The market cycle has shifted from value stocks, such as public sector firms, to quality-oriented stocks, with focus turning towards good returns on equity and independence from government contract-heavy order books, according to Sorbh Gupta, senior fund manager – equity at Bajaj Finserv AMC.

In his conversation with Benzinga India, Gupta pointed out that the large-cap fund of Bajaj Finserv, which is undergoing its new fund offer (NFO) will be underweight on IT despite decent results and guidance given by the sector as the fund expects a slow down in the U.S. market. It will also be overweight on consumer staples as it sees a revival of rural demand, he added.

The NFO of Bajaj Finserv Large Cap Fund will close on August 12. Here are the edited excerpts from the interview:

How do you view the results so far? Earnings growth has been tepid.

It’s not a season where we have seen lot of positive surprises on earnings. But we are not disappointed because there are specific reasons for domestic focused sectors that was the elections and a strong heat wave. 

Companies have said people were travelling less and consuming less because of the heat waves. Some capital goods and B2B (business-to-business) companies were in wait-and-watch mode on some of the decision-making because of the elections. So we had a slow start.

Now with the budget being over, lot of clarity have emerged. But what we like about the results is that while it’s not so great, but the full-year earnings expectation for larger companies are not very demanding. In an economy which is expected to grow 10% on a nominal GDP basis, the expected earnings growth on Nifty by consensus estimates is close to 8% to 9%.

We believe companies can achieve this from the upcoming festive season along with good rains, the rural sector picking up, and we see demand picking up. Private capex is picking up post-policy continuity assurance after elections should improve. That's the broader outlook. 

We are a little circumspect on certain sectors on the export side while the markets expect the rate cut, the demand for certain sectors and services in the US will go up. Our view is a bit contrarian here. We believe the rate cut is a signal that things are slowing down and that is primarily the reason we are a bit cautious and underweight in IT services right now. That’s the broad outlook that we have right now.

We are positive on staples. We are positive on pharma. We are positive on consumer discretionary as well but we are a little more positive on the rural side and the bottom of the pyramid consumption. So the stories which have worked very well in the past couple of years are premiumisation and companies benefiting from government spending.

We believe that should be reallocated towards consumption, staples, rural consumption and pharma on a higher side. That’s our positioning right now.

So you are saying rural weakness is now over

Yes. There are a couple of reasons we believe that the rural demand is bottoming out. One reason is the good rains which are coming after two years, so Rabi crops sowing should be good. Kharif crops harvest should be good.

The second is because of food inflation the farmer income in the hand of farmer has improved. There is a transfer of wealth from urban to rural because of higher food inflation. So that is helping the rural (sector).

Third is government spending, especially on the state government budgets. That is moving clearly towards rural through the support of direct cash outs or loan waivers. Already three states have announced loan waivers.

If you look at some of the budgets of some of the larger states, a lot of cash allowances to females and other things are given out. So we believe that also supports the rural income.

Fourthly, a large part of the rural income comes from repatriation from the cities. Primarily from labour force that works on construction and real estate. With real estate doing well and construction picking up that money should also improves the rural income.

This will be a natural bottoming out of the rural demand and think should improve on the rural side from here on.

Bajaj Finserv AMC is launching a large cap fund. Are you looking at introducing smart-beta funds? Some smart beta funds have delivered better performances than benchmark indices.

The large cap fund for which the NFO is going on is an actively managed fund. However, our investment process has an involvement of quant in terms of the investment process, not the portfolio operation process.

So there is an element of quant that we get involved within the research process. We have a quant team. As far as your question goes on smart beta and other things, our quant team continues to work on lot of products, lot of places where we believe we can add value and there is back-testing and all that research going on.

Whenever we feel that we have cracked something where we can add value on alpha for the investors, we will definitely come out with that. But as far as this large-cap product goes, it is a pure active fund.

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What are the sectors in the large cap fund that will create alpha? 

Reiterating the point that was highlighted earlier Pharma is one place where we believe we will be overweight. Consumer staples are second where we believe we can be overweight.

Communication is another where we can be overweight. Consumer discretionary, especially focusing on rural or lower-income products. So maybe not premiumisation products, but maybe downtrading products, companies offering that kind of products are something we will be positioning well over there.

We will be positioning some on the power and infra side also, but we look at the valuation comfort available over there. Because we are pricing for a recession, We will be underweight on IT right now.

We will be underweight on metals. We will be mostly underweight on banking, but within banking, we will be sticking to a strong position in private banks and also some life insurance companies.

So this is how we believe the portfolio construct will look when we go live as of now. Unless in the the next five to ten days things change from a valuation or volatility perspective.

Do you think the market cycle is shifting? Do you see the quality-oriented theme doing much better than value stocks in the next cycle? Quality factor stocks are showing much better performance since the elections

Yeah, absolutely and we thought this in March. So in the first week of March, we launched our large and midcap fund with a quality tilt and then during NFOs, we said that it was a great time to look at quality.

Valuations are comfortable. These are companies we always wanted to buy, but somehow because there is a representative bias, people are ignoring them.

We believe it’s a great time to buy and create a quality portfolio at the valuation that one likes and doesn’t need to be quality at any price strategy as of now because you are getting quality at great prices. So we have created a very strong portfolio on large and mid-cap space based on quality tilt which we called a moat-driven portfolio and we continue to be very positive on the quality strategy right now.

But our strategy is quality with some valuation anchor — we are not quality at any price. So our timing has been good and we also completely agree with the point that post-election the trend of things moving towards quality has increased.

In the last one and a half, two years companies getting support from the government and have an order book driven businesses have done much better.

From here on, we believe quality tilt companies with better ROE (return on equity) profiles, companies which can grow on their own without external support from the government or any other agency those companies could give you better returns.

So based on that strategy we created that portfolio and we can completely agree that quality is a place where one should be right now. The quality as a strategy can outperform value from going ahead from here.

How do you use gold in your portfolio after the recent custom duty cut in the budget?

We have a multi-asset strategy that we launched around May of this year and where equity is driven by dividend yield strategy we have an allocation of 10% gold in that. 

We have a reasonably positive outlook on gold because given the volatility that is coming through due to the possibility of the U.S. recession and the possibility of rate cuts and dollar depreciation and where reserve banks are adding gold I think it all adds up to a positive tilt on gold, so we have positive on gold and in multi-asset fund we have a 10% exposure to gold right now.

What do you think of the suggestion that banks are struggling to raise deposits while people are investing in equity markets. Are the fund flows that huge to their detriment?

If you look at the size of the mutual fund industry in equity vis-a-vis bank deposit base it is still very small. That is point one.

Point two is even if I take out the money from my bank deposit or my savings bank account and put that money into a mutual fund eventually that money will go back to the bank because, for example, I take that money from my savings account and use that money to put into SIP (systematic investment plan), then the mutual fund gets the money.

If it does not deploy, it goes to the bank account. if it deploys and buys shares the money will go to the person who will sell the share and that money again goes back to his bank account.

So in no way that money is coming out of the banking system. The only thing that is changing is on the margins at what money was parked. Maybe from a lower cost of deposit at 3.5%, 4% or 5% for banks that money goes out and comes in the form of a little higher cost for the banks so that can only impact that I see. I do not see it moveing a big needle.

I think the primary reason for lower deposits and one of the points is clearly lower savings rate. I think household leverage has increased. Consumption patterns have increased and incomes have not kept pace for five, six years, but the consumption continues to grow.

So that is one of the reasons we believe deposits are lagging credit. Secondly, while there is a systemic slower deposit grow we believe that after PSU banks have corrected their balance sheet over last four five years, now they are back in the game to garner deposits because now they want to grow after a decade.

So I think the fight for deposits has increased because till 2021 it was only three or four top private banks who were interested in deposits because they had the capital to grow. Now with PSU banks coming back very very strongly, the fight for deposits has increased.

So I think one of the reasons you see a lot of noise around deposits is because the competition for deposits has increased. Otherwise in previous times when deposit growth had been slow but because only three or four large private banks were fighting for it they could have gained their share and there was no noise around it.

But these things are cyclical I think inflation is also playing a role. People need more money to spend on the same things because inflation is high which also impacts deposits but squarely to blame on higher investment in mutual funds is not correct because money eventually comes back to banks only. 

⁠Is it time for large and midcap funds to look into some sectors like PSUs and railway names that have grown so large and are now large caps by definition?

Ultimately as a large cap fund manager, you have to choose from top hundred stocks that is given and that is one of the big reasons why large-cap fund managers tend to underperform — because your universe size is very small.

So for example, if you have a hundred companies to choose from there will be 10 to 15 companies which you would be not interested in buying maybe because of management quality, business quality or some of the names that you are highlighting.

Often managers cannot be comfortable with all the names, so there could be 10-15 names one does not want to buy. So you are left with 80-85 stocks of that, if you want to create a portfolio of 45-50 stocks, effectively you are buying every alternate stock.

When you do that, invariably you will be very close to Nifty. So you’ll have a very low active weight. So your positioning is very similar to Nifty. But you have an expense ratio and Nifty does not have an expense ratio, so the only way to crack through and expect an alpha in an active fund is to have a higher active share and to get a higher active share in the large-cap category you have to move to a concentrated fund with only 20 to 30 stocks and that’s what we plan to pursue.

We’ll run a concentrated strategy in large caps because in large caps sizing matters more than ideation because everybody knows what hundred stocks are available and everybody’s looking at those same stocks.

It is at the right time when you size it rightly and deviate from the index in terms of a conviction of higher size or lower size in certain names that you can create an active share and active return. That is how we plan to do it.

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