Positive macros and demand boost by fiscal and monetary stimuli will drive earnings higher and attract foreign investor inflows, subject to a weaker dollar, Gunwani said. Selective small-caps have the potential to grow much faster than large-caps, offering fund managers maximum potential for generating alpha through active stock selection.
Edited excerpts:
How have the earnings panned out for Q2 so far based on your expectations?
Earnings expectations for Q2 were quite muted. In this context, the actual numbers have done slightly better than the subdued expectations. For instance, expectations for the IT sector were low, but earnings exceeded estimates. Similarly, in the banking sector, results were better than expected. However, in capital goods, there was some disappointment relative to expectations. Remember, some sectors also had GST-related disruptions. So in the FMCG sector, analysts were looking more at the commentary on whether firms expect the (positive) impact of the GST rate cut on demand to sustain.
Has the earnings downgrade cycle bottomed out, and what are your expectations going into the second half of the current fiscal?
The earnings downgrade cycle, in our opinion, has bottomed out and the outlook is much better for the second half of the current fiscal year (FY26). The fear that the imposition of tariffs by the US on its trading partners would lead to a US recession has not played out, and global activity is at a much better level than what was feared at the start of the year. Europe and China, too, are better at the margin. If you look at the domestic economy with our fiscal and monetary stimuli, we expect the economy to start improving and you should see an uptick in a quarter or so. Therefore, we forecast that H2 of FY26 will be much better for Indian Inc. from an earnings perspective.
If that’s the case, do you expect foreign portfolio investors to return to the Indian market, which has underperformed not just EMs but the US S&P 500?
Both valuations and earnings in India are looking better vis-a-vis other emerging markets. We have already been through a one-year time correction, which has moderated Indian valuations. At the same time, other Asian markets such as South Korea, Taiwan and China have gone up between 30% and 50% in calendar 2025. This has narrowed the relative valuation gap between them and India. Even from this perspective, prospects for foreign portfolio flows look much better going ahead. However, if the US dollar strengthens, then it will impact flows to all emerging markets. But our expectation is that the US dollar will weaken in the near term. If the dollar strengthens, then global liquidity becomes tight and vice versa. At present, emerging markets are seeing a lot of flows due to the dollar’s weakness. India had outperformed other emerging markets on a 3-5 year basis, whereas other markets had become very cheap. For almost the full year, relative valuations were against us, which is not the case now. Multiple factors drive FII flows but if the dollar remains weak, we believe India will receive net positive FII flows.
How do our valuations of 20x one-year forward look, given our earnings growth numbers?
If one looks at India’s macro picture, then we have stability on the current account deficit, benign inflation and moderate bank leverage. Given all these positive macro variables, we would argue that the risk premium that foreign investors apply to India should be lower than in the past. One can argue that relative to the past, India deserves a valuation premium due to stable and positive macros. Plus, we are also expecting an earnings growth revival in India; so valuations from a FPI flows perspective shouldn’t look excessive. We expect the Indian market will offer returns in line with earnings growth. We don’t see any downside to current multiples, but we don’t forecast multiples expansion either.
The extant wisdom is that an earnings recovery is led by large caps and followed by mid- and small-caps. Your comment.
Mid- and small-caps are too vast a universe to aggregate. However, in general, relative to large caps, mid- and small-caps have the potential to grow faster. If one looks at the Nifty 100 earnings growth over the last five years, it has grown faster than nominal GDP growth by a significant margin. Over the very long term, the earnings growth of this cohort (which is a proxy for large caps) tends to converge with nominal GDP growth. Therefore, I believe that going forward, it will be very difficult for large-caps to outperform. I feel that selective small caps have the potential to grow much faster than large caps and this is where there is the maximum potential for us to generate alpha with active stock selection.
Within the large, mid- and small-caps, what’s your bias for and against?
I prefer small caps relative to others as there is a much wider choice compared to large or mid caps. Even in mid-caps, the choice is limited to 150 stocks, whereas the small-cap universe is in excess of 500 stocks. Even the number of IPOs by small-cap companies is a much larger proportion of new issues coming to the market than other capitalisation buckets.
Do you believe India’s underinvestment in new tech like artificial intelligencey makes us vulnerable in the future?
It’s still early days and India can either stand to benefit or suffer because of AI. India will not be at the leading edge of (foundational) AI, but if we can capitalize on the demand for implementation and application of AI by firms, then we can benefit quite materially.
If, on the other hand, AI kills jobs very quickly, then bear in mind that services exports and inward remittances are a big part of our economy. If AI replaces these jobs very quickly, then we will be at a disadvantage and it will become a threat to our economy. If this happens, then our stock market will get affected very quickly. However, in the past, horizontal technologies such as the internet, etc. have created more jobs than they have replaced. If this same trend repeats, then India, with its large workforce of software and engineering experts, will benefit from demand for the implementation of AI tools in firms. We, therefore, see only a tail risk in AI reducing the value of human effort very quickly.
In terms of stock markets, re-rating of AI stocks globally has already played out and most of that effect is behind us. We believe that this global market cap creation is unlikely to repeat from here.
The regulator has proposed a cap of 2 basis points on the brokerage that mutual funds pay to sell-side brokers. What’s your assessment of the potential impact?
The reduction in fees paid to brokers is part of a proposal by the regulator as part of its consultation paper rather than a policy announcement, so we don’t know what final shape and form it takes (after Sebi considers the views of multiple stakeholders). Directionally, we can say that in-house research capability will start to matter more and more. At Bandhan MF, we have invested in this research capability, and we continue to invest in this even now. At the moment, we already cover 650 stocks internally as part of our research process.
If sell-side research capabilities are affected very materially by this order, then we will have to significantly accelerate our investment in internal research.
Do you feel retail inflows into mutual funds will continue at a steady pace, with the market still in the negative returns zone since September last year?
The Indian MF market has matured. Equities have done well in absolute as well as relative terms if you compare 3,5, 7 or 10-year returns from equity funds. What we also see is that investors are much more patient now. To give you an example, even during the October 2021-March 2023 period, when markets were flattish, we didn’t see investors panicking. If returns from equities start to lag over a 3 -and 5-year period, then there can be an issue.
Real estate is the biggest asset class for Indian households. Now, if you factor in returns, liquidity and convenience, equities have outperformed real estate, too.
What’s view on debt, gold and silver?
If you consider the 2008-13 period, real estate massively outperformed equities. There may be 3-5 year periods where other asset classes outperform equity. But on a 20- to 30-years basis, you will see equities outperforming other asset classes. However, at Bandhan MF we advocate that investors should have exposure to multiple asset classes in line with their risk profile. Available data indicates that 50-60% of household wealth is represented by real estate, 30% in gold and around 10-15% in equities. As a percentage of household assets, the penetration of equities is starting from a very low base of household balance sheets. The proportion of money coming into equities is therefore not very high from a balance sheet.
At Bandhan, we believe that all asset classes will grow as the country grows. Real estate prices look very expensive from a rental yield or a global perspective. Gold has a role in an investor’s asset allocation, and fixed income is something everyone should look at for safety. To my mind , fixed income is the most undersold asset class in India.
From hereon, we believe that equities will outperform real estate and gold over the next 3-5 years.
Your view on a trade deal with the US and its positive or negative impact on the market?
For the Indian economy, the first-order impact of punitive US tariffs is not very material given that generic pharma exports are unlikely to be slapped with tariffs. How this impasse gets resolved, however, has a bearing on the risk perception of India and impacts our risk premium. If relations between two very big economies are strained , this is not seen very positively for capital flows and from a trade perspective. This will, therefore, be an overhang on the markets if the dispute isn’t resolved.
