“Investors should keep in mind that they have borrowed some future returns”

Moreover, expecting to achieve returns that exceed earnings growth from the starting point is a risky assumption. So, the best guess for returns will likely align with earnings growth. However, given that the valuations are currently high, there is a possibility that returns could dip below earnings growth if valuations start to normalize, he said.

“So, that’s the mindset I would adopt when looking at the equity markets right now," he said in an interview.

Edited excerpts:

You've witnessed the cycles of the market, having been in it for over three decades. In your view, how has the mindset of investors evolved over time?

I wouldn't frame the answer that way because there's something more interesting to note. In the past 5 to 7 years, we've seen a significant influx of young investors in the market. For those with 30 years of experience, evolution has been gradual. What stands out is the behavioural shift: equity investing has become widely accepted as a key part of strategic financial planning for long-term goals. This marks a notable change from 20 or 30 years ago, when many viewed investing as a quick way to get rich. While some of that mindset remains, especially in speculative trading, the data shows an increasing commitment to long-term investing. Equity investing is now mainstream, no longer just for a few speculators, and that is the real shift.

Could you elaborate on the significance of long-term investing compared to short-term trading or investing?

In my view, much of short-term trading—and I’ve done it earlier in my career—is essentially a zero-sum game. You're dealing with daily volatility and market fluctuations. But when it comes to investing, the key advantage is the potential upside over long periods of time. Equities, in particular, are a unique asset class because the upside can be vastly different from the downside, which gives them the ability to generate wealth over the long term.

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This is why I believe people should consider equities—no other asset class offers the same potential for wealth creation. As an investor, you’ll need to balance different types of assets: some for wealth creation, others for liquidity in emergencies, some for specific goals, and some that act as insurance. You need a diversified portfolio, but for wealth creation, nothing beats equities. They provide a significant upside relative to the risks you're willing to take.

In light of the recent listings, do you think large corporations are comfortable with the current valuations and are still looking at getting listed?

Correct. I don't recall the year-to-date data, but we analyzed this sometime last year. If you look at the calendar year leading up to that point, the total buying by foreign and Indian investors was around $43 to $45 billion. The supply of equity shares through various IPOs was nearly $35 to $36 billion. So, while demand is present, the supply side is responding as expected. It would be a positive sign if, for example, demand started to slow down, considering that current prices appear elevated.

Essentially, investors should exercise a bit of caution.

What we’ve been advising investors, as you mentioned regarding valuations, is that if you’re looking to invest more, it makes more sense to consider hybrid solutions, as they can help with asset allocation. The reality of investing is that you can't control all the variables; you're dealing with unknown factors. In such situations, it's better to focus on what you can manage. You can control your risk appetite and your asset allocation, which should align with your financial needs. Therefore, our recommendation has been to consider hybrid solutions at this time. They will help you stay aligned with your defined asset allocation strategies. Now is not the time to take on additional risk to chase short-term returns.

In the past year, we've seen the Nifty 50 delivering strong returns of over 25%. What returns should investors expect in Samvat 2081?

First and foremost, don’t think about the market in terms of New Years. The key point is that you've essentially borrowed some future returns—that’s the reality. Be aware of this if you're considering selling your position.

Secondly, expecting to achieve returns that exceed earnings growth from this starting point is a risky assumption. Your best guess for returns will likely align with earnings growth. However, given that the valuations are currently high, there’s a possibility that returns could dip below earnings growth if valuations start to normalize.

So, that’s the mindset I would adopt when looking at the equity markets right now. If you’re a long-term investor, it’s fine to ride out the cycles, but focus on your asset allocation. That’s my primary message to investors, as it's something you can manage. You can't predict geopolitical events, such as the situations in Russia and Ukraine or the Middle East, or the outcome of the US presidential election, nor can you foresee China's policies or any potential cold war dynamics with the US.

We can discuss these topics endlessly, but we won’t reach any definitive conclusions. Instead, concentrate on what you can control: your risk appetite, your assets, and your financial goals. Forget everything else.

When discussing asset allocation within equities, how would you approach the balance between investing in different market segments, across various market capitalizations, and across all sectors?

I understand that we're addressing a much larger audience, and I believe that, for most people, it ultimately comes down to their understanding of a company's history. Many investors should have a direct knowledge of the stocks they’re interested in. Therefore, my main piece of advice is to know your stocks and know yourself. If you lack knowledge in either area, the stock market can be an expensive place to realize that you either didn’t understand the stock or you were just speculating.

From a mutual fund perspective, where we operate, our recommendations stem from a valuation-based approach. We feel much more comfortable with large-cap stocks, while our comfort with mid and small caps is quite limited, primarily due to their valuations, which already factor in expected future growth. People often say that growth in India will be the fastest, which may be true, but that growth is already reflected in current valuations. You cannot expect to purchase overpriced equities and still benefit from that growth; this presents a challenge at an aggregate level.

Are there any sectors that you currently find appealing, and are there others that you think investors should avoid to exercise caution?

Certainly. One sector we've been highlighting this year is the banking and financial services sector, which still hasn't made any remarkable strides. This doesn’t surprise me, as we believe core banking has a solid medium to long-term outlook, and the financial year is looking reasonably strong. Thus, we remain positive about this sector overall.

We also see a growing number of new, technology-driven businesses in India that are contributing to significant transitions in the economy, particularly in energy and clean fuel compositions. That's why we manage what we call an innovation fund, which invests in many of these themes. We believe this theme has very attractive long-term potential, even though it comes with higher volatility due to the types of businesses involved.

So, I would say that while banking offers us the most comfort, innovation is another exciting theme, especially for those looking at the long term, despite the volatility in the underlying companies.

Additionally, over the past three to three and a half years, we've observed a growing dominance of value over quality in the stock market. Considering current valuations and our position in the cycle, we anticipate a rotation back toward quality growth. Investors can capitalize on quality growth through both passive and active strategies. This is where we recommend people focus their attention, rather than sticking with what has performed well in the past few years.

Do you still see value in sectors like industrials, power, and defence, even after their recent run-up?

I look at price signals and valuations, and I would argue that many of these businesses are currently trading at valuations that have already priced in the anticipated growth. People often cite order books as a positive indicator, but I’ve been through the 2007 to 2010 period, where stocks were valued based on their order books. By the time those orders were executed, many faced delays, leading to stock price declines as execution cycles began to taper off.

So, I advise caution when it comes to industrial-related stories. We do believe there will be selective opportunities in the renewable and clean energy sectors, especially in the transition from fossil fuels, but you must not overlook valuations. In the second area, I would approach industrials with skepticism regarding the potential for profit at current valuations.

Are there any other interesting trends you've noticed? You mentioned that large caps are worth examining more closely than small and mid-caps. Is there anything else that particularly excites you?

Large-caps offer more relative comfort compared to small and mid-caps. However, what I find particularly noteworthy is the potential for quality growth, which is quite promising. The bigger opportunities can be found in the broader market. There may be individual stocks in certain segments that look appealing, but I’m not sure if there’s a significant overarching theme to identify.

Banking is another sector worth mentioning, as it has some of the best balance sheets we've seen in nearly two decades. In a country like India, credit remains under-penetrated. While there are concerns that consumer credit has grown faster than expected, I believe that over a five- to ten-year horizon, the credit industry will expand at a rate that surpasses nominal GDP growth.

Current valuations provide considerable comfort. Additionally, it's important to note that this sector is tightly regulated, making it very challenging for new entrants. For instance, when was the last time a new bank received a licence? The banking sector in India is well-regulated, which is essential for its functioning at a certain scale. This regulatory environment creates a barrier to entry for potential competitors, allowing existing institutions to thrive without facing significant competition from newcomers. Thus, the attractiveness of this sector, especially given current valuations, is quite clear.

Is there a guiding principle you've adhered to through your investment strategies over the years?

There isn't a single mantra, but I always emphasize that asset allocation is crucial. It's important to keep that in mind at all times. Additionally, as a professional investor, I believe valuation plays a vital role. There isn’t just one approach to investing that guarantees success; many strategies can lead to positive outcomes. The key is to stick with what you understand and what works for you. Avoid altering your course simply because something else seems to be performing well at the moment.

In my view, this consistency has been the secret to successful investors who have weathered various market cycles. Survival, after all, is often underrated.

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