investment strategy: As stock market is shifting from value to quality, how S Naren is investing

He and his team of fund managers are busy hunting for quality-oriented value stocks rather than being limited to aggressive value stocks.

Value stocks, particularly in the PSU and infrastructure sectors, performed well over the last couple of years but seem to have hit a rough patch recently. Where do you think we are in the market cycle that shifts between value, growth, quality, and momentum?

S Naren: Yes, we’re seeing a shift in the cycle. Over the last couple of years, value stocks—especially PSUs and infrastructure-related sectors—performed strongly. But now, as you’ve mentioned, we’re seeing some challenges in those areas.

In our view, market cycles naturally rotate between different styles—value, growth, quality, and momentum. Right now, we believe we’re in a transition phase where growth and quality may start to take precedence, especially in sectors like consumer staples and IT. That’s why, for the first time, we’ve taken meaningful positions in these quality sectors. While value has done well in the recent past, cycles do shift, and we’re adapting to that shift by focusing on higher-quality companies.

At the same time, we don’t take a rigid approach to value investing. Sticking solely to low P/E stocks, for example, could lead to underperformance in the long run. Our strategy is flexible and adaptive as the market cycles evolve.Also read | Nilesh Shah’s market musing: Experienced investors making less money, how long can this continue?

Some of the new-age stocks have done quite well. Do you regret missing out on those opportunities or did they not fit into your value investing framework?
S Naren: Yes, that’s right, they didn’t fit in the value investing framework for us. One of our gurus, Warren Buffett, says it is okay to miss on these new-age stocks if they don’t fit into your investment style or framework. And missing out on some of those new-age sectors has not posed any problems for our fund. If Warren Buffett can manage to deliver returns over long periods by missing out on new-age sectors, I think we surely can draw inspiration from that.

Which sectors fall within your radar? The consensus on Dalal Street appears to be tilting in favour of defensives like IT and consumption. Which sectors of the market do you think have enough value right now?
S Naren: If you ask me, the most value-oriented thinking today directs us towards asset allocation. Over the last six months, as the CIO of my company, I have reiterated this; we have focused on asset allocation and that is our main value-oriented thinking. It’s less to do with the fund and more to do with the fact that value investing suggests investors can’t and shouldn’t put all their investments only in equity, because equities itself today is not an undervalued asset class.

To answer your question, within equities, there is clear value in the banking and financial services sectors. In fact, these sectors currently have one of the highest weightings in the history of our fund. However, it’s important to note that these are not low-risk sectors, so we continuously reassess our positions.A few months ago, we identified consumer staples and technology as key areas to focus on, and they’ve performed very well recently. We also recognized the value in US pharma a year ago, which delivered significant returns.

That said, while sectors like consumer staples, telecom, power, pharma, and IT services offered value not long ago, it’s difficult to see the same value for new investments at this point. Holding existing positions in these sectors is fine, but initiating new ones presents its own set of challenges.

Looking beyond your fund, how is value investing ingrained in the whole ecosystem—in the DNA of ICICI Prudential AMC?
S Naren: See, we are large asset managers of public money. The philosophy that ICICI has ingrained within us is that we have to manage large sums of public money in the right way. That is the culture that we have tried to build in this company over the years.

In the last couple of years, a lot of retail investors and even HNIs have been chasing momentum.

There will be certain periods, as we have seen in 2007 and various other times where one will feel a bit left out with this kind of framework. But that is part of the deal. No investor can outperform every single month or every single year. But since we are custodians of public money, we believe in the framework which includes debt investing, equity investing, and hybrid investing.

We are now staring at a rate cut cycle which could begin with the Fed cutting rates by 25 basis points. How should investors tweak portfolios at this stage?
S Naren: Rate cuts could lead to a good amount of treasury profits on the investment book of the banks. They are the cheapest sector (relative to history) in the entire market at this point. So I believe rate cuts would give a positive benefit to banks and NBFCs. They can help them with their borrowing costs as well. This is how we look at it at this point.

When the banks focus on deposits, the pressure on trying to compete aggressively on credit may go down, and that may even result in better margins because the focus is on deposits and not on reducing credit rates. So it may lead to a positive outcome for the sector. With interest rates coming down, maybe the deposit pressure will also come down, and that could improve the net interest margins.

Also read | US Fed meeting begins today. Does the stock market need a 25 or 50 bps rate cut?

What are your valuation models telling you about the market?
S Naren: Right now, our valuation models are telling us that equities are not cheap and hence our models indicate that asset allocation is the best approach for value investing. For the last two years, markets have not become cheaper. Rather, they have continued to go up. Given this, asset allocation has become even more important.

Other than valuation, what are the risks that you see for the market in general?
S Naren: See there’s a lot of retail investor exuberance, and if you look at the derivatives market, there is a fair amount of open interest in stock futures. There’s a fair amount of activity in the options market. For example, some of the SME IPOs are getting oversubscribed significantly. So there is a fair amount of retail exuberance and investor exuberance, which is a source of risk at this point. It is less a fundamental problem than a retail investor exuberance problem. Suddenly, one day, the leverage may go down, and when it does, it can be disruptive. A drop in leverage can cause a quick market correction.

At the same time, there’s a lot of FII money waiting on the sidelines. They can turn, but we don’t know where the money is and whether they will find the Indian markets cheap. A bigger problem exists in small and mid-caps and a smaller problem in large caps. But it will have a ripple effect on every part of the market, and it will have a higher impact on IPOs. It will have a higher impact on SME IPOs, and it will have a higher impact on small and mid-caps than on other areas.

When we are approaching a rate cut cycle, what is the ideal strategy that one should follow?
S Naren: As we approach a rate cut cycle, the ideal strategy, in my view, is to focus on asset allocation. It’s essential, and I’ve emphasised this multiple times. Additionally, you should avoid leverage—or, if you’ve taken on leveraged stocks, reduce them to zero and book profits.

A rate cut typically signals a slowing economy, which means equity earnings may not grow significantly. This is why it’s crucial to have no leverage and limit excess risk in your portfolio. Instead, focus on investing in quality stocks—quality-oriented value rather than aggressive value stocks.