Why S Naren of ICICI AMC wants you to avoid SIPs in these funds | Mint

Investors should avoid systematic investment plans (SIPs) in small cap and mid cap mutual funds right now and even consider redeeming their investments in such funds as valuations are ‘absurd’, S Naren, executive director and chief investment officer of ICICI Prudential Asset Management Company, said on 25 January at an event organised by IFA Galaxy, an association of mutual fund distributors.

He also explained why he is bullish on large caps and India’s macro situation and the risks in the initial public offering (IPO) market.

On small and mid caps

In 2013-14, the valuations of small and mid caps were very cheap. From then, it has gone absolutely absurd. Then we thought, are we looking at it the wrong way? Because, after all, India is growing, so small- and mid caps will keep growing. So we looked at the median P/E (price-to-earnings ratio). We found that the median P/E of mid caps has touched 43 and the median P/E of small cap has also hit 43. Again, absurd compared to what it used to be.

Then we looked at the entire PAT (profit after tax) contribution versus the market cap on small and mid caps. That again shows the market cap contribution is much higher than the PAT contribution. There were people who said, ‘You are looking only at valuation. Is momentum changing?’ So, we started to look at mid cap momentum over Nifty. Even here, we have a situation where the momentum has started to weaken and it has cut its daily moving average.

I am not an expert on momentum, so I went to one of my colleagues who is a very good quality-momentum person. He said it is very early, but now the momentum has been cut. Similarly, momentum is also cut on small-cap now. These things have happened in the past month or so. Small caps and mid caps are broken completely and decisively at this point of time on the momentum indicators. On re-rating and de-rating also, we have reached a situation where the momentum has weakened.

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On sentiment, we have a situation where the flows into the mutual fund industry have just zoomed. Investor interest has been very good, but as a result there is a huge amount of leverage and that leverage just keeps going up. Clearly, when you have so much leverage, you have a situation where at any point of time you can have a problem. Leverage is very clearly a challenge at this point of time.

So, we are in a situation where it is a no-brainer to take money out of small and mid caps. It is a sitter that in the medium-term, small- and mid-cap SIPs are unlikely to deliver returns. If you invest in small and mid caps through SIPs at this point of time, you are basically averaging out at very high levels. So, the chances of good medium-term returns from SIPs are likely to be low. If you are going to do a 20-year SIP from 2025 to 2045, will returns be low? The answer is no. But the chances of bad returns from SIPs in small and mid caps is very high at this point of time; particularly SIPs that started after 2023 or so, unless they are going to be 20-year SIPs.

I have spent 35 years in the market. I believe that very few are going to be 20-year SIPs.

I believe investors who started SIPs in small and mid caps in 2023 are going to have a very bad experience. Is this a time to take out money out of small and mid caps. We think it is clearly a time to take out money lock, stock and barrel from small and mid caps. I believe this is the time to even stop small and mid cap SIPs because they are so overvalued right now.

On SIPs

Everyone says ‘SIPs sahi hain’. But if you do it in the wrong product, you are headed for trouble. The best thing to do is to look at SIP returns over the past year. SIP has to be done in undervalued asset classes – those that will go up substantially.

If you are going to do a SIP for 20 years, it is fantastic. So, if you did an SIP in the Value Discovery Fund for 20 years, that would have been fantastic. Are there investors who have done this? I am yet to find one, but maybe there are one or two, or maybe 20 or 30. The problem is investors stopped doing SIPs in 2008 or 2017 or 2020.

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SIP has to be done in volatile and undervalued asset classes. If you do SIPs in overvalued asset classes – like China three years ago, or Indian equities in 1994 or 2007-2008 – you only have yourself to blame. You cannot blame SIPs. For example, I went through SIP data in 2020 and 2021 and found that no one was investing enough in small cap and mid cap funds.

On risk management

When people manage a small amount of money, whether as an AMC or a scheme, it is very easy. If you have a ₹1,000-crore scheme and make a mistake in 2% of your portfolio, you have to sell assets worth ₹20 crore, which is easy. But if you have ₹80,000 crore in assets under management and make a 2% mistake, you have to sell stocks worth ₹1,600 crore, which isn’t easy.

That is why we at ICICI Prudential AMC have spent so much time thinking about how to manage investment mistakes. It is not that mistakes won’t happen, but how does one manage them? Because if you make a ₹1,600-crore mistake, it is a big challenge. This is something people don’t understand.

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Over the past several years, most fund managers have not seen any redemptions. As a result, most people have not faced a redemption cycle. The last redemption cycle in the mutual fund industry happened in 2012-2013. What we learnt in credit funds in 2019-2020 was that you may think you don’t need to worry about redemptions, but if the market sees a redemption, you also can get one. So, after 2020 we never got any inflows into credit funds; not because we made any mistake but because the market saw redemptions.

Are all your schemes capable of handling redemptions? This is a question we have to ask ourselves – a question most people don’t even think about.

On India’s macro picture

The bright picture is clearly macro. There is zero problem on macro, whether it is the government’s focus on macro, its finances, balance sheets of banks, corporate balance sheets, household balance sheets. If you ask me, there seems to be a problem for only the people at the bottom of the pyramid, but the people at the top seem to be in very good shape in India. So, I would say that there is zero problem with macro right now.

On the IPO market

In my opinion, this is a very interesting and difficult period for IPOs. There are junk IPOs happening in the SME space (SME Exchange). In the ’90s, I became a member of OTC Exchange of India, on which many IPOs were created. I have some pieces of paper in my house. All of them went to zero.

I believe something similar will happen to many of the SME IPOs. It can also happen in many of the smaller IPOs in the small cap space. The IPO market has become completely disjointed from the overall market and people who are trading on the IPO market must be extremely careful.

On hybrid funds

I think hybrid schemes are attractive right now, depending on how positive you are on the market. If you are very positive, you will be in equity and debt. If you are less positive, you will be in a multi-asset hybrid fund – especially if you like gold. If you are slightly less positive, a multi-asset allocator and balanced advantage fund is for you. If you are negative, it is equity savings.

On large cap funds

The massive selling from FIIs (foreign institutional investors) has happened due to the big boom in the dollar against everything else. At some point, that dollar will go down. When that happens, I expect FIIs to start buying large cap stocks in a big way again in India. When that will be, I don’t know. That is why I believe this is the best time to actually do SIPs and STPs (systematic transfer plans) into large-cap-oriented funds or hybrid-oriented funds because we have seen a fair amount of purge in that area.

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On other funds

We believe India’s macros are extremely strong at this point. That is the reason we believe this is not the time to stop SIPs in flexicap funds or large cap funds. This is the time, in my opinion, to start aggressive SIPs in hybrid funds. This is maybe even the time to do SIPs in large cap and flexicap funds, while take money out of small cap and mid cap funds.

We like themes like minimum variance, which are very defensive ways to play large caps right now. We clearly like quality as a theme. We clearly like banking as a theme. Banking has never done well on big declines, but we think banking is at least reasonably attractive at this point of time.