Foreign outflows show currency concerns, not a negative India fundamentals: Aditya Birla Sun Life AMC's Harish Krishnan

After the budget classified tax on buybacks as capital gains, some relief for buybacks may help return excess capital in a few mature companies, which can then be recycled into newer capital-intensive opportunities, said Krishnan. Some consumer staples, even though they have higher price-to-sales ratios, are generating significant cash flows and could be a better bet than recent winners such as EMS (Electronics Manufacturing Services) or hospital stocks, he added. Edited excerpts: Q 1) The fiscal deficit is narrowing. Are we spending less, and what does it show? In an environment of elevated global uncertainties, the Indian government continued its path of prudence—resorting to realism rather than rhetoric. Unlike most major economies, which have continued to expand their unconventional fiscal policies (high fiscal deficits sustained for much longer, tariff uncertainties, etc.), India has chosen to maintain its glide path toward fiscal discipline. There has, however, been a shift in its priorities. Post-covid, from FY21 to FY24, the Union government went on a massive overdrive on supply-side initiatives—namely, the infrastructure and investment themes. Capital expenditure growth averaged about 31% (FY21-24), however, since last year for FY25-27 (BE), this has now come down to about 10% on average. It is still commendable that they are maintaining operating on fourth gear on an elevated base achieved till FY24. On the other hand, revenue expenditure, which averaged 4% from FY21-24, has now increased to 7% in FY26 and FY27BE. Thus, in our opinion, from the supply side stimulus, policymakers are moving towards domestic consumption. Q 2) What are your thoughts on the budget from an equity standpoint? From an equity market, higher Securities Transactions Tax (STT) on Futures and Options (F&O) to temper very high participation seen in markets does seem a bit of a surprise, which equity markets will have to digest, and possibly any changes in long term capital gains—either for domestic investors or foreign investors will have to wait some more time, as there were no changes in this budget. Some relief on buybacks may help return excess capital in a few mature companies, which can then be recycled into newer, capital-intensive opportunities. Overall, the budget is unlikely to cause a meaningful shift in the assessment of equities in the medium term. We do think the last 15 months have been a reboot opportunity with significant policy resets in the backdrop of geopolitical developments and global macro uncertainties. It is thus imperative for investors to frame investment opportunities from a fresh lens—to assess that, over the coming 3-4 years, a newer set of themes and sectors is likely to be winners compared to investment theme-heavy winners in 2021-2024. Seasonally, the first quarter has typically been negative for Indian equities—possibly, a similar trend in the near term can provide opportunities to build an equities portfolio with a medium-term perspective. Q 3) What’s the mood like during these client conversations and distributor meetings? There are phases when selling funds is easy and phases when it’s tough. Over the last four to five years, strong returns made it tempting to sell funds purely on performance. But over the past 15-18 months, even though markets haven’t been bad and many funds have delivered decent returns, it hasn’t been a rising-tide market (bullish). Only a few funds and fund managers have stood out, making it a tougher environment and reinforcing why it pays to be counter-cyclical and willing to be different. Q 4) So, in this equity reset phase, should investors look at opportunities with a fresh lens rather than rely on past winners, and which sectors do you see offering good compounding potential over the next three to five years? At the outset, we follow a framework built around four broad parameters. First, we look at a sector’s profit pool share, its profits as a proportion of the top 1,000 companies’ profits, tracked over the last 25 years. This typically throws up three kinds of sectors. One is compounder sectors, where profit share tends to rise over five-year blocks, even if the path isn’t linear; examples include private banks, IT services and FMCG (fast moving consumer goods). At the other end are declining sectors, where salience declines consistently every five years, such as certain energy or PSU-heavy (public sector undertaking) pockets. In between are cyclical sectors like autos, discretionary consumption, cement, metals and media, where profit share moves around sharply across cycles. The second lens is market-cap share versus profit pool share. In compounding sectors, market cap often runs ahead of profits because markets price in growth and durability. While these sectors are usually well priced, opportunities still emerge as valuations stretch and contract, much like a rubber band. Third, we look at ownership patterns, where ownership is heavily clustered versus under-owned, and relate that to relative performance over the last three to five years. Finally, we track the size effect: whether recent market-cap gains are coming from large caps or microcaps. When returns are increasingly driven by microcaps and large caps stall, it often signals the later stage of a market cycle, one that investors may want to approach cautiously. Q 5) Do you have a framework that incorporates these parameters into your investment strategy? Using these four factors, we arrive at what we call a clock, a figurative framework to map opportunities. Think of it like a clock face: 12, 3, 6 and 9 o’clock. One-half represents momentum, where things are going well, the Street is aware of it, and is already positioned. The other half is the value side. What really interests us is a specific segment on this clock, where fear, panic, and negativity lead to very low ownership. These are the potential dark horses, such as IT at certain points. Over the past year, for instance, we identified private-sector banks, metals, and cement as areas that were not just ignored or undervalued, but also offered scope for positive surprises and alpha if things played out right. The momentum segment, on the other hand, can deliver near-term returns as the market moves, but the scope for outsized alpha is limited since everyone already owns these stocks and sell-side coverage is strong. This is typically a sell-on-rallies zone. We also try to avoid value traps and the late stages of bubbles, where stocks can run to unsustainable levels, preferring to step aside at that point. Q 6) Which could be those sectors, though? We think that if you look at the market today, there are several names in consumption, staples and retail that are still being ignored, not because they are performing poorly, but largely because promoter ownership is very high, at around 50-75%, leaving very limited free float and little stock available for sale. These companies earlier traded at much higher price-to-sales multiples, which we believe is a more relevant valuation metric than price-to-earnings, as it better captures underlying business value. At current levels, many of these companies are generating free cash flows of around ₹400-600 crore on market capitalisations of ₹10,000-15,000 crore, implying a free cash flow yield of roughly 4-5%. While there is no near-term excitement and concerns such as higher competition and earnings downgrades persist, we believe this phase offers a good opportunity to back these businesses rather than chase recent winners like EMS or hospital stocks. It’s not that we are negative on those sectors, but strong price appreciation and crowded ownership there suggest that better opportunities may now lie in these overlooked pockets. Q 7) What about the new-age companies? Where would you place them? This is a much-debated space. These are evolving businesses, which makes them difficult to value. Many are barely profitable on an adjusted basis, and several are still loss-making. That said, in many cases, the unit economics are strong, and there is a clear path to profitability, though it ultimately depends on management choices between pushing profits or continuing market expansion. A key data point is that loss-making companies today account for just about 1.7-2% of total market capitalisation, one of the lowest levels in the past 25-30 years. Historically, Indian markets have absorbed far higher levels, often 4-5% or more, including during the pandemic. Earlier, such companies were typically PSUs, trading firms or mature businesses struggling to turn around, so today’s numbers are not unprecedented. Corrections are possible, as these are nascent business models that will remain volatile under quarterly scrutiny and competitive pressure. Still, many of these companies are built on first principles, use technology in differentiated ways and could challenge incumbents meaningfully. We don’t see this as a blanket bubble, but as a space where value can be created, alongside inevitable failures. The key is patient capital, careful sizing, and backing companies with strong unit economics, a credible path to profitability, differentiated models and driven founders. Q 8) What is your approach to valuing these new-age companies? I think unit economics matters a lot; you want to build companies that are highly capital-efficient. Even if current numbers look weak or inferior compared to peers, especially given today’s valuations, that isn’t necessarily a negative. In many cases, founders have built strong habits and moats with relatively modest capital, say $100-150 million, which is actually a positive signal. The second type of founding teams we like are those that choose to do things differently rather than follow the crowd. They don’t raise money just because others are, or copy popular value propositions. Doing something meaningfully different is how brands are built over time, though it requires consistency and the willingness to take tough knocks early rather than opting for the easy route. We’ve often seen this play out with competing startups, where one benefits from government support and the other doesn’t. We tend to back those without such support, as they are intrinsically built for tougher conditions. Q 9) You have often said currency movements could guide equities going forward. Could you explain a bit more about why and how that might impact the market? For Indian companies, rupee EPS (earnings per share) can grow even when dollar EPS stagnates, largely due to rupee depreciation. Around 55-60% of the top 1,000 companies’ revenues are linked to dollar realizations across sectors such as energy, metals, pharmaceuticals, IT and autos, so a weaker rupee lifts revenues in rupee terms, even if margins compress slightly due to foreign-linked costs. For foreign investors, nominal earnings growth of 12-14% can translate into only 4-6% dollar returns if the rupee depreciates 5-7%, making currency weakness a short-term negative. However, once the rupee stabilises, it creates a higher earnings base, which should support valuations over the next three to four years. A move (of the rupee) from 80 to the 90s, for instance, can lift the revenue pool by 3-5% as more than half the revenues are dollar-linked. This is directional rather than precise, but it helps revive revenue growth, which has remained weak over the past 2-3 years despite margins near 20-25 year highs. Even with slightly lower margins, absolute earnings rise, supporting higher exit multiples. This dynamic applies not only to equities but also to assets like gold. Over long periods, equities perform during growth phases, while gold does well in panic. With currency-led earnings uplift of 1-3% and further support from government measures and RBI transmission, earnings could see an additional 3-4% boost. Foreign outflows today reflect currency concerns, not a negative view on India’s equity fundamentals. Q 10) Over the past year, large caps have risen, but small caps have largely lagged. What’s driving this divergence, and do you see any potential for a catch-up in the small-cap space versus large caps? Earnings for large companies typically double every five to six years, while small caps do so slightly faster in four to five years, a marginal difference. Over the past five years, earnings surged across the market from a low base, with many loss-making firms turning profitable, even as small-cap prices ran ahead of earnings. Today, growth across large, mid and small caps has largely converged. Small caps now contribute about 12-13% of profits but account for nearly 22% of mutual fund ownership, making the space crowded and limiting near-term upside, even though they can still outperform over a three- to five-year horizon. In contrast, the top 100 companies generate 68-70% of profits with only about 54-55% ownership, leaving more room for upside if earnings surprise. That’s why the focus is shifting from market caps to themes. Sectors like banking, IT, metals, chemicals, FMCG, energy, textiles, alcohol, and cement have underperformed in recent years and could throw up the next set of leaders across market caps. Select small caps, especially in consumption, still offer attractive cash flow yields and strong ROEs (return on equity), but overall expectations are moderating, and margin assumptions are being reset.