Defence, financials, discretionary in structural sweet spot: SAMCO MF’s Viraj Gandhi
Edited excerpts from a chat:
What is your assessment of the current market cycle, and where do you believe we stand in terms of valuations versus earnings visibility?
The Indian markets continue to appear expensive on a headline basis as they are trading above their median valuations. However, there are pockets of opportunities across sectors and market caps that could benefit from strong domestic demand and policy support. Earnings visibility has been improving for sectors such as financials, industrial products, auto, and select consumer categories, while pockets like defense, and infrastructure continue to offer long-term growth potential. External factors such as global trade tensions, tariff concerns and India being viewed as an Anti AI trade has weighed on the sentiment of the market. India’s pursuit of signing free trade agreements (FTAs) with different countries like the EU and New Zealand is creating new avenues for trade, investment, and market diversification, which could support earnings growth over the medium term. We believe that the market is currently in a phase where broad valuations may appear rich, but earnings visibility is improving, and pockets of opportunities continue to exist for investors who focus on quality, growth potential, and sectors positioned to benefit from both domestic and global trends.
What stood out for you in the Q3 earnings season? Are you more hopeful of broad-based growth than before?
What stood out this Q3 earnings season was the divergence between underlying operating performance and the direction of earnings revisions. Corporate Earnings this quarter were broadly in line with expectations. Several consumption-linked and cyclical sector companies witnessed a growth in top-line with operating margins broadly stabilized or expanded and profit growth remained healthy. Banks and NBFCs showed signs of stability in asset quality and profitability metrics and industrial and defence names continued to benefit from execution momentum and policy tailwinds. Earnings downgrades in a couple of sectors were not driven purely by weak quarterly performance but due to a confluence of external factors such as currency volatility, commodity price swings, competitive intensity in certain segments, and global volatility. Management commentary indicated that domestic demand showed early signs of improvement following policy support, with autos and select consumer categories reflecting better business commentary. However, competitive intensity remains elevated in some sectors such as paints, consumer durables and telecom. IT services delivered a steady quarter with management commentary highlighting the concerns around AI related disruptions. Overall, the quarter reinforced a cautiously constructive view operationally, corporate India appears to be on a firmer footing as compared to previous quarters, but forward earnings expectations are still adjusting to a complex mix of macro, regulatory and competitive factors.
Which sectors appear structurally well-positioned over the next three to five years, and why?
Sectors that are beneficiary of secular trends and policy support given by the government appear structurally well positioned over the next three to five years. One prominent theme is defence. There is a multi-year potential for businesses in this sector due to rising government spending on defense equipment modernization, local manufacture, and indigenization. Strategic Partnerships with global players are improving technological access.
Furthermore, companies that are involved in the manufacturing of advanced electronics, aerospace components, and systems integration are well positioned to benefit from these structural tailwinds.
Pockets of consumer discretionary is another structurally attractive sector, reflecting changing preferences of the consumers as per capita income improves, urbanization and digital adoption encourages consumers to spend more on upgrading and preimmunizing their lifestyles.Banks and NBFCs are improving on asset quality, healthy credit growth, and increasing penetration across retail and corporate segments. The combination of robust balance sheets, policy support, and innovation in digital lending and payments provides a structural tailwind for earnings.
What is your outlook on financials, particularly in the context of credit growth, asset quality and margin sustainability?
The outlook on the financial sector remains constructive given improvement of credit growth and stable operating conditions. There are early signs that corporate lending is picking up which is expected to continue. Deposit growth continues to remain a challenge, and a higher reliance on bulk deposits could keep the cost of funds slightly elevated. Banks should be able to maintain their stable margins given the repricing of MCLR linked loans. Increased collection effectiveness and stress level mitigation, especially in unsecured portfolios, ensure that asset quality and credit costs continue to be controlled. Management commentary suggests that the second half of the year should be better, as growth is expected in both lending and controlled credit costs, which will improve their profitability. This creates a favorable backdrop for banks, balancing growth opportunities with prudent risk management.
How should investors approach the IT and digital ecosystem amid AI-led disruption and shifting global tech spending?
Investors should adopt a wait and watch approach in this space. AI is changing business models of traditional IT companies. The pace of AI-driven change is unprecedented in nature. Global hyperscalers are committing capex more than $600 billion towards AI related infrastructure, including data centers. As a result of these developments within the field of AI, companies are now investing more in automation and artificial intelligence as compared to traditional IT services. Companies who successfully implement AI stand to benefit from these changes, while others could lag, thereby impacting their revenue and profit margins. For Indian IT, the structural shift presents a dual challenge. Traditional service models face pressure as automation and generative AI reduce demand for conventional software maintenance. At the same time, India’s deep talent base and growing digital capabilities provide opportunities to support global clients in AI adoption.
How are you currently positioning portfolios in terms of sector allocation, cash levels and market-cap bias?
We use momentum as a factor across our funds and allocate capital to sectors and companies based on relative price strength, growth in revenue, and accelerating earnings, while using absolute momentum to manage risk and protect capital. From a market-cap bias, positioning depends on the mandate of the scheme. In categories such as Flexicap, ELSS and Special Opportunities where the fund managers have flexibility to allocate across market caps, we have a slight bias towards mid and small caps. Sector-wise, we are positioned in BFSIAutos, Pharma and Industrial Products where we believe the balance between growth prospects and risk is favourable. These sectors offer a mix of cyclical recovery, structural tailwinds and improving profitability dynamics. On the risk management side, we actively use hedging to reduce downside risk particularly during phases where markets remain sideways or uncertain. In addition, we maintain cash in certain portfolios where near-term risk-reward warrant a more cautious stance. Overall, our approach seeks to participate in momentum-led opportunities while maintaining flexibility and prudent risk control.
Do you think that the sell-off in smallcaps we saw in last 1.5 years is done and that we will see gradual recovery in next 2 quarters?
Given the results in Q3FY26, there are encouraging signs that the extended weakness in small-caps could be stabilizing. Across a broad set of companies, revenue and profitability growth is accelerating, with smaller companies showing stronger momentum. Earnings downgrades appear to be moderating, and we expect upgrades to gradually emerge as macro conditions stabilize and companies benefit from policy tailwinds. Supportive monetary conditions due to the rate cuts done by the Reserve Bank of India should improve corporate earnings and investor sentiment. While valuations are above median levels at the broader index level, there continue to be selective pockets within this space with solid fundamentals and clear growth drivers. The combination of the above-mentioned factors suggests that small-caps could see a gradual recovery in the coming quarters.