'Markets could remain weak if earnings don't recover'

Summary: SBI Mutual Fund’s Fund Manager discusses the ongoing correction in the Indian equity market, earnings outlook, where the economy stands amid the ongoing West Asia conflict and the performance of his funds, in this exclusive interview.

Managing over Rs 52,766 crore across three schemes, Milind Agrawal brings a clear-eyed, earnings-first lens to markets that have grown increasingly difficult to read. The fund manager at SBI Mutual Fund, with six to seven years of experience running the SBI Banking and Financial Services Fund, recently took charge of the SBI ELSS Tax Saver Fund. This five-star-rated scheme endured years of underperformance before delivering sharp, conviction-driven returns. 

In this conversation, Agrawal unpacks the valuation story behind the Nifty's correction, the structural case for India's power sector, the resilience of PSU bank portfolios and why a high-profile boardroom exit at the country's largest private bank may be more noise than signal.

The Nifty is now trading around 20x earnings, after the recent correction from its earlier 23x times. Have these valuations now reached attractive territory? What do you think about near-term prospects?

When we look at valuations, we always view them in the context of earnings growth. If you consider market returns over the last 12 to 18 months, one key reason returns have been relatively weak is that earnings growth for FY24 and FY25 has been subdued. If you go back to FY22-23, the reason markets performed very well was the strong earnings growth during that period. So, market valuations and absolute levels tend to follow earnings growth. Until around the December quarter, we were still in an earnings downgrade cycle. The December quarter numbers were slightly better than expectations, and the pace of earnings downgrades slowed. However, even in that context, FY25-26 earnings growth is still in the mid-single digits, versus earlier expectations of double-digit growth.

So, while market valuations have corrected, they have largely adjusted to reflect the relatively subpar earnings growth. Going forward, when we look at absolute Nifty levels, or one- to two-year forward EPS estimates and price-to-earnings multiples, they seem to imply stronger earnings growth in FY27 and FY28. However, if earnings recovery does not materialise, the market could remain weak. So everything needs to be viewed through the lens of earnings growth. While things appeared to be improving as we entered this calendar year, the uncertainty over the past month has once again raised questions about the near- to medium-term earnings trajectory. We remain watchful on that front.

The current geopolitical scenario is volatile, as seen in Indian markets. But is the market reaction legitimate, given the concerns, or is it excessive? What risks do the Indian economy and markets face as a result of this scrimmage?

This is a fairly broad question, and it is still a little early to assess the potential long-term impact. The markets have corrected by around 10 per cent over the last month, with only brief periods of bounce-back. Each rally is being sold into, indicating that there is still a lot of anxiety about how long this conflict will persist and whether it will become prolonged. If the situation does drag on, it can have second- and third-order effects across multiple industries. 

So far, we are still in the very early stages. We remain watchful at this point, but it is too early to make any firm medium-term assumptions based on where things stand today.

SBI ELSS Tax Saver's long-term returns are strong, but there was a substantial period from late 2018 to early 2023 when the fund underperformed severely. What caused this underperformance? Was it driven by sector calls that took their sweet time to pay off, or did the fund change its stock-picking framework to deliver the outperformance currently visible?

To provide some context and a few disclaimers, this fund was managed by my predecessor, Dinesh Balachandran, who is currently the Head of Investments. He managed this fund until the end of the last calendar year, and I have taken over from January 1.

That said, if I were to give some context, Dinesh is fundamentally a very valuation-conscious investor. He is quite cognisant of the multiples and valuations one pays for stocks. If we go back to the pre-Covid period, there was a strong focus on quality and growth companies, and valuations for those sets of companies continued to expand through the latter part of the last decade.

In the post-Covid phase, however, we saw investors increasingly appreciate the value philosophy. True to a contrarian philosophy, if you stay committed to it, there will be periods of underperformance because you are essentially investing in companies going through tough phases, but which have fundamentally strong franchises. So, this philosophy inherently leads to phases of underperformance. However, if the valuation framework and investment philosophy remain strong, you tend to see a recovery over time. That is what played out quite strongly in this fund. That said, full credit for this goes to Dinesh, who managed the fund over a long period. My involvement has only been very recent since taking over the fund.

Your ELSS fund has been overweight in Energy & Utilities, and these stocks have seen some correction from their peaks recently. How do you see this market segment, and are you still bullish on it?

Fundamentally, energy needs in a growing economy are only going to increase. Even today, when we look at the valuations of some of these companies relative to their earnings growth, they still appear fairly reasonable. In the near term, there could be some disruptions. For instance, refinery companies that depend on crude imports may see some impact. However, at this stage, we are not making any material changes to our portfolio allocations. We remain watchful, as mentioned earlier, and if the conflict proves short-lived, many of these portfolio bets should continue to make sense from a medium- to long-term perspective.

Structurally, we remain positive on power demand in India. Last year, due to a weaker monsoon and softer industrial demand, power sector growth was slightly muted. However, we had begun to see early signs of a pickup this year. So overall, our view on power demand remains positive from a medium-term standpoint.

As the new tax regime gains wider adoption, ELSS funds have been experiencing continuous redemptions from investors. What changes, if any, do you have to make in the stock picking framework of an ELSS fund compared to other diversified funds to take this into account?

Fundamentally, when we look at an ELSS fund, we treat it very much like a flexi-cap fund, as it offers the flexibility to invest across market capitalisations. The key difference is that the money coming in is inherently long-term, given the three-year lock-in. That provides a certain level of comfort regarding the stability of flows. From an investment philosophy standpoint, we continue to run this as a fund with a three to five-year investment horizon. The lock-in period allows us to take high-conviction bets without worrying too much about short-term inflows or outflows.

So, fundamentally, not much changes. The category matters less than fund performance. While the ELSS category may not have attracted strong inflows recently, funds that have delivered consistent performance have still garnered a meaningful share of flows. So whether it is ELSS or any other category, our investment approach remains unchanged, long-term focused, driven by earnings and centred on buying companies at the right valuations.

Could you explain your investment strategy, style and how a stock makes its way into your portfolio?

Just to give some context, I’ve been managing the Banking and Financial Services Fund for about six to seven years now. In terms of my investment philosophy, it revolves around identifying the right set of companies with a large market opportunity, proven capability to deliver consistent performance, and the ability to gain and expand market share. Alongside this, we place a strong emphasis on governance standards and ensure that valuations are reasonable. Broadly, the framework that I have followed for many years remains consistent. It does not materially change, even when managing the tax saver fund.

Banks, especially PSUs, turned to retail lending to expand their loan books and stabilise their portfolios. But given the rise of unsecured loans in this segment, is the safety for which retail was praised eroding slowly or is the change insignificant to worry about?

Nothing is insignificant. However, in the context of PSU banks, their customer base differs somewhat from that of private-sector banks. PSU banks typically lend more to government employees, who often hold salary accounts with them. This gives them better visibility on income flows, savings balances and the overall financial profile of borrowers. Also, while growth in unsecured lending may appear high, it is coming off a low base. The overall contribution of unsecured loans to PSU banks’ loan books remains relatively small. So at this point, we are not seeing any signs of stress there.

As far as private sector banks are concerned, there hasn’t been any material change in risk appetite. In fact, risk appetite was relatively lower about 12 to 18 months ago, especially after regulators flagged concerns about over-leveraging. Currently, based on management commentary, banks appear more comfortable, though they remain watchful. That said, it is still early days, and we will need to monitor how things evolve. For now, lenders are cautious, but we are not seeing any meaningful shift in risk behaviour.

The country's largest private bank recently witnessed a major event when its Chairman resigned over ‘ethical’ concerns. A large number of mutual funds hold the company, and it has been one of the most common positions across categories. What do you think about this event and its impact on the company? Further, did you encounter any such concerns in the company's financials?

This private bank is a very high-quality institution and a strong franchise. It is the country's largest private sector bank and among the top banks overall. In terms of governance, it is a very process-driven and institutionalised organisation.

You would have seen or heard about the recent call with the bank's Chairman and board members. When individuals with such credibility clearly state that there are no material issues at the bank, we would tend to take that view seriously. At this stage, we do not see any concerns beyond what has already been disclosed, which appears to be related to certain personal disagreements. From our perspective, nothing in the financials suggests any deeper issues. 

That said, events like these can act as a sentiment dampener. The stock has historically been a favourite among foreign investors. In an environment where we are already seeing FII (foreign institutional investors) outflows, this can double-whammy the stock price. However, if you look beyond the near-term price movement, the underlying franchise remains very strong. We do not see any meaningful impact on the bank's operations in the near to medium term, nor any broader spillover to the sector.

What do you have to say about the market’s reaction to the news? Did the market under-react, over-react or react appropriately?

In the short term, it is always difficult to rationalise every market move. There can be an initial overreaction as investors turn cautious, especially in a stock with significant foreign ownership, as nearly half the ownership is with FIIs. In such cases, the first reaction tends to be amplified.

However, as the situation settles and business performance continues to come through, some of these concerns are likely to fade. Our view remains that there is nothing fundamentally wrong with the franchise, and the issue appears to be limited to personal disagreements rather than structural concerns.

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