'We are positive on earnings but believe a lot of that is in the price.'

What are your views on market valuations, particularly in the small-cap space? We see that your small-cap and focused portfolios are valued relatively higher than most other peers. Many believe that markets are overvalued even after factoring in earnings growth. Do you see a potential rise in earnings that can justify the elevated valuations? Market valuations are expensive on traditional or oft-discussed parameters. Oft-discussed as in price-earnings and price-book. However, the definition of valuation goes and always has gone beyond simple rules of thumb. Valuations capture three essential characteristics - growth, returns on capital, and cost of equity. We run an internal model that captures a bit of all this that provides indications on market valuations basis the long-term earnings cycle (which impacts growth and returns on capital) and interest rates (which impacts the cost of equity). That model is at a positive divergence to traditional P/E, given a below-par earnings trend for many years and falling nominal and real rates. Presently, our house view is neutral to cautious on equities. We are positive on earnings but believe a lot of that is in the price. Getting to a view on small-cap valuations is tough because the category is highly heterogenous, large in terms of the number of stocks, and a lack of credible estimates on growth expectations, among others. Our view on this category over the last year has been positive purely due to an expected mean reversion on performance vis-à-vis the large-cap space. That has largely played out and probably has a bit more room to go. Our small-and-mid-cap portfolios are run almost entirely on a bottom-up basis. We look at valuations from

This article was originally published on August 05, 2021.