At a time when the stock markets seem overvalued but investors continue to pour in their money, Nimesh Shah, MD & CEO, ICICI Prudential AMC — the country’s largest fund house with assets of over ₹2.43 lakh crore — is advising investors to stick to products that will handle volatility better. Excerpts:

I think several positives are now playing out together that gives us a deep conviction that equities must be considered as a must-have asset in your portfolio.

One, corporate earnings will pick up in FY18. Two, valuations may appear high at 23 times if you look at historical earnings, but that will soon get realigned to historical valuations as earnings growth materialises. Three, companies have spare capacities that are yet to be utilised, which once utilised can add tremendous operating leverage without incurring too much capital expenditure in the near term. Four, RoEs are at their lowest levels in decades in single digits, and can only go up from here.

Additionally, government reforms like GST may see short-term challenges, but it can result in positive gains over the long term. In the short run though, markets have factored in this year’s growth. So valuations may seem stretched.

Having said this, I should add that the Indian markets have been flows-driven lately. We have seen large inflows into this market increasing the valuations. But we have to be watchful because a flow-based market can turn volatile in the short term.

Retail investors chasing historic returns is a global phenomenon, not just an India-specific one. It is up to us to structure our communication and take investors in the right direction for making investments that are appropriate and suited for the times.

We may see more flows coming in now because past returns have been good. Human psychology looks at past returns. Only a handful of people invest in the markets when they are low, and these people tend to have a better investor experience.

As an AMC, we are aware of this and we have created a suite of products that can work around this pitfall and provide better risk-adjusted returns in the long run. Among these are dynamic asset allocation funds, which works dynamically in all market conditions whether high or low, and in favour of the investor.

While these products may not offer entire market upside to the investor, it will cushion the downside in a declining market, and give reasonably better returns in a volatile market.

We have spent many years in building our own proprietary valuation model, which factors in parameters such as Price-to-Book, Price-to-Earnings and more. This has been published as part of our fact sheet for many years. It is a compelling valuation index that tells where the market is currently placed and how expensive or inexpensive it is.

I completely agree that allowing mutual funds to be sold online in that manner would really help increase the sales, and bring more investors on board. But in mutual funds, we have KYC compliance requirements. A common KYC reform across the banking and MF industry could further augment growth of the industry.

Do funds become unmanageable after a certain size? Being the largest fund houses in the country, what’s your experience?

As the asset size grew over the years, we have re-invented the product strategies and internal processes of the company. We have broken down the economies of scale by building three investment teams within the AMC to avoid concentration of AUM in terms of fund manager and investing style. So, irrespective of the size of the fund, there is an entire team managing it. We have a suite of either multi- or large-cap funds, because to that extent the risk is managed. Therefore, at the portfolio construction level only, we give the fund mandates in terms of market capitalisation. As the fund grows larger, the fund tends to have more large-caps in it. For instance, an equity fund may have more mid-cap stocks in its early days but as the fund grows in size, it will be more inclined towards investing in large-caps to better manage risks.