'One needs to be more selective with mid-cap stocks'

What has resulted in the outperformance by the fund over the last one year?
We would attribute it to our fundamentals-based stock-selection process. Specifically in the mid-cap category, sector allocation is not as critical as stock selection. Our philosophy of investing at Axis is to focus on high-quality companies that have high growth prospects. We believe a fundamental investment approach focused on identifying such sustainable businesses while controlling risk is the best way to deliver returns in the Indian equity market over the long term.

How do you pick stocks in this fund?
Our investing philosophy across all funds remains the same. Over and above the philosophy, we have to keep in mind the fund mandate and investment objective. Axis Midcap Fund has a high-conviction mid-cap portfolio, with reasonable diversification across sectors. Since these are emerging companies, it is crucial to stay alert about the business models, business prospects and management. Over and above that, while examining companies, I also bucket any stock as leaders, challengers or consolidators. This is done irrespective of the size or market cap of the company. It helps us get a better perspective on the portfolio.

When do you exit a stock?
A change in business fundamentals is the primary reason for selling a stock, which include change in competitive advantage, capital-allocation decision, corporate governance, etc. Instead of using absolute valuation as a metric, it's the relative risk-reward metric that matters more.

Your portfolio's P/E is over 40. Haven't valuations got stretched?
Though large-cap stocks have traditionally enjoyed a valuation premium over mid-cap stocks, now mid-cap companies also fetch their due multiple. Mid-cap companies with less capital-intensive businesses, lower debt levels, nimble business models and operating in niche spaces can deliver faster earnings growth than large caps and therefore may justify higher valuations. Currently, valuations are rich in the mid-cap space primarily because of liquidity. However, earnings growth would be a crucial element for wealth creation. As far as our funds are concerned, we follow quality and growth philosophy, and such companies fetch high valuations. Hence, price-to-earnings-to-growth (PEG) ratio matters more.

How do you see the recent fall in mid caps?
We saw a sharp rally in mid and small caps during 2013 to 2017. We also saw macros improving from the bottom between mid-2013 and 2016-end. Some global parameters, like interest rate and crude-oil prices, have worsened since 2017. Some macroeconomic parameters on the domestic front are also off their best, like the rupee, interest rates, etc. Due to these, we have seen a sharp correction in expensive stocks where there is no earnings delivery versus high expectations. We look at corrections as an opportunity to invest. But we continue to expect elevated volatility in the near term.

How has SEBI's new categorisation impacted you?
As far as the rule of minimum 65 per cent exposure to mid-cap companies in our Midcap Fund is concerned, it's actually relaxation for us compared to the minimum 75 per cent mid-cap exposure we had been following. While standardisation of mid-cap and small-cap definitions brings uniformity in the industry, there is little change in the new definitions compared to our earlier definitions. As a fund house, we have been the clear beneficiaries of the new categorisation. None of our portfolios had to be merged or wound up, while there may be opportunity for new schemes.

What is the outlook for mid caps?
Mid-sized companies create more wealth as compared to large companies over a longer period of time due to their high-growth profile and valuation discovery. Out of these, the valuation-discovery element is broadly in price, considering the sharp price movements in the small- and mid-cap space. Hereon earnings-growth delivery matters, and hence one needs to be more selective with mid-cap stocks.