Smallcap, midcap funds face risk of mean reversion: DSP MF MD & CEO

Data shows that markets may have mispriced the disinflationary trend that is gaining traction along with a stable demand and supply situation for government bonds, said Parekh

It is the right time for investors to rebalance their portfolios and raise their largecap allocation. This would have come down as a result of relative underperformance vis-à-vis mid and smallcaps, says Kalpen Parekh, managing director (MD) and chief executive officer (CEO), DSP Mutual Fund, in an email interview with Abhishek Kumar. Edited excerpts:

Some analysts have cautioned against the froth building in mid-cap and small-cap space. Are the concerns justified?

Currently, mid and smallcap stocks are mostly rising on account of strong inflows — both through direct buying as well as mutual funds. While many small and midcap companies have grown their profits in recent years, their valuations are significantly higher at 25-40 times of their earnings. Hence, there is a risk of mean reversion on both business cycle and valuation fronts.

Do you expect the momentum to now shift towards largecaps, considering their significant underperformance compared to the other two m-cap segments?

Flows continue to chase past performers, that is, small and mid-caps. Within largecaps, too, barring a few pockets, most companies are fully priced. If flows continue unabated, mid and smallcaps can continue to do well, despite the valuation concerns. Investors must take this opportunity to rebalance their portfolios if their largecap allocation has come down due to their relative underperformance in recent years, especially after Covid.

What factors have weighed on the performance of your equity schemes? When do you expect a turnaround?

This year, most of our funds have delivered 3-5 per cent excess returns over the benchmark. This is an outcome of our conviction in the investment framework we follow. We continued with it despite the underperformance in 2021-22. Investment portfolios, by nature, go through temporary phases of out-performance and underperformance. As asset managers, we try not to get swayed by the performance cycle. We stick to our philosophy of owning reasonably-valued companies with high or improving return on investments.

When do you expect the rate cut cycle to begin? Is it the right time to gradually raise the duration of debt portfolios?

We have added duration to our portfolios. Data shows that markets may have mispriced the disinflationary trend, which is gaining traction along with a stable demand and supply situation for government bonds. Currently, the fiscal situation and the supply of government paper are crucial factors influencing yields. We feel bond yields will remain stable after seeing a sharp spike in the last two years. Hence, most of our debt funds are having duration closer to the higher band of their mandate.

What is your asset allocation currently? Have you made any significant changes recently?

Broadly, my portfolio is currently 60 per cent in equities, 35 per cent in fixed income and 5 per cent in gold. I have reduced equity allocation owing to stretched valuations over the past year or so. At the same time, I have raised the debt allocation, considering the attractive rates. However, investors should not look at it as an ideal asset allocation. Exposure to various assets should be according to the investor’s risk-appetite.

The DSP multi-asset fund opted for debt taxation rather than a more tax-efficient equity structure. What was the rationale?

 

The effective debt tax rate (erstwhile) is generally closer to the equity taxation, considering 4–5 per cent inflation. Secondly, the indexation benefits kick in after three years; hence, incentivising investors to hold for longer periods. Lastly, this design doesn’t compel us to own a minimum 65 per cent in Indian stocks, and hence, leaves room to meaningfully invest in bonds, gold and global stocks.