What is your assessment of the current market cycle, and where do you think we are in terms of valuations versus earnings visibility?
Indian markets in general continue to look expensive as they trade above their average valuations. However, there are opportunities across sectors and market capitalizations that could benefit from strong domestic demand and policy support. Earnings visibility has improved for sectors such as financials, industrials, automotive and certain consumer categories, while sectors such as defense and infrastructure continue to offer long-term growth potential. External factors such as global trade tensions, tariff concerns and India being seen as anti-AI have weighed on sentiment in the market. India’s push to sign free trade agreements (FTAs) with several countries such as the EU and New Zealand creates new opportunities for trade, investment and market diversification, which could support earnings growth in the medium term. We believe the market is currently at a stage where broad valuations may appear rich, but earnings visibility is improving and there is still opportunity for investors focused on quality, growth potential and sectors positioned to benefit from both domestic and global trends.
What stood out to you in the third quarter earnings season? Are you more hopeful for broad-based growth than before?
What stood out this quarterly earnings season was the difference between underlying operating performance and the direction of earnings revisions. Corporate profits this quarter were largely in line with expectations. Several consumer and cyclical companies witnessed revenue growth, with operating margins largely stabilized or expanded and earnings growth remaining healthy. Banks and NBFCs showed signs of stability in terms of asset quality and profitability, and industrial and defense companies continued to benefit from execution momentum and policy tailwinds. The downward revisions to earnings in a number of sectors were not solely due to weak quarterly performance, but to a combination of external factors such as currency volatility, commodity price fluctuations, competitive intensity in certain segments and global volatility. Management commentary showed that domestic demand showed early signs of improvement following policy support, with autos and certain consumer categories reflecting improved business commentary. However, competitive intensity remains high in some sectors, such as paint, consumer durables and telecom. IT services delivered a stable quarter, with management commentary highlighting concerns around AI-related disruptions. Overall, the quarter reinforced a cautiously constructive operational view. Indian business appears to be on firmer footing compared to previous quarters, but future earnings expectations are still adjusting to a complex mix of macro, regulatory and competitive factors.
Which sectors appear to be structurally well positioned over the next three to five years, and why?
Sectors that benefit from secular trends and government policy support appear to be structurally well positioned over the next three to five years. A prominent theme is defense. There is multi-year potential for companies in this sector due to increasing government expenditure on defense equipment modernization, local manufacturing and indigenization. Strategic partnerships with global players improve technological access.
Additionally, companies involved in the manufacturing of advanced electronics, aerospace components and systems integration are well positioned to benefit from these structural tailwinds.
Another structurally attractive sector is the consumer discretionary sector, which reflects changing consumer preferences as per capita income improves, urbanization and digital adoption push consumers to spend more on upgrading and pre-immunising their lifestyles. Banks and NBFCs are improving asset quality, healthy credit growth and increasing penetration in the retail and corporate segments. The combination of robust balance sheets, policy support and innovation in digital lending and payments creates a structural tailwind for profits.
What is your view on the financial sector, especially in the context of credit growth, asset quality and margin sustainability?
The outlook for the financial sector remains constructive given improving credit growth and stable operating conditions. There are early signs that corporate lending is picking up and is expected to continue. Deposit growth remains a challenge, and greater reliance on bulk deposits could keep the cost of funds somewhat high. Banks should be able to maintain stable margins given the repricing of MCLR-linked loans. Increased collection effectiveness and reduction of stress levels, especially in unsecured portfolios, ensure asset quality and credit costs remain under control. 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 environment for banks, balancing growth opportunities with prudent risk management.
How should investors approach the IT and digital ecosystem amid AI-driven disruption and changing global technology spending?
Investors should take a wait-and-see attitude in this area. AI is changing the business models of traditional IT companies. The pace of AI-driven change is unprecedented in nature. Global hyperscalers are investing more than $600 billion toward AI-related infrastructure, including data centers. As a result of these developments in AI, companies are now investing more in automation and artificial intelligence than in traditional IT services. Companies that successfully implement AI can benefit from these changes, while others lag behind, which can impact their revenue and profit margins. For Indian IT, the structural shift poses a double challenge. Traditional service models are under 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 customers in AI adoption.
How are you currently positioning portfolios in terms of sector allocation, cash levels and market capitalization?
We use momentum as a factor in our funds, allocating capital to sectors and companies based on relative price strength, revenue growth and accelerating earnings, while using absolute momentum to manage risk and protect capital. From a market capitalization bias, positioning depends on the fund’s mandate. In categories such as Flexicap, ELSS and Special Opportunities, where fund managers have the flexibility to allocate across market capitalisations, we have a slight preference for mid- and small-caps. Sector-wise, we are positioned in BFSI, Autos, 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, especially in phases where markets remain sideways or uncertain. In addition, we hold cash in certain portfolios where the short-term risk-reward ratio warrants a more cautious approach. Overall, our approach seeks to participate in momentum-driven opportunities, while maintaining flexibility and prudent risk management.
Do you think the small cap sell-off we have seen over the last year and a half is over and that we will see a gradual recovery in the next two quarters?
Given the Q3 2026 results, there are encouraging signs that ongoing weakness in small caps could stabilize. Across a wide range of companies, revenue and profitability growth is accelerating, with smaller companies showing stronger momentum. Earnings downgrades appear to be easing, and we expect upgrades to gradually emerge as macro conditions stabilize and companies benefit from policy tailwinds. Supportive monetary conditions following the Reserve Bank of India’s rate cuts should improve corporate earnings and investor sentiment. While valuations at the broader index level are above average, selective segments remain within this segment with solid fundamentals and clear growth drivers. The combination of the above factors suggests that small caps could see a gradual recovery in the coming quarters.
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