Select midcaps will emerge stronger post the ongoing crisis

What is your outlook on corporate earnings in FY 2021 and FY 2022? When do you expect recovery from the slowdown caused by COVID-19?

The ongoing pandemic will determine the timeline of earnings recovery, which remain uncertain in the near term. In our base case, we are building in H1 FY21 earnings to be a washout with gradual recovery settling in during H2 FY21. Earnings recovery could be sharper in FY22 led by lower interest rates, Government stimulus and continued strong rural demand, assuming things doesn’t altered severely because of COVID outbreak. At this point, we are of the view that FY22 aggregate earnings cut could be relatively benign (10-15% range) in comparison to pre-COVID estimates.

Midcap stocks have rallied over the past 4 months, with Nifty Midcap 100 index up nearly 45% from the March lows. Do you think that midcap stocks have bottomed out? What is your near to medium term outlook on midcap stocks?

YTD, midcaps are down around 9%, similar to that of large-caps which are down by around 8%. In between there has been volatility in returns caused by the COVID pandemic. At an aggregate level, present valuation discount of mid-caps Vs large caps at around 10% is similar to their historical levels. However, selectively across size we believe that the pandemic dislocation offers decent opportunities. Our view is that strong companies will become stronger. In this context, within midcaps companies with a strong balance sheet, thought leadership of management will be better able to weather the challenges. Select midcaps will emerge stronger post the ongoing crisis.

What are the risks in the midcap segment in current economic and market conditions?

Prolonged lockdown and further spread of virus remains a key risk as it can further delay overall economic recovery. In this scenario, Midcaps may exhibit higher earnings volatility Vs large-caps, particularly for companies with relatively weaker balance sheet.

In the past, we have seen midcap funds giving strong returns in 3 – 5 years after a deep correction. Are you seeing attractive investment opportunities and industry sectors you like in the midcap segment in the current conditions with a 3 to 5 year view?

Historically, midcaps do offer strong returns after every down-cycle and so is true in case of mid-cap underperforming during uncertain times. Post COVID scenario, our fundamental view remains unchanged as we are taking current disruption as cash flow loss for 9-12 months for most of the businesses. We are positive on 4-5 themes; 1) Domestic consumption (incl financials) because of secular story of favourable demographics, increased penetration and market share gain providing comfort on longevity of growth; 2) export led businesses (in sectors like chemical, auto ancsetc), because of good growth visibility; 3) Certain PSU names across utility, industrials because of attractive valuations; 4) Unorganized to organized segment theme help in gaining market share and higher growth for organized players in sectors like building material, electricals, packaged food etc; and 5) Pharmaceuticals because of favourable valuations.From the COVID led disruption stand-point, we have made certain changes in the portfolio while reducing weightages in businesses with relatively weaker balance sheets and longer road to business normalcy particularly in financials and consumer discretionary sector. At the same time we have increase weightage in businesses like AMC/insurance, chemicals, IT and utilities.

Mirae Asset Midcap Fund has recently completed 1 year since launch. For the benefit of retail investors who are not familiar please describe the investment strategy of this fund in terms of stock selection?

As per mandate, mid-cap fund has to invest in minimum 65% into mid-cap stocks (out of the universe of 150 stocks based on last 6 month average market cap). For, remaining 35%, there is flexibility to invest across any market-cap. In this fund, apart from mid-caps weightage of 70% (+/-5%), we do have large-cap weightage of around 20% (+/-5%) in order to manage overall portfolio liquidity.

Our investment orientation is mainly towards growth businesses with a focus on capital efficiency and quality management. We follow a bottom-up approach in our investing. We prefer businesses with large growth opportunities, good returns on invested capital, competent management and reasonable valuation. With regard to portfolio construction, we seek to construct a diversified portfolio, which could handle mistakes and deliver decent risk adjusted return.

How should investors approach this fund? Who should invest and what is the recommended minimum investment tenure?

Given situation being fluid globally led by COVID pandemic has resulted in huge volatility. Moreover, Mid-cap tends to under-perform large-cap in such uncertain times which has been the case during this time around as well. Over last 1 year, Midcap (-3.5% YoY) has under-performed large-cap (-0.3% YoY) by 300bps. Historically, over a reasonable timeframe of 5 years+, midcaps tend to outperform large-cap. Given increasing volatility world over, mid-cap investors should have a time frame of 5 years to withstand near term shocks and generate reasonable risk adjusted returns.

Mutual fund investments are subject to market risks, read all scheme-related documents carefully.