Don’t wait for FIIs: Nippon MF CIO Sailesh Raj Bhan on why market will rise before foreign money returns

Nifty has hardly given any returns in the last 2 years. What is so wrong that we haven’t been able to fix yet?
Post-COVID, we had a big recovery and returns were phenomenal. Seeing that, a lot of money started chasing equities, and there were very high return expectations from investors coming in. Now that is consolidating. We’ve seen nearly two and a half years of flat markets, which has taken away — or is starting to take away — the excesses of the market, including excess valuations.

The second important point is that FII sell-off has also prevented excesses from forming. If you look at it now, world-class businesses are starting to become available at sensible prices because of lakhs of crores of selling by foreign investors. That was actually helpful during a period of heavy domestic inflows. Some sell-off happened due to global changes — where investors wanted to deploy money elsewhere — and that has also kept prices in a reasonable zone.

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Third, there are certain problems that impact international investors more than domestic ones, and currency is a big one. When you start losing on currency, or fear you will, your net dollar returns look low and you become cautious. The combination of all these factors has now made our prices sensible.

Today you can get large banks at 1.5 times price-to-book — proven enterprises that have delivered, at sensible prices. The market has settled into a reasonably good balance.As India performs and earnings recover — and they were recovering in Q3 and Q4, with post-GST and income tax benefits flowing in — the underlying strength is there. However, the West Asia conflict may impact earnings for at least two quarters from here, because of the inventory cycle. That’s an extra challenge we have to live with for some period. But the underlying momentum, which was weak, was getting better post-GST cuts, and I’m sure it will remain unless crude again balloons and creates a further problem.

So we seem on an okay wicket. At the start of the year, people were expecting 14–15% earnings growth. We’ll likely end up lower, around 7–8%, and the mix of earnings may change — metals might contribute more. That’s not ideal, but we were on a reasonable footing when this happened, and we had already gone through two years of consolidation. We’re not in a bubble valuation either.

Which pockets of the market do you think have valuation comfort?
In terms of where the valuation concern exists, it is mostly in the large-cap space. In the small-cap and mid-cap space, there are pockets where strong inflows have pushed prices up quite a bit. But if you look at two years back, most indexes are up only around 5% or so — there has been consolidation.

If you look at the broader market, you’ll be surprised how many stocks have fallen 30–40%. About 30% of stocks would have fallen more than 30%. Unlike two years ago, when there was nothing to buy at reasonable prices, today you can choose. Stocks have fallen 50–60–70% in some cases. Excesses have gone away, and expectations have been reset to 4–7% growth. Since November, the correction has been across categories — large caps, mid caps, and small caps alike. Below 10,000 crores market cap, there has been much, much more correction.

Today, you’re getting reasonable businesses at sensible prices across many pockets. Even if oil stays elevated, you can’t always stay out of the market because of one risk — you can’t just stop driving because of an accident.

But on paper, you can think about making meaningful IRR by investing at these values. That was not the case two years back. And broadly, this is happening across the spectrum — more in large caps, okay in small caps.

Earnings growth has also been reasonably good in mid-caps — more resilient than small caps and large caps in this period. But we shouldn’t overanalyze the cap-category split. Internally, we talk about large cap and mid cap mainly for conversation purposes. What really matters is good sectors vs. bad sectors.

The problem in a bull market is that bad companies become a large portion of the universe — IPOs, all of it. That has gone away. Today, in a normal environment, valuations are decent starting points for a lot of investments.

We see it in two segments. First, world-class companies at sensible prices — either because of foreign selling, because they’re in a bad cycle, or because domestic money isn’t flowing into them much. Second, good companies that were at very expensive valuations two years ago and have corrected dramatically — 50–60%. They have longevity, the excess bubble has burst, and they’ve now corrected to reasonable valuations.

In both segments, the market allows you to create portfolios, think, change, and work with conviction.

I think, in general, the advice is: use this year to accumulate. If you’ve accumulated for one or two years, then in the third, fourth, and fifth year you make bigger money. In the next 12 months, you’ll be in accumulation mode. It will keep going up and down. De-rating from 20–22x P/E to 18x has already happened. From 18x, you’re unlikely to go much lower in 12 months. A lot of fundamentals are in good shape. The only negative is the sentiment shift — from extreme euphoria to extreme pessimism. When that happens, you get better prices.

Tell us about which sectors you are comfortable with at this point.

We have one core framework: sustainable growth at reasonable prices. These two constructs are guiding us.

Banking: We’ve added to large private sector banks. We are overweight by at least 200 basis points versus the index. If the index weight is 27%, we’d be around 29% or higher.

Within banks, we are finding relative value significantly higher in private sector banks. Earlier, PSU banks were at 0.8x book and private banks were at 3–4x book. Today, the price-to-book difference between the largest PSU bank and the largest private sector bank is only about 20%. So the earlier case for owning PSU banks as the largest weight in the portfolio no longer holds to the same degree. You’re now getting large private banks that can do ₹90,000–1,00,000 crore in profits in two years at 12x earnings, with no real credit cost challenges.

IT Services: We are underweight — around 300–400 basis points underweight — though we have reduced the underweight. We’re close to neutral. The turning point is uncertain, and there’s genuine confusion about AI disruption. But expectations are running very low now, and most disruptions don’t happen at the pace people fear. Regulatory, consultancy, and transition phases slow things down. Large IT firms understand technology — they’re also transforming themselves. The bigger problem for them right now is that enterprise customers are trying to cut costs on existing projects to fund their own AI investments, even though those same customers don’t know what their real AI use case is or which path to take. Small errors in AI-native systems still require human interfaces, especially for regulatory compliance or cybersecurity issues. Those human-plus-agent combinations will be built and managed by IT services firms. The sector also has currency as a tailwind now, which the market has been overlooking.

Power Utilities & Industrials: We are positive on power utilities and have positions there. On industrials — specifically power transmission, transformers, and related industrial companies — there was euphoria and excess valuation. We are moderating our exposures there. Long-term growth is intact, but some of these businesses moved from 10% to 25–30% margins and are trading at 70x earnings. We want to be paid for the risk we take. Where the risk-reward doesn’t hold, we move on.

Pharmaceuticals: We are reasonably positive. They are currency beneficiaries and do not face technology disruption risk the way IT services might. Businesses have longevity, and valuations are reasonable. This construct works.

Auto: We owned these as part of the GST beneficiary theme and it worked for a while. We think there should be reasonable recovery here. No significant challenge.

FII selling has been pulling the market down. Do you think they will return as net buyers in next few months?

Don’t base the market solely on whether FIIs come back. They come when their cycle turns. FII selling has been going on for years and valuations haven’t collapsed — that tells you something. What you should ask is: why would any investor put money in India? Because of longevity of growth. With 6–7% real GDP growth over 15–30 years, 3–4% nominal growth on top, you have an 11%+ compounding nominal GDP growth construct. We are a far better-governed country than any peer country of our scale.

My personal view is that markets will rise before FIIs come back. They need a trigger too — earnings visibility. Right now that visibility is low because of elevated oil costs. The minute there’s a sign of earnings recovery, market expectations will shift and FIIs will have to participate.

Two years ago, the smallest Indian company was more expensive than the largest Chinese company. Our premium to emerging markets has collapsed from 86% to around 23–30% today. That re-rating downward is largely done.

What would be your asset allocation framework for a moderate risk investor with a 5–10 year horizon?
In a normal environment, a base allocation of 50% equity / 50% debt might work. Given where valuations are today — stagnant and reasonable — the right allocation could be closer to 70% equity / 30% debt.

Gold: Treat it only as a hedge. In any environment, no more than 10%. If gold runs up from 10% to 15–20%, sell that appreciation and redeploy into equity or debt. People get bullish on gold after it has already run — and the 10-year dollar returns after that can be close to zero.

Within equities: Earlier, the bias was toward large caps because that’s where you could justify sensible valuations. Now, opportunities are emerging across the board — large, mid, and small caps. A multi-cap portfolio makes sense — roughly 50% large cap, 25% mid cap, 25% small cap. There’s no longer a strong reason to bias against any category.

The nature of cycles in equity: you come in during a bad period, accumulate for the first one or two years, and then the third, fourth, and fifth year is where you make the bigger money. With a 3-year horizon minimum — ideally 5 years — you can sit through the volatility and take advantage of it.