With skyrocketing order books driving massive rallies in power and defence stocks, retail euphoria is at an all-time high. However, ICICI Prudential’s Senior Fund Manager, Mittul Kalawadia, who manages over ₹72,000 crore across major schemes like the Equity & Debt Fund, Dividend Yield Equity Fund, and iSIF Equity Long-Short Fund, is striking a strong note of caution.
In this interview with ET Markets, he warns that current valuations have already priced in future growth, leaving little margin of safety for aggressive new bets. Edited excerpts from a chat on market outlook, sectoral bets and stock picking in a tough macroeconomic environment.
How has your allocation between equity and debt changed over the last year in ICICI Prudential Equity & Debt Fund?
We do not maintain a static allocation between equity and debt. The allocation is dynamically managed based on valuations and certain macroeconomic factors, with valuations being the primary driver. Over the last year, our equity allocation has moved between approximately 65% and 75%. Currently, it is around 73-75%. Whenever valuations become attractive, we increase equity exposure, while expensive valuations prompt us to reduce it. The fund’s mandate allows us to operate within a 65-80% equity range.
Which sectors currently offer the best opportunities from a valuation and growth perspective?
Valuations are close to their long-term averages, expectations are reasonable, and fundamentals remain healthy. Banking is one sector we find attractive from a valuation perspective. We also like certain discretionary consumption businesses, particularly those with pricing power. In an inflationary environment, companies that can pass on costs tend to maintain profitability better. This includes select automobile and consumer discretionary businesses. On the export side, we like pharmaceutical companies and exporters of manufactured goods. Currency depreciation can enhance their competitiveness globally. We also find opportunities among companies benefiting from import substitution.
The consumption narrative has been strong over the last year. Do you still remain positive?
We were not very positive on consumption as a broad theme. Consumption is not a homogeneous category. Different segments perform differently depending on demand conditions and competitive intensity. We prefer specific discretionary categories where either competitive dynamics are improving or pricing power remains strong. While GST reductions have supported consumption, inflation has partially offset some of those benefits. However, in most categories, price increases have not fully negated the gains from lower GST rates.
What is your outlook on PSU banks?
The key question is whether current profitability levels are sustainable. PSU banks benefited from treasury gains and lower credit costs. Going forward, treasury income may moderate and credit costs could increase marginally. The strong earnings upgrade cycle that PSU banks enjoyed is largely behind them. While valuations remain reasonable, the scope for meaningful re-rating depends on whether economic conditions improve again. Currently, we have very limited exposure to PSU banks.
What is your view on the broader PSU space, particularly defence, power and energy?
Within PSUs, we continue to like the power sector. The underlying business cycle remains favourable, although there could be some seasonal fluctuations. Defence remains an attractive long-term theme, but valuations in many defence stocks already reflect a significant portion of future growth expectations. Execution will now become critical. Companies must deliver on order books and profitability. While we like some individual defence names, we are not broadly positive on the entire sector at current valuations.
There has been a shift in investor preference from PSU defence companies to private defence companies. How do you view this?
The theme remains intact, but valuations across both PSU and private defence companies have become expensive. From a thematic perspective, defence remains attractive, but valuation comfort is limited.
Your dividend yield fund owns IT stocks. There are concerns that AI could significantly disrupt IT services companies. How do you think about that risk?
The growth environment for IT remains challenging. Economic growth globally is moderating, and AI introduces additional uncertainty regarding future demand pattern. However, valuations have corrected, dividend yields have improved and cash flow generation remains strong. This creates a case for owning the sector, although we are not taking a significant overweight position.
This is a contrarian opportunity, but unlike some previous contrarian calls, it is not one where investors can take very large bets. AI is not a temporary phenomenon. It is a structural change and has the potential to be disruptive. That said, disruption often takes longer than people expect. Traditional newspaper companies, for example, continue to operate profitably despite digital disruption. However, their valuation multiples have compressed significantly over time. Something similar could happen in IT. Even if earnings remain resilient, valuation multiples could continue to de-rate. Therefore, while there is a case for investing in the sector, position sizing becomes very important.
Have you increased your allocation to IT over the last year?
Compared to eight or nine months ago, our allocation is higher. At one point, we were significantly underweight in the sector. Today, we are closer to benchmark weight. The combination of attractive valuations, strong cash generation and increasing shareholder returns through dividends and buybacks has improved the investment case.
What is the starting point for stock selection in your dividend yield fund?
The first filter is yield. We evaluate both dividend yield and operating cash flow yield. However, yield alone is not enough. We focus equally on the sustainability of those yields and the probability that they can grow over time. Our process combines yield, sustainability and growth potential to identify the most attractive opportunities.
How is the portfolio constructed?
The portfolio is built through two approaches. The first is a systematic ranking framework that combines dividend yield, operating cash flow yield and sustainability metrics. The second is a bottom-up approach where we identify businesses undergoing positive cyclical change. In such situations, current yields may not appear attractive, but future cash flows could improve significantly. We have used this framework successfully in sectors such as telecom, automobiles and power in the past.
Why has your allocation to REITs reduced over time?
There was a period when REIT valuations were significantly more attractive, and our allocation was higher. Over time, valuations improved and yields compressed. Relative to other opportunities available in equities, REITs became less attractive. As a result, our allocation has reduced.
What is your outlook on the power sector, particularly power equipment companies?
The underlying theme remains strong. Global AI-related capital expenditure is driving demand for power infrastructure and equipment. However, valuations have become quite rich. The market has increasingly priced in the growth opportunity. However, there could be a possibility that these companies could surprise positively. We have seen similar cycles in the past where strong demand supported earnings growth for several years. That said, given the elevated valuations, it would be risky to have a very large allocation to the sector. Any slowdown in global capex could quickly affect sentiment and valuations.
From a value perspective, where do you currently find opportunities in the market?
Banks remain attractive from a valuation standpoint. Beyond banks, we see opportunities in pharmaceutical companies and export-oriented manufacturing businesses. These are the areas where we currently find the best combination of valuation comfort and business visibility.
