Large-cap stocks present a promising opportunity for investors as small-cap and mid-cap stocks have already priced in strong earnings growth of 20% to 30%, according to Arihant Jain of Franklin Templeton. While large-caps are valued against more modest expectations of 10% to 12% earnings growth, this leaves room for potential earnings upgrades and valuation re-rating.
The Sapphire Equity Long-Short SIF fund, managed by Franklin Templeton, can hold 75% to 100% in long positions and short up to 25%. The fund's asset-allocation model, which does not permit leverage, determines its long and short exposure. The fund was 100% long in July due to bullish domestic macroeconomic signals, with credit growth above 15% to 20% and earnings growth between 10% and 30% across various market caps.
Jain explains that the fund uses a multi-factor model to select stocks based on quality, valuation, price momentum, and earnings momentum. The model is continuously upgraded, and the portfolio is generally rebalanced monthly. The fund's exposure is around 80% to large-caps, aligning with its benchmark, the BSE 200.
“In large-caps, investors are expecting nominal earnings growth of around 10% to 12%. That leaves room for earnings estimates to be revised upwards and for valuation multiples to expand.”
Arihant Jain, Franklin Templeton
Despite the market being range-bound for two years, Jain remains optimistic about earnings growth, expecting the second quarter to be strong with 20% to 30% growth in mid- and small-caps. He notes that large-caps may look better on a risk-adjusted basis going forward due to room for upward earnings revisions.
The fund has taken very small short positions since its launch, as shorting opportunities are limited in the Indian market. Futures and options are available in about 200 stocks, representing 80% to 85% of the market by capitalization. The strategy is not designed to maintain short positions at all times but can increase short exposure during stressed or bearish markets.
Jain highlights the structural gap between regulations and available tools for fund managers, noting that SIFs provide an additional source of alpha and drawdown protection. The ability to take active short positions differentiates SIFs from mutual funds, which cannot undertake naked shorting.
Background
The Indian stock market has been largely range-bound over the past two years, with domestic flows cushioning the downside and new supply limiting the upside. The return of foreign investors and a robust IPO pipeline have added complexity to the market dynamics, making it challenging to generate alpha.
Looking ahead, investors should watch for potential earnings upgrades in large-cap stocks as they offer room for valuation expansion. The market's trajectory will depend on earnings growth and the multiples available for that growth.
