ETMarkets Smart Talk| Large caps offer stability, but alpha lies in selective mid- and small-caps: Rakesh Vyas

Indian equities have entered the second half of 2026 on a cautious note amid rising geopolitical tensions and elevated crude oil prices, triggering a broad-based market correction.

While the near-term outlook remains clouded by inflation concerns and margin pressures, Rakesh Vyas, CIO & Portfolio Manager at Quest Investment Managers, believes the underlying earnings story for India remains firmly intact.

In an exclusive conversation with Kshitij Anand of ETMarkets for Smart Talk series, Vyas explains why the recent correction has made selective mid- and small-cap stocks attractive, why large caps continue to anchor portfolios with stability, and how active stock selection—not blindly chasing popular themes—will be the key to generating alpha over the next few years.


He also shares his preferred sectors, biggest market risks, and the structural themes he believes could create long-term wealth for investors. Edited Excerpts –

Q) Indian markets started 2H2026 on a sombre note, falling over 1% so far in July. What is weighing on markets?
A) The immediate pressure has come from renewed geopolitical uncertainty, the spike in crude oil prices and some apprehension around the impact of higher input costs on June-quarter margins. Crude moving above US$85–100 per barrel naturally raises concerns for India’s current account, currency and inflation.

However, we believe these pressures are largely transient. The underlying domestic demand environment remains healthy: automobile sales continue to be strong, bank credit growth is running well above historical averages and infrastructure activity remains robust. Therefore, the recent correction should be seen more as near-term risk aversion rather than a weakening of India’s underlying earnings outlook.

Q) Are current market valuations justified by earnings growth? How are you reading the June-quarter numbers so far?
A) Valuations have become considerably more reasonable after the correction, particularly in selected small- and mid-cap companies. The June-quarter results declared have shown resilience, however coming quarters may show some margin pressure because of the rise in energy and other raw-material costs, although several companies have already taken price increases to mitigate this impact.

More importantly, we expect corporate earnings over the next 12–24 months to be significantly better than what we have seen over the previous two years. Bank credit growth of around 17–18%, healthy automobile demand, strong industrial order books and improving consumption should progressively reflect in earnings.

We expect earnings growth in the broader market to be in mid-teens. Thus, valuations appear justified where companies can deliver superior earnings growth.

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Q) If you were building a fresh portfolio today, how would you allocate between large caps, midcaps and small caps?
A) We would build a diversified portfolio but with a meaningful allocation to selected mid- and small-cap companies. In fact, we have been gradually increasing our exposure to these segments over the past six months because the correction has created attractive gaps between stock-price performance and underlying profit growth.

Large caps would continue to provide portfolio stability, but the higher earnings growth and alpha potential currently appear to be in selected mid- and small-cap businesses. The emphasis, however, would be on active selection rather than simply buying the small- and mid-cap indices.

We would look for companies where earnings can grow faster than the market and where the risk-reward is more favourable.

Q) Which sectors are you overweight, underweight and why?
A) Our largest area of conviction is consumer discretionary, particularly businesses benefiting from premiumisation and formalisation. This includes automobiles, organised retail, food delivery, quick commerce, travel and hospitality.

Credit growth and higher disposable incomes are supporting consumption, while organised players continue to gain share from fragmented and unorganised competitors.

We are also positive on Power T&D. Rising electricity demand, renewable-energy integration, data centres, HVDC investments and grid modernisation are creating a multi-year opportunity in India as well as globally. Order books and execution visibility remain strong across the value chain.

The third major opportunity is India manufacturing. We see attractive businesses across pharmaceutical CRDMO, aerospace and defence, auto ancillaries, EMS, engineering products and other export-oriented segments. Supply-chain diversification, localisation, recent FTAs and a competitive currency can enable Indian companies to gain global market share.

We remain selective in IT services rather than structurally underweight. Large-cap IT growth may remain subdued, but the correction has created opportunities in mid-sized companies capable of growing materially faster than the industry.

We would similarly avoid a broad-based call on any sector where valuations have moved materially ahead of earnings.

Q) Which structural theme has the potential to create the most wealth over the next five years—manufacturing, AI infrastructure, defence, financialization, energy transition or consumption?
A) If one broad theme has to be selected, it would be India’s manufacturing opportunity. Unlike a narrow sectoral cycle, it spans multiple areas—electronics manufacturing, pharmaceutical CRDMO, aerospace and defence, auto ancillaries, engineering products and other specialised exports.

India is becoming more competitive because of supply-chain diversification, recent FTAs, localisation, improving manufacturing capabilities and currency depreciation. The more interesting opportunities are likely to be in niche companies entering global supply chains, where the addressable market is large and growth can be significantly higher than the underlying industry.

Power T&D and consumption are also high-conviction structural opportunities in our view & our portfolio positioning reflects the same. However, manufacturing would have the widest opportunity set across domestic growth, import substitution and exports.

Read Also: ETMarkets Smart Talk | Manufacturing and financialisation could create the most wealth over the next five years: Siddhartha Khemka

Q) What is the single biggest risk to Indian equities over the next 12 months?
A) The biggest risk would be a prolonged geopolitical conflict that keeps crude oil structurally elevated and disrupts global trade. A temporary spike can be absorbed, but sustained crude near US$100 per barrel would affect inflation, the currency, the current account and corporate margins.

However, this is a risk rather than our base case. India received meaningful energy supplies during the period when the Strait of Hormuz remained open, companies have taken price increases and the domestic demand environment remains resilient.

Unless the disruption becomes prolonged, we do not believe it changes the medium-term earnings or market outlook.

Q) What is the biggest mistake retail investors are making in the current market?
A) The biggest mistake is treating small and midcaps—or any popular theme—as a homogeneous basket. The correction has created significant opportunities, but it has not made every company attractive.

Investors often buy a stock merely because it belongs to a popular theme such as defence, railways, power or manufacturing, without adequately assessing earnings visibility, competitive advantage and valuation.

The opportunity today lies in identifying companies where profit growth has remained strong despite a correction in the share price, rather than chasing whichever segment has performed well recently.

Q) Brent crude is again hovering around US$100/bbl. Will higher crude cap the upside for Indian markets in 2H2026?
A) Sustained crude near US$100 per barrel would create near-term volatility and could cap index-level returns because of its impact on inflation, the currency, the current account and input costs. Some companies may also experience margin pressure during the initial period before price increases take effect.

However, we would distinguish between a temporary geopolitical spike and a prolonged supply disruption. Our base case is that the current flare-up is largely transient.

India also has some near-term supply cushion, and several companies have already raised prices and so far underlying demand and earnings environment remains strong.

(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)