Atleast 60% in mid and small caps and rest in large-caps can be an optimal allocation now: Taher Badshah

Despite a strong second COVID-19 wave, Indian equity markets are holding strong. Taher Badshah, chief investment officer-equities, Invesco Mutual Fund says that while the Nifty is holding up at around the 15,000-mark, markets are rotating from one sector to another. There has been significant investor interest in the Invesco India Contra Fund, which has outperformed peers. The fund house (Rs 37,000 crore assets) itself has many consistently performing equity schemes. In an interview with Vatsala Kamat, Badshah talks about the changing composition of the markets through the second wave, the fund’s portfolio construction strategy and more. Excerpts.

Has the ferocity of the second wave made stock-picking challenging for fund managers?

Last year, after the initial collapse in the economy with the national lockdown, the Nifty moved up steadily from 7,500 to the 15,000 mark. As risk levels kept declining with economic recovery getting broad-based, equity markets climbed up.

This time, lockdowns are state-driven and hence protocols vary between states. Yes, there is a risk to earnings from a fiercer second wave. The challenge for fund managers is that we cannot switch investments (from one sector to another) so frequently. Even within the Nifty, the smaller constituents such as commodity stocks are moving up fast and the heavy weights are all stagnant. That is why, although the smaller stocks have moved substantially, they have not been able to do the heavy lifting of the Nifty this time. Clearly, there is a lot more focus on value bets in the markets.

As a fund house, we are trying to strike a balance in the strategy and ensure that our portfolio mix covers most of sectors. Last time, during the recovery from the pandemic, most of the B2C (business-to-consumer) companies led the rally. This time, it could be the B2B (business-to-business) firms.

Do you expect any sharp earnings downgrades due to COVID 2.0?

It would be tricky to forecast earnings, as the composition of earnings may change. Incremental earnings will be driven by commodities and oil-marketing companies that are on a roll, after several years. This might absorb some disappointment in FMCG companies, retail and banks. With the GDP growth estimate coming down from 12 percent to about 10-10.5 percent, we are shaving off some earnings growth.

In January, Nifty earnings growth for FY2022 was estimated at 22-24 percent. This may be watered down to about 20 percent. But a good part of the growth will be driven by sectors such as metals, which may compensate for shortfall in earnings from other sectors. This is assuming that vaccine rollout will accelerate in the coming months and about 70 percent of the eligible population can be administered a single dose by the first quarter of calendar year 2022.

Could you explain your winning equity strategies?

Risk-adjusted returns are important. We cannot afford to take excessive risks even in a small-cap scheme despite being a small-sized fund. We prefer to split our diversified funds’ portfolios into three parts. But we pick stocks from our curated basket of about 150 stocks, from which fund managers can pick and choose, depending on the scheme they manage.

The first portion is our backbone; companies that aren’t as fanciful but are stable. Now, the second part comprises growth-oriented, mid-sized companies, which benefit from robust earnings growth rates. Their business models are established and they could be market leaders as well.

And the last one-third portion is where the fund manager takes a little more risk. To try and predict future winners. These could be niche businesses or new emerging themes or disruptive businesses. So, the risk taken is higher in the quest for higher returns.

If a person is willing to allocate funds to equities at this point, should he invest in large-caps or mid-caps?

At this point, a 60 percent allocation to mid and small-caps and the balance to large-caps would be optimal. Of course, it depends on his personal risk profile and the changing circumstances in equity markets.

Invesco’s Contra Fund has been a star performer in your equity basket. What contra strategies would you adopt?

In the Contra Fund, we have a value-oriented strategy. We prefer companies that are either in a turnaround situation or are trading below their intrinsic/fundamental value. The focus is on inexpensive valuations. Entry of a new idea is necessarily ‘value’ based, whereas exit from a stock is based on the risk-reward equation.

At least 60 percent of the portfolio is in value opportunities at any point in time. The typical journey of a stock in the fund would be to enter when it is out of favour and cheap, and exit when valuations turn unreasonable. This way, we capture both earnings recovery and valuation re-rating of the stock. This ensures that the aggregate valuation of the portfolio is attractive and generally at a discount to its underlying benchmark.

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