ETMarkets Smart Talk | Defence and electrification are multi-year structural themes for India: Prateek Agrawal

Geopolitical uncertainties and the growing need for strategic self-reliance are reshaping India’s investment landscape, creating long-term opportunities in sectors such as defence and electrification, according to Prateek Agrawal, MD & CEO of Motilal Oswal AMC.

In an interaction with Kshitij Anand of ETMarkets for the Smart Talk series, Agrawal argues that rising global defence spending, increasing indigenisation, and the push towards domestic energy security will drive sustained growth across these themes for years to come.

He also shares his views on active investing, FPI flows, the AI-led global shift, and why investors should focus on businesses with durable earnings growth rather than getting distracted by short-term macro narratives. Edited Excerpts -


Kshitij Anand: Funds focused on active management, active momentum, as well as large and midcap strategies have already created strong alpha for investors. So, how does Motilal Oswal AMC’s product suite fit into the current market scenario?
Prateek Agrawal: We have been saying that this is the time for alpha. By alpha, we mean returns that are higher than those of large-cap indices. One can explain this theoretically. If stock prices move up because of earnings growth—or, more accurately, cash flow growth—over a period of time, then the chances of generating alpha increase if there are segments where growth is happening at a much faster pace than the index.

If we look at the period from 2008 to 2020, the index saw earnings growth that was higher than the broader market, making it extremely challenging to create alpha. This period is different. Index earnings growth is likely to remain in the sub-10% range over the two-year period you mentioned, while at the same time we are witnessing a phase of significant disruption. Many new sectors have emerged, a few of which you mentioned, where growth is of a completely different order.

So, higher growth in niche spaces, coupled with better earnings growth in the broader market versus the narrower market, makes this an ideal time for alpha generation.

If you look at our portfolio constructs, we run funds with very high active ratios. You mentioned two of them—our Large & Midcap Fund has an active ratio of around 92%, while our Active Momentum strategy has an active ratio of nearly 200%. These are funds that have not hesitated to take differentiated positions and maintain high active ratios. In that sense, they are riskier, but they also invest in newer growth spaces where both the magnitude and longevity of growth create a strong foundation for alpha. Our objective is for these strategies to deliver exactly what they are designed to achieve.

Kshitij Anand: In fact, if we look at the Nifty, it has remained largely range-bound despite earnings growth over the past two years. What do you think will be the trigger for the next leg of the rally?
Prateek Agrawal: Ultimately, it is earnings growth. Markets move higher on the back of earnings growth. Sometimes earnings lead the market, and sometimes the market moves ahead of earnings—that keeps happening.

For the index to deliver stronger returns, earnings growth has to accelerate. If index earnings growth remains around double digits, then that is the kind of compounding investors should expect. Since markets fluctuate, if we have this conversation during a market downturn, the point-to-point returns will naturally appear subdued.

If we are talking specifically about the index, there are two large sectors that need to perform well—banking and IT. In IT, there is considerable fear around AI and the disruption it could bring, leading to a correction in valuations. Frankly, I think that concern is overdone. Large-cap IT services companies are now trading at valuations that imply almost no growth, in our view.

Despite that, our portfolio constructs currently have zero allocation to large-cap IT.

Similarly, the recent measures around NRI deposit schemes and related initiatives, with relatively limited SLR commitments, provide banks with access to cheaper deposits. Some private sector banks had been facing pressure due to elevated credit-deposit ratios, so these measures are positive for the banking sector.

If banking remains resilient and IT has largely found its bottom, as we believe, then the pressure on the index that we have witnessed over the past several months should reduce and eventually stabilize.

The second point is that by February, many of the concerns around the economy and the markets had already been addressed. February also witnessed positive FPI flows, and India had moved forward on trade discussions with the US. This suggests that much of the correction after that has been driven by oil prices.

Oil prices moved from around $60 to nearly $90. Every $1 increase in oil prices costs India approximately $1.9 billion. Compared to earlier levels, we are effectively losing around $7 billion more every month. Investors understand this, which has led to increased capital outflows and created a vicious cycle.

However, this situation can reverse quickly if oil prices decline sharply. We believe that as global trade normalizes, the outlook could improve. Today, there is more oil available globally than before. If Venezuelan and Iranian oil re-enter global markets, OPEC continues increasing production, Russian supplies remain available, and US production also rises, there will be significantly more oil in the system. That could lead to a sharp decline in oil prices.

Many forecasts also point in that direction. If the primary reason for India’s recent underperformance has been oil-related stress, then removing that factor could allow markets to recover to previous levels relatively quickly.

Kshitij Anand: In fact, it’s good that you pointed out both those factors. Smart money is definitely moving towards other countries, which has largely resulted in the underperformance of Indian markets compared to several global peers. Do you see this as a temporary phase, or is it a sign that investors are reassessing India’s growth premium?
Prateek Agrawal: I believe India is the last strongly and secularly growing economy in the world that can absorb sizable domestic as well as foreign capital flows. However, in a long-term journey, there will always be periods when one niche—whether in developed markets like the US or in developing markets that supply to the US and other developed economies—outperforms.

This is one such phase where a major theme attracting global attention, AI, is less represented in India. In fact, it is even perceived to be negatively impacting our software services industry, while economies with memory chip manufacturers, AI-driven technologies, and AI-led manufacturing are benefiting significantly.

Over the long term, these phases occur from time to time. What has happened this time is that the outlook for the AI theme has kept improving. Normally, markets are forward-looking and price in future expectations quickly, so such trends do not last this long. They have continued because the outcomes have consistently turned out to be bigger than initially anticipated.

That said, while AI-driven opportunities exist, India also has sectors that benefit from AI. Our power equipment companies, fibre optic manufacturers, and related businesses stand to gain. However, we do not have the marquee AI companies.

The point is that while the capex cycle can continue, once valuations fully factor in the upside, markets will stop responding and investors will again start looking at opportunities elsewhere, both within the same economy and across other economies. At that stage, India’s turn will come.

In the interim, domestic investors should continue to focus on what India does best. At the same time, we should remain open to opportunities where the rest of the world excels. Ultimately, capital should be invested where returns are attractive. India does many things exceptionally well, but other countries also have their strengths. Therefore, investors should remain open to allocating capital abroad as well.

Kshitij Anand: Back home, sectors such as defence, power and import substitution are gaining traction. Can these become long-term winners? What makes these themes structurally different from previous investment cycles?
Prateek Agrawal: Whenever we encounter major geopolitical disruptions, there are important lessons to learn. First, we had the Russia-Ukraine conflict. Then we witnessed tensions involving the US and Iran, along with a spike in oil prices. The whole world watches these developments, and our policymakers must be watching them too.

The question is: what do you learn from such events, and how do you prepare? While we hope for peace, it is always prudent to be prepared. The Russia-Ukraine conflict is one kind of challenge, while a potential Iran-US conflict would be very different in terms of technological capabilities.

For a country like India, there is a broad spectrum of capabilities that need continuous upgrading, especially after the recent events involving our neighbours. Once you demonstrate your capabilities, your adversaries prepare for the next encounter, so you also need to keep upgrading. It is a never-ending process.

As a result, defence spending as a percentage of GDP is likely to rise globally, not just for one year but over several years. The reduced security umbrella from NATO for Europe will push European defence spending higher. The US is already increasing its spending, and I believe India will also see higher allocations in future budgets. Alongside this, there will be a stronger emphasis on indigenisation. That makes defence a multi-year structural theme.

Similarly, another lesson is the need to become more self-reliant in domestic energy sources. India does not have abundant oil reserves, so we need to depend on what is available domestically—coal, solar energy, wind power, compressed biogas and coal gasification.

The transition becomes even more effective through electrification. If we continue building internal combustion engine (ICE) vehicles, dependence on imported petrol and diesel will remain high. Electrification offers a viable alternative.

Forget environmental considerations for a moment. Even from the perspective of being better prepared for future disruptions, electrification is essential. We have already seen significant progress, with Indian Railways being almost fully electrified, and this trend will continue across transportation. More incentives, policy pushes and regulatory nudges are likely to accelerate the shift towards electric vehicles.

Many of the earlier debates around slowing the adoption of EV technology have now become less relevant. It is increasingly clear what direction the country needs to take, and these trends are likely to remain in place for a very long time.

Kshitij Anand: In fact, earlier in the conversation, you were also talking about FPIs. Foreign investors have been very selective in their allocation towards India. What will it take for FPIs to return in a meaningful way? Is it valuations, earnings, or global liquidity?
Prateek Agrawal: There are two or three factors. Money goes where there is growth, and growth comes at a price. As we discussed, things have kept getting better for that narrow growth space, but at some point, it gets priced in. Once that happens, other sectors within the same country and even other countries come back into focus. India is something that keeps moving steadily. We do not sprint, but we keep jogging faster than most others. So, our time will come.

The second point relates to the index itself. In my view, FPIs originally came to India for growth—that was our promise. We are a young, fast-growing economy. They invested heavily in sectors like IT services, which, until 2008–09, were delivering exceptionally strong growth. From the 1990s until 2008, profit growth of 50–100% annually was not uncommon.

Similarly, they invested aggressively in private sector banks. If you do not have a dedicated India team and want exposure to the country, buying banks is often the easiest route because banking growth broadly mirrors economic growth. If the banks are well managed, the outcomes tend to be even better. Most private sector banks performed very well.

Now, after 20–25 years in banking and nearly 45 years in IT, these sectors together account for almost 50% of the index. They have become mega-cap companies, but they are now delivering earnings growth in the range of 10–13% for banks and 5–10% in constant currency terms for IT services. That no longer appears exceptional.

So, what does an investor do? They reduce exposure to these mature sectors and look for newer growth opportunities. However, the growth sectors we discussed—electric vehicles, renewables, defence, niche pharmaceuticals, and new technologies—are still relatively small. There is only so much capital they can absorb.

As a result, you see a situation where FPIs are buying growth sectors while simultaneously selling mature sectors. The net outcome is negative flows. If you look closely at what they are buying, it is these emerging growth areas, which is why those segments continue to hold up relatively well. They are selling where growth has slowed, resulting in an overall net outflow.

It will take time for this adjustment process to settle. It is not something that will reverse overnight. If you compare our cheapest banks with some expensive global peers, India does not necessarily look cheap in that context. If growth is also not exceptionally strong, then valuations alone may not justify fresh allocations from FPIs.

Kshitij Anand: Another segment that was extremely popular was the mid- and small-cap space. Valuation corrections have been sharper there. Can we say we are nearing a point where the risk-reward equation is becoming attractive again?
Prateek Agrawal: Once again, I am not particularly inclined to think in terms of large-cap, mid-cap, or small-cap. I prefer to think in terms of growth sectors versus slower-growth sectors.

Many of India’s high-growth opportunities happen to be in the mid- and small-cap universe. If you look at digital businesses, perhaps one company is a large cap while the rest are mid and small caps. The same is true in defence—two companies may be large caps, but most others are mid and small caps. That is simply the nature of these emerging industries.

Most of these companies have come into existence over the past 8–10 years, and many of the sector leaders are still in the mid- and small-cap category. That is the first point—they are growing rapidly.

The second point relates to ownership patterns. FPI ownership in large caps has declined but still stands at around 19%, while domestic ownership has increased to about 22%. Nineteen percent is still a significant shareholding.

In mid caps, FPI ownership is roughly 11–12%, while in small caps it is around 9%. Therefore, FPI selling does not significantly affect the mid- and small-cap space. What impacts these companies more is promoter selling or large fundraises by the companies themselves as they seek growth capital.

So, FPI selling is primarily a large-cap issue. During periods like the current one, when fundraising activity and promoter selling in the mid- and small-cap segment remain limited, these companies tend to hold up much better. On the other hand, if several large-cap companies come to the market with sizeable issuances, they can attract capital away from existing large caps.

If we do not see excessive fundraising or promoter selling in the mid- and small-cap universe, I believe that segment could perform relatively better.

Kshitij Anand: One theme we have also discussed during this conversation is EVs. Initially, investors focused on EV manufacturers, but the opportunity set has broadened significantly. Which part of the EV value chain—battery makers, auto components, charging infrastructure, or software—appears most attractive from an investment perspective?
Prateek Agrawal: We start with the OEMs. If we find pure-play EV OEMs with a strong product offering, that is the clearest and easiest way to participate in the theme.

We do not currently have exposure to a charging infrastructure company, but that segment could also be interesting depending on the sustainability of its revenue model.

Auto component companies are a more mixed story. Many legacy auto component manufacturers continue to have substantial traditional businesses while simultaneously trying to transition into the EV ecosystem. Therefore, the growth profile is not always straightforward, as gains in one segment may be offset by declines in another.

For us, pure-play EV businesses are more compelling. There is still significant uncertainty around many legacy players because not all new EV initiatives will succeed.

That is why I keep saying that if a company is executing well, consistently delivering results and improving its numbers over time, those are the businesses that become particularly interesting investment opportunities.

Kshitij Anand: In the current scenario, geopolitical events have impacted investor psychology and the way they look at the markets. Investors often tend to overreact to such events. So, in your experience, how should a long-term investor separate noise from genuine risk?
Prateek Agrawal: We entered the markets in 1994. In 1991, India had pledged its gold reserves. Then, the country discovered a new growth engine called software, which generated a huge amount of alpha. If you look at the period from the early 1990s to 2000, the index itself did very little, but it was a great period for alpha because the new software sector emerged and delivered exceptional returns.

Then, from 2000 onwards, the dotcom bubble burst. Once again, markets did very little for several years. But another new growth area emerged—private sector banks—which went on to generate significant alpha.

Many investors get fixated on market indices. Yes, indices perform well over time because they comprise businesses that have had a glorious past and have therefore become large enough to be included. However, for large businesses, disruptions can be painful, and over time such disruptions are inevitable.

We believe this is one such period. Frankly, in my view, the scale of change we are witnessing today is unparalleled compared to any other period in the past. Every wave of change creates new champions, throws up fresh opportunities, and allows new leaders to emerge. This is one such phase.

If we keep getting bogged down by macroeconomic numbers, it does not help much. To give you an example, last year was almost a perfect year from a macroeconomic perspective, but what happened to market returns? The strength of the economy alone does not make markets move up unless corporate profits also increase.

Suppose the macro environment is very strong, but companies are not making money for some reason. Markets will not move higher. Last year, for instance, good rainfall affected earnings for a couple of quarters. Once that phase passed, the situation improved. But during that period of heavy rains, earnings were impacted and markets reflected that.

Similarly, if earnings growth remains strong despite current challenges, the segments witnessing that growth will continue to perform. If the sectors represented in the index fail to deliver earnings growth and underperform, it does not mean that businesses outside the index experiencing robust growth will also underperform.

Gone are the days when weakness in one large index constituent would drag down the entire market. Today, markets are much more compartmentalized. Market depth has increased significantly.

Of course, if the economy itself weakens and macro conditions come under severe stress, there could be pain in the future because today the government and some PSUs are absorbing part of that burden and shielding the economy. Eventually, the broader economy will have to absorb it. Investors should be prepared for that possibility.

However, if you are invested in sectors benefiting from structural tailwinds and aligned with the direction of policymaking, the probability of good outcomes remains high—just as software did in the 1990s and private sector banks did in the early 2000s.

Kshitij Anand: In fact, I remember an old market saying that markets are always slaves to earnings.
Prateek Agrawal: Yes, and nothing else.

Kshitij Anand: And nothing else, yes.
Prateek Agrawal: Exactly. There is no point getting confused. Let me share an anecdote.

I do not know if we have time for it, but back in 2011, when I joined a new platform, it was a difficult period with stressed macro conditions. During one interaction, people were discussing how we would fare in such an environment, and I poured my heart out explaining all the challenges.

Afterwards, a very senior investor, who was also part of the board, called me over and said, “Prateek, come here.” I went up to him and he asked, “You were saying something. Tell me again.”

So I explained everything once more for nearly 30 minutes without interruption. After listening patiently, he simply said two words: “Ho gaya?” I replied, “Yes, sir.”

Then he said, “Chal, ab naam khojte hain. Let us find a stock.”

That conversation stayed with me. The macro discussion was interesting, but ultimately it did not matter. What matters is finding businesses where earnings growth can be sustained at a meaningful pace over the long term—not for one quarter or one year, but over many years.

That is the endeavour investors should focus on. Of course, value investors may approach things differently, but the core principle remains the same. The rest is largely noise.

Over the last 30 years, we have seen everything—India pledging gold, the dotcom bubble, the Global Financial Crisis, 9/11, COVID, and much more. These events keep happening. As long as human beings aspire to improve their lives and innovation continues, markets, in the long run, will continue to respond positively.

Kshitij Anand: Finally, I wanted to get your perspective. If someone is building a fresh portfolio today, what would be the three most important themes to own for the next five years?
Prateek Agrawal: If you are doing it yourself, that is one approach. The other is to entrust it to a fund manager.

If you are entrusting it to a fund manager, one thing I keep saying is: do not over-diversify. If you believe growth creates wealth, then allocate accordingly. We believe we run one of India’s highest earnings growth portfolios. So, if growth investing is what you believe in, we would be happy if you entrusted us with that responsibility. We hope to do a very good job for you.

However, if value investing is your preferred style, then do not entrust your money to us because we do not claim to be experts at it. Instead, choose someone who does value investing exceptionally well.

Also, do not over-diversify across fund managers. If one manager builds a portfolio of 25–35 stocks, as we do, and another manager holds 50–100 stocks, then by allocating to both you may end up owning well over 100 stocks. At that point, you are already over-diversified. So, pay very close attention to the number of managers you allocate to if you are investing through funds.

For us, if you trust our approach, we started this conversation by discussing our Large & Midcap Fund and our Active Momentum Fund. These are two very different strategies with minimal overlap, each addressing the challenge of alpha generation differently. One strategy identifies businesses that are likely to do well in the future and waits patiently for that thesis to play out. The Active Momentum strategy, on the other hand, leaves something on the table and enters once momentum begins to build. Both are broadly growth-oriented, but they approach the opportunity differently.

If you are investing on your own, then once again decide whether you are a growth investor or a value investor.

If you are a growth investor, identify sectors where growth is likely to emerge. One simple way to do that is to observe where jobs are being created and how younger generations are behaving. That is where the future lies. Markets are not about the past; they are about the future. If you want to succeed, watch what the younger generation is doing. They adapt very quickly.

If you are a value investor, it is relatively easy to identify sectors that appear cheap. What most people fail to ask is why they are cheap. A business will remain cheap unless the reason for its low valuation changes. So, ask yourself why it is inexpensive and whether that reason is likely to be corrected soon enough for you to make money within a reasonable period. Only then should you invest.

Finally, think about your own capabilities and competencies. If you work in a particular industry, you are likely to understand it better than most others. If you have friends working across different industries, that broadens your circle of expertise. For everything beyond your area of competence, professional managers and mutual funds are often the better route.

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