Got Rs 10 lakh to invest? Kotak AMC’s Harish Krishnan shares strategy for retail investors

Harish Krishnan, Senior VP & Fund Manager (Equity), Kotak Mahindra AMC

Harish Krishnan, Senior VP & Fund Manager (Equity), Kotak Mahindra Asset Management Company (AMC), manages close to Rs 22,900 crore in investor money across five funds, including the AMC’s balanced advantage fund. The fund manager is banking on increased capex (capital expenditure) by Indian companies to double corporate India’s earnings over the next 6-7 years.

“The capex companies are doing today will be the source of cash flows and profits tomorrow. And, we are clearly seeing the large caps doing the heavy lifting there,” says Krishnan. Given the current valuations, he doesn’t expect the return dispersion between small and mid-caps, and large caps, to be markedly very different.

Krishnan spoke to Moneycontrol’s Maulik Madhu on his outlook for the Indian equity market, his stock-picking strategy, how retail investors should deploy a lumpsum of Rs 10 lakh, and more. Edited excerpts.

What’s your outlook for the Indian market? What are some key factors that investors must watch out for this year?

There is going to be a reasonable amount of volatility in the runup to the 2024 elections. Investors generally want a stable government, and possibly the market will come to some collective view 3-4 months before the actual event. Not that we can do anything about the volatility but that provides an overall backdrop.

We look at equities from the lens of three aspects: earnings or fundamentals; sentiment, which is more a proxy for, say, interest rates; and then, liquidity.

Earnings doubled in about three years during the covid phase (2019 to 2021-22). And we think that the next doubling, if at all, would happen over the next 6-7 years. That is primarily predicated on capex (capital expenditure) happening now, as capex done now will translate to future cash flows and profit pools. Capex by Indian companies has been pretty much muted pre-covid. It has been flat at Rs 6 lakh crore for the last 10 years. So, for the first time, we are seeing capex move to the Rs 7 lakh crore mark (annualised) for the top 1,000 companies — sort of from neutral gear to first gear.

In the near term, we have seen a significant margin compression for companies, especially in the September and December quarter of last year. And that was primarily predicated on the fact that manufacturers were facing far higher inflation compared to what they could pass on. I think it will take under 2-4 quarters to get back to earlier levels.

On sentiment and liquidity, we are slightly more sanguine.

We have had a significant amount of FII selling in the last 18 months or so. In dollar terms, the Indian market has corrected as much as the US. India being a structural story, this kind of a drawdown might appeal to many foreign investors to come back.

And if I look at interest rates globally and in India, the rate of change seems to suggest that we are coming to an end to that (rate hike) cycle.

I would say that the medium-term backdrop remains very encouraging. In the near-term, we think this is going to be a year of accumulation, rather than any meaningful fireworks. That’s our base case view but markets can always surprise.

What has changed capex-wise?

In the previous cycle, let's say the GFC (global financial crisis of 2007-08), or pre-2011-12, mid-cap and small-cap companies — if we go by the AMFI definition — used to account for almost 60 percent of capex. It was very broad based. Today, large caps account for almost 70 percent of capex so it has completely tilted. And that's primarily because obviously, there's been significant mortality among mid- and small-cap companies. And, the higher risk appetite is going to come from the bigger business houses.

In terms of sectors, it has been reasonably diversified. So, capex has been coming though in chemicals, PLI-led (the government’s production-linked incentive scheme) sectors, cement, and processing sectors, including metals, renewables and gas utilities.

Which market segment (large, mid and small cap) looks attractive today?

Given the fact that the froth has dissipated, especially in small caps, I would say there is a case for a slightly higher allocation from a 3-5-year perspective. That said, I don’t think that there is going to be a meaningful dispersion in returns between small, mid and large caps by and large, because we are clearly seeing the large caps doing the heavy lifting in capex.

If I look at valuations, they are at par or maybe in certain cases, even at a premium for mid and small cap companies. So, the return dispersion isn't going to be markedly very different. This wasn’t the case 10 years back, from where we have seen such a huge difference in dispersion of returns between small and mid and large caps because their starting point for valuations was significantly cheaper compared to large caps.

Given that large caps have a slightly better liquidity profile, they are the better place to be in from a risk-adjusted basis.

What’s your investment style? How do you pick stocks (apart from what you have already highlighted)?

Our preferred thing is ‘best of breed’. From a style point of view, if you were to slot us, we are ‘growth and quality at a reasonable price’.

To us, all sectors are cyclical and they will go in and out of favour at varying points of time. But if you're able to back the best of breed, that is, the better companies within a sector that can gain mindshare and market share, especially during troubled times, then these will typically dominate the value chain as the sector tailwinds start coming through.

We are diversified across sectors, and we typically give 4-5 years for a company to execute.

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Where should someone with Rs 10 lakh invest today?

I think debt today is offering a reasonably good yield, so I wouldn't want to pass up this opportunity. But at the end of the day, equity is going to compound wealth over the long term. So, it’s finally a call on the horizon of the investor. I would say 50:50 (equity and debt), assuming, say, a 3-5-year horizon.

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Apart from capex, what other themes / sectors are you bullish on?

Investment rather than consumption is broadly where some of our bigger bets are.

Another set of companies are those where the brand or franchise is intact, but margins have been significantly impacted. So, we are looking at companies that have the ability to increase margins. For example, sectors such as gas utilities and cement, where the cost of energy, which is the key raw material, went up significantly. As energy prices have stabilised year-on-year, and in certain cases, new regulations have come in place, the earnings flow after a few quarters might be stronger than today.

The other way to look at sectors is from a profit pool perspective. Let me give you a few examples. So, auto and auto ancillary is a cyclical sector, and the profit pool share for this sector (as a percentage of the top 1,000 profitable companies) has typically varied from 1.5 percent to 9 percent over the last 20 years. Today, it is at 3.5 percent. So, we think that sectors that are at the bottom half are the ones where the earnings share can potentially increase faster than the rest of the market. Similarly, the profit pool share for healthcare or pharma is almost at 15-year lows; for cement, it’s almost at a 25-year low. Many of these sectors have also under-performed over the last five years. Thus, they present a better margin of safety.

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