'2021 could be the year of small and midcaps, choose high-quality firms at right price'

I believe easing of COVID-era restrictions in 2021 may be more-or-less priced in at this point. So, I think the Budget 2021 is going to be an early trigger for the markets. Progressive policy changes and support for the ailing SME and MSME sector could raise spirits, Atanuu Agarrwal, Co-founder at Upside AI said in an interview to Moneycontrol's Sunil Shankar Matkar.

According to him, 2021 could be the year of small-and mid-caps. Here are edited excerpts from that interview:

Q: What is your biggest lesson learned from 2020 and what do you want to avoid in the coming year? Also, what is your advice to investors for 2021?

I guess for me it reinforced my belief that the factors driving the fate of the global economy and the direction of capital markets are far too complex for any human 'expert'. Hindsight is of course 20/20 and we all now understand that the key factor is the unprecedented liquidity and quantitative easing (QE) from the Federal Reserve, ECB (External Commercial Borrowing) and other central banks. However, it is hard for me to believe that any expert consensus would have predicted this pace of recovery in global markets in the throes of March.

So, like always, I want to continue to avoid paying any attention to experts making predictions on the direction of the markets.

In the same vein, I urge investors to follow a portfolio approach while looking at their net worth; let me explain. Depending on your age and risk profile, you should always have a certain percentage of your net worth invested in the equity market. This portion should always remain invested irrespective of whether the market is at its 52-week high or 52-week low or at an all-time high. What you should pay close attention is towards choosing your investment manager; focus on 3 factors here, in the order presented: (i) investment philosophy and demonstrated discipline of sticking to this philosophy, (ii) costs/management fee; make sure you are not paying someone active management fees to essentially replicate the Nifty, and (iii) past returns.

If you are bored and want to dabble in the markets for entertainment, do it with a small sum of money you are prepared to lose – just like you would when gambling in a casino. Do not gamble with your future.

Q: Key sectors one must add/avoid in 2021 portfolio

China +1 is a theme I think has some legs. India could be a key beneficiary, assuming the government continues to support our manufacturing and export sectors through tax incentives, labour reforms, and general streamlining of the regulatory regime. So, small and mid-cap companies in sectors like speciality chemicals, pharma, textiles, and the manufacturing sector, in general, could stand to benefit. IT is another sector that should benefit from the accelerated adoption of technology around the world.

Some sectors like auto, BFSI, travel and real estate have disproportionate exposure to the vaccine rollout and sustained recovery in demand. Any issues with the vaccines or supply chain disruptions could severely impact sentiment around these companies. We have already seen the new strain tantrum play out over a couple of days in December. So, beware of the COVID wave and its consequences for these sectors.

However, let me reiterate that our philosophy is that irrespective of sectoral themes, the key as always is to build a portfolio of high-quality companies at the right price.

Q: PM Narendra Modi said India received a record FDI in 2020 despite pandemic and kept $100 billion target for next 2 years. Do you expect more FDI in 2021 than in 2020?

As per DPIIT, India received $30 billion in FDI in the first half of FY20 (from April 2020 to September 2020) up 15 percent from the same period last year. The most popular sectors were services (including BFSI), computer software & hardware, and telecom.

While some of this increase can be attributed to the attractiveness of India as an investment destination, most of it is driven by the mountain of liquidity sloshing around in global markets. With interest rates in developed economies near zero or in negative territory, it is hardly surprising that yield starved investors are piling into emerging markets like India.

Unfortunately, I am afraid that the fate of FDI flows in 2021 lies in the hands of Jerome Powell, Christine Lagarde, and other central bankers much more than those of PM Modi and FM Sitharaman.

However, if India continues to make progress on metrics like 'ease-of-doing-business', we will continue to capture a larger pie of EM FDI flows, especially given the negative sentiment around China. That's the best we can hope for, the absolute amount is out of our hands.

Q: Should one prepare for big selling pressure in the market in 2021 after witnessing fresh record high levels in 2020? Also given the current record-high levels, should one book profits or wait for some more rally, though it is a case to case basis?

The short answer is neither I nor any other 'expert' has any idea. As I said above, (i) always remain invested with the equity portion of your net-worth, (ii) if you are a retail investor, focus on picking the right investment manager, and (iii) don't try to profit from making market direction calls.

Q: What are the major key triggers in 2021 that can continue supporting the market and can take the market to new levels?

I believe an easing of COVID-era restrictions in 2021 may be more-or-less priced in at this point. So, I think the Budget 2021 is going to be an early trigger for the markets. Progressive policy changes and support for the ailing SME and MSME sector could raise spirits. In the cacophony of the markets, we forget that COVID-19 has had a devastating impact on the real economy, which had not fully recovered from the fall-out of demonetization and haphazard GST implementation.

2021 could be the year of small-and mid-caps. As demand recovers, companies could demonstrate robust profit margins and superior return metrics vis-à-vis the BC (before COVID) era. It is reasonable to assume that the lockdowns have forced companies to become more efficient and we could see some of that play out in the form of operating leverage as their revenue recovers. While the Nifty50 and the Sensex30 grab all headlines, the MS 400 index (a basket of the 400 largest mid-cap and small-cap companies) has just about crossed the level it achieved in January 2018 – nearly three years ago!

Q: What are those expected key risks one should keep in mind for 2021, given the experience of 2020?

Just like it was for the Indian team of the 1990s and 2000s, the vaccine rollout is the Sachin Tendulkar of the market's batting line-up. Any material slip-up (supply chain issues, unaddressed new strains, adverse side-effects of existing vaccines or fake news regarding the same) on that front is going to probably have a negative reaction.

Another side-effect of this cocktail of liquidity could be higher-than-expected inflation in markets around the world. This will have a knock-on effect on interest rates and some belt tightening on the liquidity front. As I explained above, that will affect FDI flows leading to selling pressure in the Indian markets.

However, if you plan for the long term, follow sound principles of asset allocation, and avoid emotional buy/sell decisions, you have nothing to worry about. Happy New Year and it is fair to say that after some soul searching in 2020, we are all looking forward to 2021.