The biggest news flow that we were tracking over the last couple of days was the fact that Kotak has re-initiated the inflows in the smallcap fund. What led to that? What is the rationale because when they were stopped a few months ago, the Small Cap Index was at lower levels, and valuations were lower than where it is today? What made you reverse that decision?
Harish Bihani: There were several key points that we had thought through before reopening this particular fund. First, we thought through the terms of the business cycle and post the events that have played out over the past couple of months, including the elections that are over. We are very clear that any changes done in the last 10 years we are moving in a certain direction and should continue to move in that direction so there is no change in the pace or the tempo of change that has happened over the past 10 years. It will move in the positive direction even further.
Second, the business cycle continues to be in an upcycle. There are opportunities across large-cap, mid-cap, and small-cap companies when we look at the business cycle. And when we talk about the business cycle, we look at many points. We look at profit to GDP. We look at the net debt to equity of companies which is at a 15-year low. We would look at the balance sheet of the banking system, which is phenomenal at this point. So, many factors went into this particular decision.Essentially, we said that can we still identify ideas and deploy large sums of money that we have in the smallcap category. And the answer was yes. There were events that we thought have played out and so the probability of any event specific to India disrupting the market is low at this point. With that, we thought that it was an opportune time to reopen the fund. You are saying it is an opportune time and you see some value in the smallcap. So, where is it? Which specific sectors, any specific names you are looking at on the smallcaps?
Harish Bihani: We are looking at opportunities across many segments, but most important is the healthcare segment where we are looking at more opportunities. These are companies generating exceedingly good free cash flows, not trading at a very high valuation in the context of the growth that we look at three, five, or ten years out. When you look at India’s journey from a $3.5 trillion to a $10 trillion economy over the next 12 to 15 years, give or take a couple of years more or less, there will be many small companies that will become big. These will be in certain sectors, certain thematics that are ongoing at this point or new themes will emerge and so our entire intent is to identify those themes and ideas that should become big. Amongst those, healthcare is one particular theme where there are many companies across the hospital space, diagnostic space, and pharma space especially related to the domestic pharma names which are doing exceedingly well as we speak and these are not as expensive as the aggregate smallcap or midcap basket. We would look at names in the auto-ancillary space. Capital goods stocks are trading at a very high valuation. But look at auto ancillary names which are no longer pure auto ancillary, they are moving towards more value-added engineering, into aerospace, some part of defence, etc. Again, that particular pocket is not as expensive as the capital goods stock. We are looking at the construction stock very carefully. We are looking at the entire consumption names. Consumption as a theme has not played out over the past couple of years. There are pockets where things are recovering as we speak and we have seen sharp movement, sharp uptick in stock prices as those recovery takes place. So, we have eyes on this particular theme which should do well when India grows from a $3.5 trillion to a $10 trillion economy. The near-term headwinds should go away in the next 6 to 12 months. So, that is another sector that we are looking at very carefully.
How difficult it is right now to differentiate the FOMO stocks versus the fundamentals? How difficult it is to identify those ideas and if there are some risks within the segment, what are those risks? Is earnings the biggest factor to watch out for or is it that the valuations have become expensive, making some of these stocks fall under their weight?
Harish Bihani: One has to be careful in terms of identifying sectors where the multiples have moved to a level where, as you rightly pointed out, there is a fear of missing out. So, what we are doing actively is to look at those sectors, those stocks where there is a FOMO today and trying to take money off the table. Vice versa, there are themes, and there are names that will do well long term in India but there is no FOMO in those themes today.
So, just keep concentrating on that. Maybe get into those themes a little early and these themes should likely do well over the next 3, 5, and 10 years. So, yes, there is FOMO in some themes. We will have to be careful in those. This is in aggregate across the market cap, this is not specific to only smallcap, this is happening in largecap, in midcap, in smallcap. So this FOMO in certain sectors and certain themes is across caps and not necessarily only in smallcap space.
I just want to talk about a point that you were making in terms of the consumption side. So, when you are looking at the consumption story, would it be more discretionary side, more staple side, what are you looking at right now on that front?
Harish Bihani: We are very clear as a smallcap manager that we are looking at themes where earnings will grow in double digits over the next 3, 5, and 10 years. The QSR space for example, should highly likely do well over the next 3, 5, and 10 years, but it is not doing well today. So, are there names in that pocket where you can identify that name which is the market leader, which should do well in the long term, but there are specific near-term issues and headwinds that should go away as the base impact plays out, as the company is working hard to ensure that there is a recovery ahead of any macro recovery.
So, there are many actors that we are looking at in that consumption basket. The idea is that staples will not give you that kind of growth. So, less of staples, and more discretionary names. For example, a couple of years back, many pockets in consumer durables were fairly cheap in the context of the growth that should come in that sector, but people were not looking at that sector largely because near-term headwinds were there. Now, as the near-term headwind turned into tailwinds, that sector has done phenomenally well, especially in the last six months.
Nifty Realty and all the stocks over there surely have seen a run-up. Do you think the plays that come in after that may be consumer-durable, maybe more on the infra side? When I am looking at it in terms of the Kotak Small Cap Fund, some bits of holdings have increased, higher top sectors, consumer durables, and construction. Could that play still work out?
Harish Bihani: Absolutely. The second-order impact of a real estate recovery is that there will be a building material that will play out. There will be a lot of consumer durable names that should play out over time. There will be a lot of fast-moving electrical goods that should play out over time. So, within those, consumer durables have played out, especially in the last couple of months given the summer season was exceedingly good. But building material stocks’ valuations are in a comfortable zone. When you look at the entire fast-moving electrical goods (FMEG) stocks, again, valuations are comfortable across several names over there and as demand recovers in these names, we should start seeing an improvement in the earnings which should play out in the stock price all else being equal.
Manufacturing has been called a big sunrise space, not that it is unidentified because in the last couple of years, we have seen big investments, but given just the sheer scope and scale available here do you still find value and would you be an investor in the theme?
Harish Bihani: There are specific names in that particular basket that are looking good to us. We will have to be much more discerning today versus a couple of years back. But yes, we still have ideas and opportunities in that particular space.
