'Even after the correction, mid and small caps aren't cheap'

Summary: After a sharp correction, Indian markets look calmer on the surface. In this conversation, Shreyash Devalkar explains where risks remain, why recent underperformance is more about valuation resets than broken growth and how portfolios are being reshaped for what comes next.

After a sharp correction and a year of global underperformance, Shreyash Devalkar believes Indian equities have moved into a more balanced, though still selective, valuation zone. The Head of Equity at Axis Mutual Fund, Devalkar oversees six equity schemes with assets of around Rs 1.25 lakh crore and brings over two decades of experience across market cycles. He notes that while headline valuations have eased and India’s premium to emerging markets has normalised, pockets of the market remain expensive, particularly in mid- and small-cap segments.

That backdrop has sharpened his emphasis on growth at a reasonable price, as sustaining high multiples becomes harder in a sub-10 per cent nominal GDP environment. Devalkar, who joined Axis AMC in 2016 after stints at BNP Paribas AMC and IDFC, has largely stayed anchored to this valuation discipline even as market leadership has shifted.

In this conversation, Devalkar explains how valuation sensitivity, sector rotation and diversification are shaping portfolio decisions and why recent underperformance reflects valuation resets rather than a breakdown in underlying growth themes.

After the recent correction, some valuation excesses have eased, but markets still don't look cheap. How are you reading valuations and the earnings outlook now, and how does that influence your portfolio positioning?

As far as valuations are concerned, the headline valuations of the Nifty have corrected. It is well established that India's underperformance relative to the world, both emerging and developed markets, has been quite significant over the last calendar year. We have underperformed by almost 20 per cent or more in certain markets, especially in US dollar terms.

With that, our valuation premium compared to emerging markets, which had reached nearly 100 per cent at certain points during the post-Covid cycle, has now come down to closer to 60 per cent, which is broadly in line with the 10-year mean. From that point of view, headline valuations look reasonable.

However, if you drill down further into valuations, they are still slightly expensive on both the mid-cap and small-cap sides. Historically, the Nifty Midcap one-year forward P/E is still almost 1.5 to 2 standard deviations above its historical mean. A similar observation holds true for small caps as well.

As you rightly asked about growth and base effects, when we look at valuations and drill down further, we analyse two aspects: growth and valuation re-rating. When I talk about re-rating, I am referring to the multiple compared to pre-Covid levels, which would be somewhere around 2019.

What we observe is that sectors which have not shown growth or have failed to demonstrate meaningful growth have not seen much valuation re-rating. In some cases, there has even been de-rating. A classic example is the private sector banks, which, as a segment, have been de-rated.

If you look at FMCG and other segments, they have been re-rated by only about 20 per cent. These include staples, PSU banks, consumer discretionary and autos. These segments have seen only around 20 per cent re-rating compared to pre-Covid levels. On the other hand, segments that have shown substantial growth have seen re-rating ranging from 30 per cent to almost 100 per cent. These include capital goods, electric utilities, electrification themes, construction materials, CDMO, space and metal mining.

The broader point I am making is that most fast-growing themes—whether hotels, hospitals, capital goods, electrification, electronics manufacturing services, and so on—have seen significant re-rating. Even after the recent correction, one cannot call them cheap or attractive from a valuation perspective. On the other hand, segments where growth has been relatively slower appear visually cheaper than pre-Covid levels.

With this backdrop, how has your portfolio positioning evolved, even as your core philosophy remains unchanged?

Our investment style remains the same; there has been no meaningful change in that regard. The differences you will observe between earlier periods and now are less about the factor we follow and more about shifts in the market, the economy and the broader recovery we have seen. One change you will notice is that, earlier, our portfolios were very compact—30, 40, or, in some cases, 50 stocks. Now, the number of stocks has increased, reflecting more market segments doing well than before.

Second, earlier, because quality and growth were disproportionately priced, the market rewarded that factor strongly. Today, with nominal GDP growth below 10 per cent, sustaining high growth while carrying high multiples is challenging even for high-quality companies. That is why focusing on growth at a reasonable price and keeping a close eye on valuations is very important. From that point of view, whatever changes we have made over the last year are broadly aligned with that approach.

There are segments that have not seen meaningful re-rating. In some of these, we have increased weights over the last year. For instance, in financial services, where we were usually underweight, we have increased exposure, especially in lenders, because valuations are more favourable. With supportive monetary policy and government measures, the sector has begun to show improvement in growth over the last several fortnights.

Similarly, we increased exposure to certain segments such as autos. That is more related to the GST impact, as among consumption segments, autos have seen a relatively larger share of the benefit so far. However, we hope other consumption segments will benefit as well going forward.

We have remained underweight on export-oriented stories. That started with the tariff-related developments we saw in the first half of the last calendar year. As a result, we reduced weight in some export-facing segments. Yes, valuations are reasonable in some areas, such as IT, but when we look at the long-term growth potential, as of last month, we remained underweight there.

Across several schemes, relative returns have lagged category peers not just recently, but across multiple market cycles. At a broad level, what do you see as the key reasons for this persistent gap?

Most of the underperformance began emerging during the post-Covid market recovery. A large part of the underperformance occurred in 2022 and 2023, with some impact in 2021 as well. Calendar year 2024, however, was relatively better from a performance standpoint.

In calendar year 2025, there was also a good recovery in performance until around August-September. However, over the last three to four months, we saw sharp corrections across multiple stocks and themes. That phase again eroded a significant portion of the alpha for the full year 2025. Broadly, our investment approach has remained unchanged. As mentioned earlier, 2024 was a good year from a performance standpoint. In 2025, however, the drawdown in the last quarter, driven by sharp falls across multiple themes and sectors, resulted in underperformance.

This included airlines, capital goods, e-commerce, and several other themes, many of which corrected sharply simultaneously. That broad-based correction across multiple segments contributed to the recent underperformance. As a fund house, we continue to focus on quality and growth. However, in this market environment, there has been a much stronger emphasis on growth at a reasonable price. When markets become highly valuation-sensitive, even quality growth stocks can face sharp drawdowns, and that has been a key factor influencing relative performance in recent periods.

Looking specifically at the shift from 2024 to 2025, we see that relative performance improved and then weakened again. What changed in the market environment or leadership that made your 2024 positioning less effective, and where do you think your style was underexposed to the drivers of 2025 returns?

In our view, we had identified the right themes and positioned accordingly through 2023 and 2024. These themes worked well until the first half of 2025, roughly up to July or September. After that, for various reasons, there was a sharp correction across many of these categories, with each theme having its own specific triggers. The common underlying factor was that most of these themes were expensive at the time. Some started correcting only recently, capital goods being a case in point. Importantly, if you look at the underlying growth numbers, there has not been a meaningful change in their trajectory so far. We will, of course, see how results unfold. That said, the broad-based correction across multiple themes over the last three to four months clearly impacted performance.

Chemicals have remained persistently overweight despite prolonged earnings and pricing pressure. What gives you confidence that this is a bottoming cycle rather than a value trap, and what indicators would prompt you to reassess this exposure?

If you look closely at the chemicals portion of our portfolio, many of these holdings have been with us for a fairly long time. Also, part of this exposure includes companies in adjacent areas, such as fertilisers, so it is not a pure-play on the traditional chemical cycle. The conventional chemical cycle, as we saw earlier, began around 2014-15 and continued into the post-Covid period. However, our exposure has generally not been to commodity chemicals. Instead, it has been to companies operating in relatively specialised segments such as CDMO, crop protection, refrigeration-related chemicals, or businesses building capabilities in pharmaceutical or CDMO-related areas.

So our exposure has been more towards differentiated businesses with structural drivers than towards purely cyclical, commodity-linked chemical players. That distinction is important in how we view the risk of this exposure. If the earnings profile, balance sheet strength, or strategic direction of these companies were to change materially, we would reassess our positioning. But as of now, we believe the exposure remains aligned with our long-term quality and growth framework rather than being a value trap.

Axis recently launched a Gold and Silver FoF, and we’ve since seen a sharp rally in both. Do commodities still offer a compelling risk–reward, or has much of the upside been priced in? How should equity investors think about this space now?

In commodities, especially precious metals, price movements have been driven less by traditional demand–supply dynamics and more by broader macro factors, particularly a lack of confidence in certain currencies. As a result, money has been shifting towards assets such as gold and other precious metals.

These underlying triggers are not new. High debt levels in developed markets have been known for years. However, post Covid, this process accelerated due to geopolitical developments and further increases in debt. This is where we are now seeing the repercussions play out in precious metals. More recently, investors have begun extrapolating this trend to other metal categories as well.

However, precious metals, especially gold, have delivered extraordinary returns over the past few years. It is difficult to extrapolate similar returns going forward. Much like equities, after a phase of very strong returns, subsequent returns tend to normalise. So returns from here may not be as high as those seen recently.

That said, from a portfolio construction perspective, precious metals still deserve a place in an investor’s portfolio. The key question is whether the overall portfolio is well diversified across asset classes, geographies, and currencies. Indian equities should remain a core allocation, given India’s long-term growth prospects. But alongside that, diversification through assets such as gold or even foreign equities can play an important role in improving portfolio resilience over time.

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