Top Indian Mutual Funds On Market Correction, Sectoral Bets and Omicron Scare

As the Omicron variant of Covid-19 has triggered concerns globally even as Indian equity benchmarks have retreated from record highs, three of India's largest asset managers spoke with BloombergQuint on how investors can navigate this volatility.

Axis Mutual Fund and ICICI Prudential Mutual Fund expect market consolidation. While DSP Mutual Fund foresees a further pullback, it expects the economic impact to be mild even if there is a lockdown.

Axis MF considers India overvalued in the short term. DSP MF, however, finds the premium to peers justified due to higher growth, which is likely to be aided by the entry of new-age businesses.

ICICI Pru MF is overweight on auto, telecom and pharmaceutical sectors and underweight on consumer non-durables and software. Axis MF advises caution and going stock-specific, while DSP MF follows a long-term approach of buying stocks with growth potential and sees the banking and financial sector outperforming as rates rise.

Here's what the three asset managers said in response to BloombergQuint's emailed queries:

Do you believe that there will be a steeper fall or are you heavily buying quality stocks already?

Axis MF: We think it’s better if the market consolidates for a few months. This thesis stands if no major event like a new variant balloons and topples equity markets globally.

ICICI Pru MF: Indian equity markets have been under pressure over the last one month, as could be seen through weakening market breadth. Foreign institutional investors, too, have been sellers to the tune of Rs 25,000 crore each in October and November.

Excluding India, other Asian markets have already seen a sell-off. Post the one-way rally, we believe the Indian equity market is likely to see an element of consolidation.

DSP MF: There's no way to predict how steep the fall would be. We are using the weakness to build good quality businesses as the economic growth is just beginning to turnaround and there is a large runway ahead as far as the long term is concerned.

In the short term, there is some nervousness in the markets due to the Omicron scare and this will continue till more clarity emerges. The markets were heated up a bit in terms of historical valuation parameters, and hence, some correction is quite reasonable to expect.

What's the biggest possible reason for Indian markets overshooting downside estimates?

ICICI Pru MF: The strengthening dollar index indicates a risk-off environment, rising inflation print across the U.S. and Europe, increasing probability of a hike in interest rates by the U.S. Fed and the RBI, rising global yields as economies recover even if inflation moderates, crude oil spike and a newer Covid-19 variant are all factors which are weighing on the market.

Axis MF: Overexuberance, especially from retail and high net worth investors.

DSP MF: The current year is likely to end on a strong note, as far as the corporate earnings are concerned. However, the last few years were affected due to cleansing exercise being initiated by the government in the form of demonetisation, GST, banking sector reforms, etc.

Public and private investments did not also keep pace with the requirement. However, most of these issues are behind us and we are looking at the future with more optimism.

How serious can the new Covid variant and possible lockdowns be?

DSP MF: The initial impact of Omicron seems mild. However, its real impact would be known in the coming days as more data comes out in terms of mortality, transmissibility, and efficacy of existing vaccines.

Further, we have got used to working under restrictions and hence, the overall economic impact may not be significant even if we must resort to lockdown.

What is your view on the impact of higher interest rates?

DSP MF: The interest rates have bottomed out and we see them rising as economies grow. Higher interest rates can temporarily cause volatility and lead to sector rotation.

Theoretically, higher interest rates should lead to lower stock prices as the future cash flows get discounted with higher rate. But this may not hold true as it is also accompanied with faster economic growth. We feel in this environment, the banking and financial sector should outperform.

What is your view on valuations relative to the rest of the world?

Axis MF: India is overvalued in the short term, but for the longer term, we need to see results for a few more quarters.

DSP MF: India is an expensive market in relation to the world markets. However, the premium is justified due to higher growth for which the visibility has improved now.

Further, the valuations would look higher optically, as some of the new-age businesses find place in the index replacing a few old economy cheaper names.

What is your portfolio approach to the current uncertainty and volatility?

Axis MF: A bit cautious, not worth adding high beta, going stock-specific more than sector calls.

DSP MF: We follow a long-term approach to buying companies in our portfolio and follow a philosophy of looking at businesses which have a long runway available for growth — companies that have clear competitive advantage, have demonstrated superior capital allocation and are available at a reasonable valuation. We avoid the short-term noise, rather consider them as an opportunity to build good quality companies for longer term.

ICICI Pru MF: The top three sectors we are overweight on are auto, telecom and pharma.

• Auto: The auto industry is plagued by multiple headwinds such as Covid-19 impact on volumes, margin pressure due to higher input costs, and most recently, production cuts due to semiconductor shortage. But the launch of new models, especially electronic vehicles will be a game changer for several automakers.

• Telecom: The sector is on the cusp of multi-year upcycle driven by changing user behaviour, consolidating industry structure, deferral/moratorium of adjusted gross revenue and average revenue per user recovery and de-leveraging of the balance sheet, etc. The sector continues to witness tailwinds led by rising data consumption on account of work from home, learn from home, rising penetration of digital payments and increased usage of video applications. Top line growth in the sector will be driven primarily by increase in ARPU rather than subscribers’ addition.

• Pharma & Healthcare: Post the recent correction in the pharma sector, valuation turned reasonable. The sector is in the midst of a robust capex cycle and continues to show healthy traction in earnings (rupee depreciation to benefit exporters). We expect to see margin improvement on the back of cost optimisation. We continue to remain positive on the domestic market where the focus of key players remains on growing its strong brands using digital tools. We expect valuations for the domestic pharma segment to remain strong as mergers and acquisition activity/private equity deals continue to remain healthy.

The two sectors we are underweight on are consumer non-durables and software.

• Consumer Non-Durables: Valuations appear stretched due to decent results. But margins may come under pressure. The high premium seems unsustainable, and thus, may gradually contract a bit as we see better growth coming from other sectors. Also, consumers are feeling the pinch of rising product prices. Cessation of the one-off pandemic support from the government and high unemployment could suppress growth for fast-moving consumer goods companies.

• Software: Major software stocks are trading at rich valuations. But selective bets have headspace for growth alongside a reasonable margin of safety. One needs to be watchful over management ’s growth guidance and monitor effects of supply-side challenges.