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With the market in a tailspin since the last couple of months, many investors remain on the edge as to how much more money they would lose. However, Harsha Upadhyaya, Chief Investment Officer of Equity at Kotak Mahindra AMC, offers an optimistic outlook, stating that even if there's no substantial recovery of earnings in the near term, the "risk of losing capital is low" as the market will continue to deliver modest returns over a 3-5-year period.
Upadhyaya currently manages six schemes at the fund house, having a collective AUM (assets under management) of Rs 84,919 crore. Of these, the Kotak Equity Opportunities Fund and Kotak ELSS Tax Saver Fund have a four-star rating from Value Research.
In this interview, Upadhyaya shares his views on market valuations, suggesting that while large caps remain relatively stable, mid- and small-cap stocks may face price corrections if earnings continue to fall. He also explains the reasons behind the multi-cap fund's high turnover ratio and the factors driving the recent success of the Kotak Emerging Equity and Kotak Small Cap Fund.
Given the recent market correction, have valuations become more attractive, or do you still consider the markets overpriced?
I think valuations are comfortable on the large-cap front as they are more or less around the long-term averages. Therefore, the risk of losing capital is low if you want to invest for three to five years. Typically, if you are a long-term investor, your returns should align with the growth in earnings. Hence, even if you don't anticipate a significant recovery in earnings in the near future, we remain confident that, given the ongoing growth story in India, you should expect reasonable returns from equities over three to five years. However, mid- and small-cap valuations are still high, so we cannot predict their outcomes.
The underperformance of mid and small caps has started only in the recent few weeks. I would like to share some statistics. From the post-Covid period until FY24, the mid- and small-cap basket grew at almost twice the rate of large caps in earnings on a CAGR basis. Right now, when you look at the earnings for large caps, they have shown very subdued levels at about 3.5-4 per cent. When you look at mid and small caps, there is no positive differential over large caps. In fact, many of the mid and small caps have started to degrow year-on-year. At this point, mid- and small-cap investors lack confidence. So, it is difficult to make the same kind of comment on mid and small caps compared to large caps. Clearly, comfort is more in large caps at this point. In the case of mid- and small-cap investments, I think you need to be watchful in terms of what kind of portfolios you are betting on and be more staggered in your approach rather than making lumpsum investments.
Do you think it will be time or price correction for the market's mid- and small-cap segments?
Making a call between a time and a price correction is challenging. To me, it looks like it's going to be a combination of both. We have seen underperformance in mid and small caps for just the last four or five weeks compared to sustained outperformance in the previous four and a half to five years. We need a reasonable price and time correction. However, that would depend on where the fundamentals will be over the next couple of quarters. If earnings continue to be weak, like the second quarter of this financial year or the current quarter, I expect a price correction. However, if earnings disappointments decrease, we will likely see a more gradual correction.
Can you share your investment philosophy and how it has evolved?
Over the years, nothing has changed. We have stuck to our discipline of looking at growth at reasonable prices or reasonable valuations as our fundamental principle for investment. We evaluate companies from three angles - business, management and valuation. We generally like companies that have very stable businesses and have scalability and sustainability of those businesses. This is because, typically, if you look at our portfolios, our churn has been much less than our peers, so we usually try to bet on businesses from a longer-term perspective, and that's where the scalability and sustainability of those businesses will be important. Then, we also evaluate management in terms of whether their interests are aligned with the minority shareholders or what their capital allocation policy has been. Many companies, particularly in the Indian context, have made poor capital allocation decisions that have hindered their growth.
Apart from that, the management vision, the execution, the track record and the governance standards all come into play once we are positive about both the business and the management. The final filter would be on the valuation in every case; it's not that we will not look at valuation when we are positive on the first two elements. We always look at valuation, and only when we are comfortable with valuations do we proceed and take that particular business into our portfolios. This has been our approach, and we typically invest in companies that demonstrate compounding characteristics. As I mentioned earlier, our portfolio turnovers have been relatively low compared to the industry, and we try to find businesses that we can hold on to for a longer period and bet on the compounding characteristics of those businesses to make money for our investors.
Kotak's diversified equity funds are often associated with a low turnover and a buy-and-hold strategy. However, the Kotak Multicap Fund deviates from this style with a higher turnover ratio. How does this approach fit within Kotak's broader equity strategy, and how do you see this evolving in the future?
This is the general strategy we follow across our funds, but some strategies may differ by mandate or due to current opportunities. For example, if you look at our contra fund, it's supposed to look at investments from a contrarian approach, so you may not find the same kind of growth at the reasonable valuation approach.
As far as the multi-cap fund is concerned, it has to invest across segments with a minimum of 25 per cent going into large, mid and small caps. There is always a choice between segments, stocks and sectors. We'll experiment with moving between segments if you find more market opportunities. Hence, certain strategies may deviate from our overall framework at specific times. We don't make these deviations solely to distinguish ourselves from the crowd. You need those opportunities in that fund management style or mandate right now. Thus, you will see some of those changes. But when you look at it from an overall perspective over some time, I would say that you won't see those kinds of deviations.
The Kotak Flexicap Fund and Kotak Focused Fund were in the third quartile in 2024, and a longer-term analysis indicates they have consistently struggled to outperform their peers on a three-year rolling return basis. While their performance has improved, what steps is the team taking to sustain this momentum and enhance returns?
I think you should make that analysis one or two months down the line and see a completely different picture because, as I explained earlier, we are always conscious of the overvaluation in the market, especially in the mid- and small-cap segment. To that extent, compared to peers or even the benchmark, we had taken a lower exposure to mid and small caps, given our discomfort with valuations. That call has gone right, given the volatility we have seen in January and February of this year. While we may have been a little early in adopting a cautious outlook on the market, it's impossible to abandon a strategy at the last moment. So, our cautious approach has helped the fund reduce the drag in a volatile period, and you will start seeing that advantage coming back in terms of long-term performance when you look at performance over the next few months.
Kotak Emerging Equity and Kotak Small Cap Fund have delivered decent performance over the past year. Interestingly, both funds also underwent leadership changes during this period. How do you assess the impact of these changes on fund performance, and what has been the driving factor behind their recent success?
The numbers are self-evident. I think we follow an institutional framework for investments. It's not dependent on any individual, whether in research or fund management. As long as we maintain the institutional framework, an individual is unlikely to change the course of performance. I think it shows how strong our institutional framework has been, how strong our research process has been and how well our research team has given recommendations in a period where the valuations were so exaggerated in the case of mid and small caps, especially in the two funds you mentioned. All of that has happened for a while, and if you hadn't looked at the fund manager's name or fund management team details, you wouldn't have noticed a change. We are thrilled that our institutional framework has paid dividends. I believe there was likely no chance to demonstrate this for the past 10 years, as our team remained intact. However, when we experienced these exits, we were able to bring in similarly talented individuals. The new members have seamlessly integrated into the team and the process, and the institutional framework is a testament to its strength.
Also read: Interview with Daylynn Pinto of Bandhan AMC
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