Edited excerpts from the conversation:
What is your assessment of the current market cycle, and where do you believe we stand in terms of valuations versus earnings outlook?
Indian markets look expensive on a headline basis as they are trading above their median values. However, there are pockets of opportunity in sectors and markets that could benefit from strong domestic demand and policy support. The revenue outlook has improved for sectors such as financials, industrial products, auto, and consumer staples, while pockets such as defense, and infrastructure offer long-term growth prospects. External factors such as global trade tensions, tariff concerns and India being seen as an anti-AI trade are weighing on market sentiment. India’s pursuit of signing free trade agreements (FTAs) with various countries such as the EU and New Zealand is creating new avenues for trade, investment and market diversification, which can support income growth in the medium term. We believe the market is currently at a stage where broad valuations look rich, but the earnings outlook is improving, and there are pockets of opportunity for investors who focus on quality, growth potential and sectors positioned to benefit from domestic and global trends.
What did the Q3 earnings season show for you? Are you more hopeful for broad-based growth than before?
What this Q3 earnings season revealed was the discrepancy between core operating performance and revised earnings direction. Corporate earnings this quarter were broadly in line with expectations. Most consumer-oriented and cyclical sector companies saw top-line growth with operating margins broadly stable or expanding and profit growth remaining healthy. Banks and NBFCs have shown signs of stabilization in asset quality and profitability metrics and industrials and defense names continue to benefit from implementation momentum and policy tweaks. The decline in revenue in a few sectors was not entirely due to poor quarterly performance but due to external factors such as currency volatility, commodity price volatility, increased competition in some segments, and global instability. Management commentary indicates that domestic demand has shown early signs of improvement following policy support, with the auto and luxury consumer categories reflecting the business’s favorable outlook. However, the intensity of competition remains high in some sectors such as paints, consumer durables and telecommunications. Information technology services delivered a steady quarter with management commentary highlighting concerns surrounding AI-related disruptions. Overall, the quarter actively reinforced a cautiously constructive outlook, with corporate India looking on a stronger footing than previous quarters, but future earnings expectations still depend on a complex mix of macro, regulatory and competitive factors.
Which sectors are structurally well positioned over the next three to five years, and why?
Sectors benefiting from secular trends and policy support provided by the government are well positioned to structure over the next three to five years. An important issue is defense. There are multi-year prospects for business in this sector due to increased government spending on defense equipment modernization, local manufacturing, and indigenization. Strategic partnerships with international players enhance technological access.
In addition, companies involved in the development of advanced electronics, aerospace components and systems integration are well positioned to take advantage of these structural advantages.
Consumer discretionary pockets are another structurally attractive sector that reflects changing consumer preferences as rising per capita income, urbanization and digital adoption encourage consumers to spend more on their lifestyle upgrades and early retirement. A combination of strong balance sheets, policy support, and innovation in digital lending and payments provides structural sustainability for earnings.
What is your outlook on financials, particularly in terms of credit growth, asset quality and margin sustainability?
The outlook for the financial sector remains positive given credit growth and stable operating conditions. There are early signs that corporate debt is rising which is expected to continue. Deposit growth remains a challenge, and a high reliance on large deposits could keep the cost of funds somewhat high. Banks should be able to maintain stable margins by re-pricing MCLR-linked loans. Collection efficiency and stress reduction, particularly in unsecured portfolios, ensure that asset quality and credit costs continue to be controlled. Management commentary suggests that the second half of the year should be better, as growth in lending and controlled credit costs is expected, which will improve their profitability. This creates a favorable backdrop for banks, balancing growth opportunities with risk management.
How should investors approach IT and the digital ecosystem amid AI-led disruption and global tech spending change?
Investors should adopt a wait-and-see approach at this point. AI is changing the business models of traditional IT companies. The pace of AI-driven change is unprecedented in nature. Global hyperscale commits more than $600 billion in capex for AI-related infrastructure, including data centers. As a result of these advances in the field of AI, companies are now investing more in automation and artificial intelligence than in traditional IT services. Companies that successfully implement AI stand to benefit from these changes, while others may lag behind, thereby affecting their revenue and profit margins. For Indian IT, structural change presents a double challenge. Traditional service models are under pressure as automation and productive AI reduce traditional software maintenance demands. At the same time, India’s deep talent pool and growing digital capabilities provide opportunities to support global customers in adopting AI.
How do you currently position the portfolio in terms of sector allocation, liquidity levels and market cap bias?
We use leverage as a factor in our funds and allocate capital to sectors and companies based on relative price strength, earnings growth, and earnings acceleration, while using absolute momentum to manage risk and preserve capital. From the market cap bias, the position depends on the order of the scheme. In categories like Flexicap, ELSS and Special Opportunities where fund managers have the flexibility to allocate across market caps, we have a slight bias towards mid and small caps. Sector-wise, we are positioned in BFSI, Autos, Pharma and Industrial Products where we believe the balance between growth potential and risk is appropriate. These sectors offer a combination of cyclical recovery, structural sustainability and improving profitability dynamics. On the risk management side, we actively use hedging to reduce downside risk especially during phases where markets remain volatile or uncertain. In addition, we hold cash in certain portfolios where the near-term risk-reward warrants a more cautious stance. Overall, our approach seeks to participate in momentum-led opportunities while maintaining flexibility and prudent risk control.
Do you think that the sell-off in small caps that we have seen in the last 1.5 years is done and that we will see a gradual recovery in the next 2 quarters?
Looking at the results in Q3FY26, there are encouraging signs that there could be broader weakness in small caps. Across a broad set of companies, revenue and profit growth are accelerating, with smaller companies showing strong momentum. The decline in revenue appears moderate, and we expect the upside to gradually materialize as macro conditions stabilize and companies take advantage of the policy tailwind. Supportive fiscal conditions due to rate cuts by the Reserve Bank of India should improve corporate earnings and investor sentiment. While valuations are above average across the broad index, there continue to be pockets of choice in this space with solid fundamentals and clear growth drivers. A combination of the factors mentioned above suggest that small caps could see a gradual recovery in the coming quarters.
