Too early to reallocate investment into large-caps: Feroze Azeez

There's a shift in the way Indians are spending., says the Anand Rathi Wealth CEO

It's still early to reallocate investments because small-cap funds have seen inflows, and small-cap stocks are gaining momentum, Feroze Azeez, deputy CEO, Anand Rathi Wealth, said in an exclusive interview with Moneycontrol.

He highlighted that there's comfortable liquidity, robust household savings, and potential earnings growth in small caps.

Regarding the impact of geopolitical concerns on oil prices, Azeez noted that while sentiments are an important factor, India's oil imports primarily come from Russia, Iraq, the United Arab Emirates, and Saudi Arabia. The overall impact on India's finances on the fallout of the conflict in Israel is expected to be limited, he believes. Azeez emphasised that domestic factors and liquidity have greater bearing on Indian markets.

When discussing the impact of rising treasury yields on foreign institutional investors (FIIs) and financial stocks, Azeez noted that small corrections in the equity market are normal. He believed that liquidity, driven by index fund investing, would support financial stocks, adding that a negative report might lead to minor corrections but not a significant downturn. Azeez underlined that investors shouldn't react to short-term fluctuations.

Regarding sector preferences, Azeez suggested that service sectors such as healthcare, transport, education and entertainment could benefit from changing spending patterns in India. These sectors might see volume growth but could have some margin concerns. He also mentioned that midsized IT companies offer opportunities due to expected improvements in European discretionary spending.

On public sector banks versus private peers, Azeez said that PSU banks are considered value stocks but could face outflows from domestic institutional investors due to changing mandates. However, they remain relatively attractive compared to private sector banks. Edited excerpts from the interaction:

We're headed straight into the earnings season. There’s also a bit of geopolitical concern. At this point in time, what do you suggest in terms of allocation? 

I would say that it's still early to say. We have a method in which we can compute what kind of inflows small-cap funds were given in September. Of course,  AMFI has not released the official data, but I'll tell you that the estimate suggests Rs 2,000 crore addition into small-cap stocks. Small-caps as a universe is a low free float several times  and when you look at the small-cap index, the top 10 stocks like Suzlon, KPIT and the like, there is a reasonable amount of inflow coming in. Surprise re-ratings have happened in large capital index fund investing. I think index fund investing in small-cap stocks is also bringing momentum. So there is going to be liquidity, which will drive these valuations and the re-ratings.

Point one is that there is an addition September inflow. The Rs 2,000 crore number is my estimate. It could be marginally up or down. We are still seeing liquidity.

There's a paradigm shift in the way Indians are investing. Household savings have been reasonably robust. Small-caps will have re-ratings. That’s point three.

Point four—, I think earnings estimates will catch up. Analysts have not been able to predict earnings estimates on the small-cap side reasonably well. In 16 out of the 17 quarters, the estimate has gone wrong by 3-4 percent. But I think that the earnings will catch up to the valuations.

So I would say that we are a little early in the game to move from small-cap to large cap. We moved in the first half of the financial year. We increased our small-cap exposure from 5-6 percent to 30 percent. And of course there's been about 20-25 percent outperformance of the small-cap index. We think we will not want to miss the last lap of the rally as we get into the next calendar year. I think going into General Elections- there could be some degree of risk aversion which could mean flight of safety.

What’s the bearing of crude oil on equity markets? Because the positive correlation between oil and equity markets now will be disturbed with the geopolitical concerns that have set in. Also, in terms of themes, what could be in store for oil producers, paint companies, oil marketing companies? 

From a sentiment standpoint, this becomes a very important variable, but if we break down our $205 billion of oil imports last financial year, 16.7 percent came from Russia, 16.6 percent from Iraq, and the UAE and Saudi contribute another 30 percent. So 60 percent of our $205 billion of oil imports come from these countries. Qatar is about 6-7 percent. Iran already has an embargo (against it). So I don't think it will have a significant material impact financially. But sentiments definitely are very, very critical. I think that's why you see some degree of buoyancy in the equity markets in spite of what happened over the weekend. And if you look at what we get from Israel, it is less than 1 percent So I don't think it will impact materially because there are other overwhelming variables from an Indian standpoint that would dictate the markets’ direction and liquidity.  If you look at it, the FII flow has been negative for about $1 billion for the first few days of this month, and last month you saw about Rs 14,000 crore going out. But we are comparing $/rupee// Domestic inflow was Rs 20,000 crore. I think liquidity will drag the market. Still, the general election will become the key focal point for the direction of the market and crude, I think, will be behind us. Of course, this time around the concern is calling for countries taking sides, which could have implications, I think we have to keep an eye on it. But I don't see a large concern from the equity market and its correction, because we're already down about 3-4 percent from September levels, which was driven by FII flows.

Are treasury yields rising? Do you think if the trend continues, FIIs could be more of net sellers, and by virtue of that, you would see further selling down in financials?  

I don't think so. Of course, there could be 4, 5, 7 percent corrections in the equity market which for the investor is the part of the game. If you're trying to predict trends that are going to be accentuated or a larger fall, I don't think this could be the reason for a larger fall from a financial services standpoint. Thirty-three percent of the Nifty is financial services and there's so much index fund investing happening that these 33 percent stocks will get an impetus from the liquidity.

Of course, the negative report could result in about 3, 4 or 5 percent kind of corrections. But as an investor, I don't bog myself down with any variable that does not materially impact me. The long-term average fall from peak to trough in the Nifty is about 14.3 percent, even if you exclude 2008 and 2020. This year, the average rise is about 19.3 percent from the March lows till the peaks of 20,160-odd points.

So a 10 percent fall is not something that should cause an investor to materially change his portfolio. Coming back to your point, I think FIIs were net positive for the first six months after a long period of time. If you look at the US Treasury yields reaching 17-year highs, of course, there's going to be some degree of volatility, but there is going to be sanity which will prevail, because the RBI (Reserve Bank of India) stance on liquidity will become neutral, by our estimate. If that happens, Indian equities will be relatively more attractive given the global sentiment on interest rates and the 17-year-high yields. And India is not at the highest yields. It's rather cheap. So I think relative attractiveness will bring FIIs back. Having said that, like you rightly pointed out, a 4-5 percent correction is very, very healthy from an investor's standpoint. Traders generally have stop-losses, investors don't have stop-losses.  So it's very, very dangerous for an investor to stay out because he does not book his losses and come back in with 2 percent moves. He's out of the market for 20 percent, which is a very, very scary thing. If you try five times in 10 years, you will have one such instance where you stayed out for a 20-25 percent rally. That's why I'm not too worried from an investor's standpoint. From a trader's standpoint, this seems like a worry.

Are you looking more towards the IT side or pharma? Which are the sectors essentially that stand out for you and why, and which are the top bets within that space? 

I think one thing from a larger theme perspective is that there's a shift in the way Indians are spending. I think spending towards services is going up. So the service sector—healthcare, transport, education, entertainment—all these will get some impetus because of the paradigm shift in the way India is spending, and when India starts spending, it's a big elephant that goes in a certain direction over long periods of time. Structurally, there could be volume growth for these industries and in turn margin growth could be a little concern, but I think over the next four or five years, this is one theme one should definitely play out in the portfolio because there is a shift in the spending pattern and the green shoots of that are very evident.

Since you have spoken about export-driven stocks, if we're specifically talking about IT, which stocks do you like? Something like Tata Consultancy Services (TCS) which is perhaps going to be giving in details of a much-awaited buyback plan? Do you think the outperformance in the markets recently is because of IT shares? The weakness perhaps could be shrugged off in this quarter. Do you think they are attractive bets? 

I think buybacks are a great way from a tax-efficient payback standpoint to the promoter and all shareholders. If you look at the behavioral pattern of a stock after buyback, especially TCS, you will not be very excited . I would say that in the IT space, I would look at the midsized IT companies that you have to cherry-pick because there's some degree of valuation concern there. But I think there are still opportunities available. IT as a sector has gone through a rough patch over the last one year. Of course, the bottoming out from the last quarter was called out by us, especially because bad results also resulted in a reasonable move for the IT as an index. So to answer your question, midsized IT companies cherry-picked is what we still believe has a lot of value to be made, because I think the European discretionary spending on the IT side will improve significantly from the sluggishness it has shown for the last year.

I'd also want to chat with you about public sector banks. They faced a bit of a drubbing in the previous session. Perhaps you might just call it a healthy correction for these stocks, and a bit of recovery has followed. At this point, how are you comparing private banks versus PSU banks? Which look more attractive? And within the category, what do you like? 

See, PSU banks will always be categorised as value stocks. The funds that are driven by the principle of value are now in a dilemma whether these remain value stocks or not. Do they remain dividend yield stocks? There is going to be some degree of outflow from the domestic institutional players because the mandate they have is value and dividend. We create a value index and a growth index. Value index is the one where you can say these are the 500 companies out of which this subset has value, this subset has growth. A large set is neither of these. The rallies in public sector banks have thrown out some of these stocks outside the value index or the dividend yield is no more attractive. So there is going to be domestic institutional selling, given that the mandate was dividend yield. I think that's one headwind you will see in the stocks. But otherwise, these stocks are relatively more attractive from the private sector banking space.