The Chief Investment Officer of SBI Mutual Fund, Navneet Munot, believes that mid-cap stocks will be the biggest beneficiaries of the upturn in the economic cycle.

So, despite the run-up in their valuations, they still remain good bets.

You have several mid-cap funds — SBI Midcap, SBI Magnum Global, SBI Small & Midcap, and SBI Emerging Businesses. What are the differences between these?

It’s true all these funds have a pre-dominantly mid-and-small-cap focus. But, there are clear differences. Our mid-cap cut-off is the 100{+t}{+h} stock in terms of market cap. For small-cap, the cut-off is the 400{+t}{+h} stock in terms of market cap.

SBI Midcap is a plain and simple mid-cap fund. SBI Emerging Businesses is our more risky offering — we take concentrated, high-conviction bets in this fund. Technically, it is more of a multi-cap fund, but as most of our convictions belong to the mid-cap space, you see a higher component of those. For the Magnum Global fund, our main focus is quality, which we define as a right-to-win characteristic, return on capital and growth, so it tends towards a low-beta portfolio. Finally, in the Small and Midcap fund, a minimum of 50 per cent goes into small-cap stocks.

The SBI Bluechip and Magnum Equity funds seem similar.

SBI Magnum Equity is a pure large-cap fund with very tightly defined template in terms of sector and stock calls. The focus is on the benchmark (Nifty index) on a more consistent basis. In SBI Bluechip, the portfolio is split 80-20 between large-cap stocks and mid-caps.

What are the strategies you follow in your mid-cap funds?

As far as possible, we try to look at a three-year-plus horizon. We focus on five key factors — core competency, return of capital, growth, management and valuations. Management is a core differentiator in many cases between winners and also-rans.

Management commitment, attitude and aptitude to adapt to changing business circumstances matters. We like managements that display hunger and which have good governance.

What do you make of valuations now?

The market is now trading at about 17 times estimated 2014-15 earnings. This valuation is only marginally above the 10-year historic average. Mid-cap valuations too have moved up and are now trading above the 10-year average. The recent catch-up in this segment has brought the mid-cap valuations at premium to large caps.

The market is certainly factoring higher expectations from the mid-cap space. I expect this gap to continue, given that mid-cap companies would remain larger beneficiaries of the upturn in the economy.

Earnings upgrades will also occur now, across the board, though it will be dispersed more in mid-caps.

With mid-cap and small-cap stocks, do valuations really matter at this point?

Valuations always matter in any investment. Market values both growth and earning power as well as their sustainability.

Larger caps have size and track record on their side. Mid-cap companies have volatility or uncertainty of cash flows, so visiblity of business gets embedded in valuations.

Still, on the flip side, being completely wedded to valuations in markets such as these can push one into missing early-cycle opportunities that can provide multi-fold returns.

Has the consumption theme run its course?

With 1.3 billion people and GDP per capita of $1,500, the only direction is up. But one must start looking at themes like ‘premiumisation’ of product lines, creation of brands, delivery at the bottom of the pyramid, and enablers like the internet. In the current environment, I expect the discretionary space to perform better.

Indian pharma and software are two other sectors which have run up. Software will continue to benefit, witnessing interesting trends like big data, cloud computing, mobility, analytics and increased automation.

Though both pharma and software are primarily seen as export plays, there could be opportunities onshore.

How do you see economic reforms playing out now?

Energy, agriculture, education and logistics would remain beneficiaries as India corrects its supply-side mechanism.

Manufacturing focus with more clarity on FDI policy can be expected, along with localising some larger imports such as defence equipment. Revival of dedicated manufacturing zones, with appropriate incentive structures, can also happen.

Utilities such as water, power and gas would witness a national blueprint along with urban development.

I also expect railways and ports to get special attention to connect the resource, manufacturing, and consumption centres with dedicated freight corridors. Renewable energy and irrigation would be among the interesting spaces to watch.

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