Beaten-down mid-cap stocks may be the best long-term bet: Reliance MF

This is the tenth in a series on the best of the fund managers who share their views on stock play. Today, we bring you the insights of Reliance MF's head, CIO-equities, Sunil Singhania.

MUMBAI: Equities may trend lower, at least for a few quarters as investors come to grips with a government that scrambles to control a wobbly economy and the global geo-political developments that can destabilise trade and commerce, said a fund manager.

During such uncertain times, investors tend to pile up on large-cap stocks and shun smaller ones, widening the valuation gaps that could benefit long-term value investors who can buy mid-cap shares at inexpensive valuations.

Banks and pharmaceutical shares are among the best positioned to outperform the market when the overall market begins to rally. While banks' valuations are attractive, drugmakers' market is widening both in India and abroad, said Sunil Singhania, head and CIO-equities of Reliance Mutual Fund who oversees assets of over 1,01,577 crore at Reliance Mutual Fund.

"The perception we get is that the government is somehow not on top of it as they should have been,'' he said.

"Because of all this, confidence levels are a little low. As such, capex is not happening on the scale it should be. However, our view is that it is a short-term phenomenon and should get sorted out in the next two quarters," Singhania said.

India's benchmark Sensex is among the worst performers in the emerging markets category, as investors trimmed equity due to delayed policy responses that expose the economy to price rise. Inflation is threatening to eat up the Indian consumption story, and nine policy rate increases don't seem to be enough.

The Reserve Bank of India (RBI), economists at Goldman Sachs, Citigroup and Nomura Holdings have lowered economic growth estimates from last fiscal, and some have slashed corporate earnings estimates. The government is sending out signals that it may not be able to achieve its fiscal deficit target. This could amplify interest rate increases when it borrows more from the market, crowding out private investments.

The Sensex has lost over 11% year to date, while overseas investors have sold 2,300 crore, or $464 million worth of Indian shares. In 2010, the index rose 17% and foreign funds bought shares for a record $29 billion.

"Suddenly, you had a market which started drifting towards safe sectors, one directly related to pharma, or consumption,'' said Singhania, whose holdings include Ranbaxy, ICICI Bank , Infosys, Bank of Baroda among others.

"So we had a distortion wherein a few sectors were trading at 35 P/E and a few at 4-5 P/E. Today, finance and banking which was essentially viewed as a safe sector, got hit. Sectors in any way connected to the government - infra, power or capex related - have all got hit."

Companies such as chocolate producer Nestle, drug maker GlaxoSmithKline and pizza maker Jubilant Foodworks , trade at more than 30 times their earnings, while roads builder IL&FS Transportation and JSW Energy , whose fortunes depend on government policy actions, are at around 10 times their earnings or even lower. Reliance Mutual's holdings in power, infrastructure, fell sharply in the past one year.

The BSE Mid-Cap index is down 23% since its peak on November 11 2010, indicating that the broader market is in a bear territory. The Sensex is off 13% since its peak last November. The BSE Power index has lost a quarter of its value since the peak, while the banking sector index is off a fifth.