That is, at its core, our work.

Your question essentially relates to the philosophy and process I use to pick stocks. It comes from my own experience. I joined the industry back in 2007 and spent about seven to eight years in the Indian mutual fund industry, learning the basics of the market, understanding the structure and how the industry operates. Later, I had the opportunity to work outside India with a global asset management company. That helped me understand how India stacks up against multiple countries and global markets.

I'm trying to bring both these learnings together and build them into the philosophy I am implementing here. And the story is actually very simple: India today is at around $2,500 per capita GDP. We've seen many countries successfully scale up from this level to $5,000, $8,000 or even higher. India is on that same journey. And when that journey takes place, certain sectors tend to benefit disproportionately.

If you look through that lens, sectors like Consumer Discretionary, Financial Services and Healthcare typically act as strong proxies for a country getting richer. These form the core of my approach: high-quality companies in sectors that can grow for a long period and generate strong return on capital (ROC) and return on equity (ROE) ratios.

But the second and equally important pillar is valuations. You may have an excellent company in an excellent sector, but if you overpay, you generally won't create alpha. So the investment philosophy is built on these two pillars: the quality of the industry, business and company and the valuation you are paying to own it. The right stock is always a combination of both the right quality and the right valuation. That is how the portfolio is constructed.

The market narrative keeps shifting – AI, digital demand cycles, manufacturing and BFSI credit growth. Which themes are you structurally aligned with over the next 3-5 years?

Not just for three to five years, but even over a much longer term, the structural theme I am aligned to is what I spoke about earlier: as India gets richer, the biggest opportunities come from aspiration.

All of us want better cars, better homes, better clothes, better food choices, better financial products, insurance, mutual funds, wealth management, digital convenience and online consumption. So, as India moves from $2,500 per capita GDP to $5,000-6,000, all these sectors tend to benefit disproportionately.

That is where I would structurally look for ideas. But again, valuation is a very important pillar. Just because a company or sector is growing does not mean we hold it at any price. If you overpay, even if earnings grow, returns may not come because valuation compression offsets the growth. So, being disciplined in valuation is critical.

Several large-cap and large & midcap funds, including yours, are overweight on Financials. Is this mainly about staying close to the benchmark weights, or do you see genuine, long-term tailwinds for the sector?

From my perspective, while I’m aware of the benchmark, I don’t build the portfolio just to mimic it. Even in Financials, if you go back six to nine months, the weight was not as high as it is today. We have also taken large underweight calls in the past. So, we are benchmark-aware, but we don’t stick to weights just to match the index.

Specifically, the long-term opportunity is genuinely very exciting. If you look at various parameters, retail loan growth and penetration levels, there is a long runway. And Financials are not just banks. In the large & midcap fund, I also have exposure to wealth management companies, online insurance aggregators, asset management companies, life insurers and general insurers. The entire ecosystem is interesting.

These companies typically have strong management teams, good return ratios and operate in industries with very attractive long-term dynamics. So yes, Financials tick many of the boxes we look for in quality management, a good industry structure and a long growth runway. That is why the exposure is there.

Also read: More value has emerged in large caps this past year: Mirae Asset's Siddhant Chhabria