Mid-caps appear to be expensive: Chirag Setalvad, head-equity, HDFC AMC

Chirag Setalvad, the new head of equities at HDFC Asset Management Co Ltd, India’s third-largest mutual fund house with assets worth Rs 4.15 lakh crore, met distributors and advisors on August 24.

Setalvad is one of the fund house’s longest-serving fund managers. He was part of the original team when the fund house was set up in 2000. He was a fund manager till August 2004. Then, he left HDFC AMC to join a hedge fund.

In 2007, Setalvad came back to the AMC and has been there ever since. Known for his mid-cap and small-cap picks, Setalvad manages four schemes -- HDFC Mid-Cap Opportunities Fund (HMOF), HDFC Small-Cap Fund (HSCF), HDFC Hybrid Equity Fund and HDFC Children’s Gift Fund.

HMOF is one of the largest equity funds, with a size of Rs 33,683 crore. HSCF’s size is Rs 13,459 crore.

Edited excerpts:

What are the major trends driving the markets?

There is uncertainty around growth right now. But if you look at over the last 40 years, India’s GDP growth has been around 13-15 percent on a compounded annualised basis.

This is despite all the challenges over the years, like the global oil crisis, Asian crisis, US Fed tapering, etc.

There are large trends that will benefit certain pockets of the economy.

For example, the shift of market share from the unorganised to the organised sector should continue. The unorganised sector came under pressure after demonetization. After that, GST implementation and supply-chain disruptions caused by COVID-19 came as a big blow. Also, most of the companies in the organised sector are in the listed space. So, they should benefit from that.

After COVID-19, global businesses are looking at the ‘China Plus One policy’ to diversify their supply chain. We can see companies in the chemical and auto ancillary sectors benefiting from this.

Housing prices have remained flat, while salaries, over the last five years, have gone up. So, this will improve affordability in the housing industry as well. Growth in the housing sector should also benefit other sectors, such as cement, housing materials, consumer durables, etc.

Banks are also seeing a pick-up. NPAs have peaked out, and are now down around 2 percent. Since the last 7-8 quarters, NPAs seem to be in control. The capital adequacy ratio (CAR) is close to 13 percent.

We also expect the capex cycle to pick up. Large corporates have deleveraged their balance sheets. We have also seen a lot of support from the government’s production-linked incentive scheme (PLIS) for the manufacturing sector.

What is your outlook on market valuations?

Nifty 50 valuations are 19 times one-year forward price-to-earnings, compared to 17 times historical averages. This is a premium of roughly 10 percent. These are still reasonable valuations. We are constructive on equities in the medium term.

However, mid-caps are pretty expensive, trading at one-year forward price-to-earnings (P/E) multiple of 22 times, which is a 15 percent premium to the historical averages.

Small-cap valuations, like those of large-caps, are close to historical valuations, trading at a P/E multiple of 16 times, closer to the historical average of 14 times. Normally, small-caps trade at a discount of 15-16 percent to large-caps. It is more or less in line with the average discounts.

How should investors approach these markets?

When market benchmarks are valued 10-15 times one-year forward P/E multiples, it is a cheap market. That is when you can use a combination of SIPs and lump-sum investing to take advantage of the cheap valuations.

However, it is difficult to invest in such markets as there is often a lot of bad news flow when markets are this cheap. Now, valuations are between 10-15 times P/E multiples. This is the market where investors should continue with their SIPs. When valuations are over 20 times P/E multiples, markets are expensive.

How are you managing your mid- and small-cap funds?

We ensure that both the mid- and small-cap funds are well diversified, across stocks and sectors.

For example, in the mid-cap fund, we hold 55-60 stocks. While the index is trading at a premium to historical averages, the average P/E of our portfolio is at a significant discount to the index. We are very stock-specific in our approach, and look for quality management and strong business models.

We don’t want to overpay for a stock. We are looking for growth at a reasonable price. We tend to do well when markets are correcting or are range-bound. That’s when markets become more stock-specific.

Your mid-cap fund is the largest in the category. Can size become an issue?

We are a Rs 30,000-crore fund, but we also invest in companies with an average size of Rs 30,000 crore. On the other hand, the industry average of a mid-cap fund size is Rs 6,000 crore. But they are investing in companies of an average size of Rs 50,000 crore. So, they are actually investing in larger companies. We are genuinely a mid-cap fund.

Even our percentage of ownership of market cap has come down. The fund size may have grown, but the segment has also grown. We have had new stock listings, and the market caps of companies have also grown. So, we used to own 0.9 percent of the segment. We now own 0.7 percent.

So, I don’t think size is the challenge. Today, we are among the best-performing funds despite being the largest. There are times when we do well and times when we will not. So, size is the only factor of performance. A lot of it is about stock selection, sector selection and investment style.