largecaps: Using current rally to shift more into largecaps and to fully deploy new cash: Jigar Mistry

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Jigar Mistry, Co-founder, Buoyant Capital, says “if you look at the ownership spectrum of largecap versus smallcaps and look at the free float as an additional variable into this, very interesting data is shaping up. There are a few graphics running there but if you look at the free float ownership in the largecaps, FIIs are the predominant investors with almost 42% of the ownership in free float largecaps. But if you look at smallcaps, retail ends up owning 49%.”

On Friday, largecaps were pretty quiet but that had been the story for the last few weeks. How are you analysing the construct of the market right now?
See, it is an interesting time because if you look at India from a slightly longer term perspective, it looks like it is not just the fundamentals that are reasonably good but we will eventually end up attracting a lot of flows as well. A lot of investors are now taking that to mean that because the long term is great, the run-up to the long term still needs to be great and a vast section of the retail investors in India have started after Covid and they sadly have not really seen any down cycle so far. So, the way in which we are approaching this is that if you look at the ownership spectrum of largecap versus smallcaps and look at the free float as an additional variable into this, very interesting data is shaping up. There are a few graphics running there but if you look at the free float ownership in the largecaps, FIIs are the predominant investors with almost 42% of the ownership in free float largecaps. But if you look at smallcaps, retail ends up owning 49%.

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In the rally that has begun from March this year, a lot of businesses, 150 plus businesses have more than doubled in share price and if you analyse that on a sub-basis, you will find that the lower the free float, the higher was the extent of gains; the smaller the market cap, higher is the extent of free float and then when you superimpose what really happened in the 2018-19 cycle, things become rather questionable.

If we take 25% of a drawdown as a particular pullback or start of a new cycle, then arguably we are in the second best smallcap rally since the start of equities investing in India. So, our sense is that a large part of play out has happened. One needs to keep an eye out.

Now allow me a minute to run you through what happened in 2018-19. In 2018, we were coming off 2016-17 strong gains in the smallcaps and after that the long-term capital gains was introduced in the Budget of 2018 and later that year, the categorisation of mutual funds to stick to true to label had come through. Now those two individual changes in and of itself should not have resulted in a huge pullback but it did.

So, profits during that same period kept on rising. In fact, in those two years, it rose almost 40%. But the index, the BSE Smallcap Index fell 38% during that time and there were 250 companies which fell more than 60% and 50 companies fell more than 80% during that time. While the going is great, there are still a lot of quality businesses that are up there and we need to keep an eye on what is really happening in the smallcaps. As a sector, it still puts some interesting businesses but this plain vanilla, broad brush to paint everything looks a little bit questionable.

So, what does your portfolio look like right now? What are the top three biggest weights in your portfolio right now?
I will run you through the change that we have had and then the sectoral ownerships. Clearly, by March 2023, we were 60% small and midcap as a fund. You remember in March, there were Budget changes and a lot of investors were busy investing into fixed debt products and buying a lot of insurance and therefore some midcaps because of low liquidity were available at very attractive valuations. That is where we had turned dramatically into small and midcaps and if I look at our October portfolio, that proportion has fallen below 40%.

We operate in this aggressive and defensive mindset where we bring down the portfolio weightage to 30% if things go in the other direction. So there is still some leeway but we are using this current rally to shift more into largecaps and taking time to fully deploy the new cash that we are getting. In terms of sectoral allocations, given where banking and financials is in India, that is one space which has the highest space in our portfolio as well but incremental insurance, cement, pharma is a space where we are finding a lot of value as we go there.What have you picked up in pharma and the rationale over there because it is very stock specific call in pharma?
Yes,, stock specifics for sure but look at what led to the correction. I am taking maybe a step back and you go to what allowed Ranbaxy to announce the Lipitor generic in 2002, it got launched much later, that rally played out until 2014-15, after which all the ingredients that led to such a strong rally had started withering down. India traditionally has been a great single molecule manufacturer or rather reverse engineer and that way we were doing fairly good but all the patent cliffs that happened after that were either complex molecules or complex generics and multi molecule sort of ingredients and that is where India did not do very well.

Secondly, the GDUFA framework that came through that not only raised the fees for a lot of people, but the R&D budgets for many companies kept going up and after that the inspections that fell through, there were a lot of companies in India where found wanting is an understatement.

Also, how the PBMs essentially merged together and the purchasing power got a lot more potent. At the margin and after that Teva, Lupin here fell dramatically and post that we are sensing, so rather we were in April sensing the first rounds of turnarounds where the generic pricing in the US were not falling as much as they used to and since then the things are looking great.

So, we wrote an article in April saying that there were businesses where we find a lot of value and if you rank down the generic, we did give out an order that Auro, Alembic, Zydus, all those appear to be reasonably well positioned businesses if there was a turnaround in the US. As you said, stock specific, yes, but at a more generic level, it looks like the worst of the pains as far as generic pricing is concerned is behind us.

What are the latest additions or changes which you have made, addition and deletions in your portfolio in the last three-four months?
At the webinar that we put out in November, we highlighted the three businesses that we have added. One clearly was ICICI GI. That is where we have increased weights in a meaningful manner and the other two were small and midcap businesses. One was RR Kabel and the other was Aavas Financiers.

What are the risks you are looking at and are also building in your portfolio just to be prudent in risk management right now?
One of the major issues that we are grappling with is how high US interest rates and higher for longer interest rates are two separate things and I do not think the market is very appreciative of that just yet. When the interest rates go up and then come down immediately, we do not see a full transmission in the system. For example, the mortgage rates in the US at the marginal level is upwards of 7.5 percentage points. But if you look at the lock-ins that were set up two years back or so, the average mortgage payer is still not paying upwards of 3 percentage points.

So, if the rates stay higher for longer, then you are likely to see that reset coming through which will impact the companies and the earnings at the CRB or the commercial and real estate business level. Secondly, post Covid, we are seeing a lot of cash flows being put out to the individuals and businesses by the US government and the cash levels if you see have only been normalised now. So, if these rates stay higher for longer then what most of us believe or used to believe that oh, rate hikes have happened, whatever worst is now behind us, it is in the price then that may not end up being true, that is as far as the US is concerned.

As far as India is concerned, the biggest challenges continue to remain at the current account and BOP level. Crude settling down lower below $80 is great news and I do not know if we have checked recently, but there has been a dramatic drop in the net FDI levels, gross FDI was still chugging along reasonably well but with the spate of selloffs that have happened, the net FDI has come down to below $5 billion. Last quarter, it was in excess of $30 billion.

The last point here is that there is a lot of resettlement of the short-term maturities that needs to happen upwards of $250 billion in the next nine months. So, if you can have the cocktail of events where oil moves up to $90 and net FDI stays low, you might have a pressure on the RBI to act completely distinct for where the central banks across the world are acting, so that remains one of the challenges.

Secondly, challenges with regards to some valuation concerns remain. A lot of investors are not waiting for the proof of the pudding. With huge increase in order backlogs that we are seeing with some of these businesses, I would want to see if that translates into higher earnings eventually because order backlog driven stock price movements are great but unless companies can deliver on the OPM, the operating profit margin or the PAT level, it ends up becoming more of a drag than a gain.

So, those proof of the pudding concepts need to be proven before we go up on the next leg in the small and midcap space. Other than that, state elections are not really a big challenge. Enough and more has been said, how the share percentages at the local assembly versus the general elections tend to change and therefore policy construction needs to be more or less remain, so those are not really great risk elements but these are at the broader macro level and the valuation level is what we are watching out for.



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