Are largecap funds losing their edge? Edelweiss CIO Trideep Bhattacharya argues that structural market share losses to nimbler competitors mean traditional giants are no longer the ultimate safe havens. Instead, he points to flexicap and midcap funds as the optimal vehicle for modern wealth creation, blending stable leaders with high-growth challengers.
Edited excerpts from a chat:
What is your broad outlook on IT services as a sector, and how are you positioned within IT? Have you been buying the dip we’ve seen over the last six months?
Not yet. My thinking on Indian IT is that it’s in the middle of a technology change. The Indian IT services sector has gone through multiple such changes before, starting with Y2K, followed by package implementation, followed by cloud, and AI is the latest one, probably the biggest one, and the sector is in transition.
My sense is that this transition will take about two to four quarters to complete, so we don’t buy into the early dip. We want to get gradually closer to the end of that transition before nibbling in. Our starting point is that we’re underweight IT services, not that we don’t own any, but we’re underweight, and as we get more clarity on this shift coming to an end, we’d be inclined to increase our position. So, not yet.
And what’s your overall positioning in banks, particularly private banks?
Financials is a sector where we’re meaningfully overweight across our portfolios. We’ve been talking about this for a while. We also launched a financial services fund earlier this year. Our thinking has been that credit growth in India has bottomed out. It bottomed around September to December last year at 8% to 10%. It’s currently hovering around 15% to 16%, and my sense is that if it goes to plan, it will be somewhere around 18% to 20% by the back half of this year. That has a strong positive bearing on financials as a sector.
While this is a top-line tailwind for financials, from a margin standpoint we need to watch which part of financials benefits, because there’s an inflation angle that also brings in an interest rate angle. But net-net, we’re positive on financials as a sector, and within financials, we particularly like private sector banks. We think they’re net winners of demand trends, and valuations are reasonable.
Over the last two to three years, investors who have been seeking safety in largecaps have been disappointed. Are largecaps no longer safe?
I wouldn’t go as far as that. But let me say that we’ve been a big proponent of mid and small caps over the last couple of years. Part of that argument, particularly for mid caps, is that some of the business models in mid caps are challengers to the incumbent business models that dominate large caps. In the consumption basket, the overall pattern of consumption in India is changing, and as a result some of these could see structural market share loss, with the gainers mostly being smaller companies in mid, small, or unlisted categories.
That’s why we’ve favoured a flexicap strategy over a largecap strategy. Some largecap business models are seeing structural market share losses, which can be complemented by mid and small cap stocks that make up a good portfolio from a wealth creation standpoint. So for the last couple of years we’ve suggested flexicap over largecap, for that exact reason, and now even more so.
In that context, what would you recommend to someone who’s owning a largecap fund?
Generic advice is difficult, since it depends on overall asset allocation and where you stand on profit or loss. But putting that aside, if I were starting with a clean slate today and choosing between a largecap fund and a flexicap fund, my choice would be flexicap over largecap.
Generally, between the two, we’ve been recommending a combination of flexicap and midcap as a fertile combination to cover the entire market.
Why do you say that?
Because a flexicap fund, including ours, is generally largecap dominated, more than 60%. Ours is positioned at roughly 55% to 75% largecap at different points in time, with the rest in mid and small cap. That’s why I say it’s a good replacement for a pure largecap fund. There are largecap names doing quite well, particularly in consumption and jewellery, for instance, gaining market share, so you want exposure there. But in areas where largecaps are struggling to gain share, and where new business models are taking over, replacing them with mid and small caps is a good idea. That’s why a flexicap fund is a suitable replacement for largecap.
The midcap segment, in my opinion, is the best play India has on the earnings upgrade story, which is why most people come to emerging markets in the first place. The reason we’ve favoured midcap as a category is that the category exposure you get there is concentrated in high-growth areas such as hospitals, capital markets, defence, and industrial exports. These sectors are fundamentally underpenetrated in India and are seeing structurally higher growth rates. They’ll have their ups and downs, but they carry a higher weight in the midcap segment, which is why they’re, in many ways, the categories of the future. So a combination of flexicap and midcap covers the entire market quite nicely.
And where does small cap fit into this picture?
We’re a little more selective on small caps right now, because as I mentioned, there could still be some earnings downgrades coming through in the June quarter, and small caps might feel that impact more. So we’re positive on midcap, selective on small cap, though when I talk about midcap generally, I’m referring to the mid and small cap space as a whole.
Within India, largecaps are probably the most undervalued, with mid and small caps somewhere in the middle. Largecaps have some challenges, which is why we’re positive on midcaps and selective on small caps.
How are you and your portfolios playing the AI-proxy theme in India? Is there a genuine AI-proxy theme in India at all?
India, for all practical purposes, is seen as an anti-AI trade in general. Most of us are users of AI rather than beneficiaries of it. But let me put this in a time-series context. The AI beneficiaries in India right now are the data centre players, and we do have a couple of them in our portfolios. The bigger part of the pie, though, isn’t really present in India to that extent.
Any technology wave typically starts with semiconductors and hardware, then gradually moves into software and services as the trend matures. We’re in the first stage of this AI wave, which is why we don’t have much of a direct play in India yet. But over time, as the wave progresses more towards software, services, models, and design, you’ll see Indian companies emerge in that space too.
We’re more bullish on power capex plays that are indirectly linked to this theme and are also export oriented, though I wouldn’t put those under the AI trade. I’d call that an energy security trade instead. One of the problems India has faced, and I hate to say this, is that 70% to 80% of our energy imports come from the Strait of Hormuz, which is a vulnerable position for a country to be in. Over the next four or five years, India will spend a considerable amount of money diversifying away from that. The plays here are power generation and renewables, and the best plays within that supply chain are the companies providing the nuts and bolts to it, which is where we’re most bullish.
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