Dislocation - विक्षेप
Markets are dislocating, presenting an excellent opportunity for investors to increase their equity allocations, including staggering investments over the next few months.
Normal Market Correction and Not The Bear Market Cycle
The small-cap 250 index is rebased to 100 for various periods of correction.
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We are experiencing a normal market correction, which occurs every few years, as seen in 2016 and 2022. This is not a bear market cycle driven by recessionary or weak macroeconomic conditions, like in 2018. The current correction is primarily due to a reset in expectations toward normalised long-term earnings growth following the above-normal earnings growth of recent years. Macro indicators remain stable, and FIIs will likely return as valuations become favourable.
- As shown in the above chart, the recent correction in small caps is towards the bottom of prior ones. Investing at similar points in the past has rewarded investors well. For example, as shown in the above table, small-cap indices have gained more than 2x within approximately 2-3 years from the bottom in previous market corrections.
Dislocation => Correction Across Valuation Style
Indian Market Style Evolution
Data Source: Ace Equity. The percentage inside the bubbles represents the number of stocks in the particular style. Style classification is based on Vaikarya’s proprietary method, which combines several factors in addition to Valuation. Percentage numbers in boxes with arrows indicate correction over Oct’24 – Feb’25
There is a dislocation in this correction.
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The above table shows that higher valuations stocks dominated the pool of most corrected from the 52-week high.
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However, as shown in the above chart, corrections were nearly similar across investment styles. Fear of short-term loss leads to dislocation and broader technical selling across stocks.
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Many stocks in our target universe of Value and Growth at a reasonable price (GARP) now show higher IRRs for a similar degree of investment risk.
Portfolio Performance and Positioning
Portfolio performance during the recent correction
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From 01-Oct-2024 to 28-Feb-2025, the fund has outperformed NIFTY500 by about 2% and NIFTY Small Cap by about 9%. Note that the fund has a higher weightage of small caps.
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The following factors have contributed positively.
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Select stocks are up on an absolute basis. For example, for a special situation in the chemical sector, Q3-FY25 was an inflexion point in the turnaround strategy by closing the loss-making segment. Products demonstrated price stability. And the rights issue last month reduced the leverage. This position generated +20% returns.
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On a relative basis, cash levels helped on outperformance. Select positions in financials, pharma, IT, and manufacturing outperformed as positive changes were delivered, and valuations were reasonable.
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The following factors dragged down the returns
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Select small caps in the portfolio had 20-30% drawdowns. These stocks are in the pre-discovery phase as CHANGES are in the early innings.
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Interestingly, a portfolio stock corrected despite delivering 20+% growth in Q3-25 and trading at <13x PE. These are signs of dislocation !!
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Portfolio Positioning
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We use a structured position sizing framework, balancing return scenarios, probabilities of those scenarios, and risks.
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This correction has increased returns in several of our existing positions. Additionally, there are a few stocks that we have been tracking where returns have now become attractive.
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After revisiting the other two factors – risks and probabilities of risk/return scenarios - we are buying per our framework.
Valuation data represents a weighted average across the fund’s positions. Forward P/E is used, except for turnaround stocks (approximately 8% of the fund), where a 24-month forward P/E is applied. Returns (ROE/ROIC) are incremental or based on a 12-month forward view. Growth rates are forward-looking, steady-state, and measured at the top-line level.
Disclaimer
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