Indian stocks face a cyclical correction, not a deeper earnings reset: Mahindra Manulife MF CIO

Indian equities are undergoing a cyclical correction rather than heading into a broad-based earnings reset, according to Krishna Sangahvi, chief investment officer for equities at Mahindra Manulife Mutual Fund.

The fund house remains neutral on equities as energy price volatility, geopolitical tensions, AI-led disruption risks and strong primary-market activity weigh on sentiment. Sangahvi says corporate earnings remain resilient, but investors should expect greater volatility and rely on stock-specific opportunities across both long and short positions.

Edited excerpts from a chat on market outlook and their new long-short SIF.


MSIF Equity Long-Short Fund is launching after a sharp correction in Indian equities. Do you see the current weakness as a cyclical adjustment or the beginning of a deeper earnings and valuation reset?

Indian equities delivered exceptional returns since the pandemic till Dec 2024, significantly outperforming most global markets. A meaningful contributor to this performance was valuation re-rating accompanying the healthy earnings growth.

The recent correction, in our view, is more of a cyclical adjustment rather than the start of broad-based earnings reset. While valuations have moderated from elevated levels, corporate earnings remain resilient and continue to grow at a healthy pace. Markets are also digesting a range of near-term uncertainties, including energy price volatility, geopolitical tensions and the potential impact of AI-led disruption on future employment patterns.

Additionally, the robust primary market has temporarily diverted capital away from secondary markets, as investors rebalance portfolios to participate in new listings. Overall, while periods of volatility may persist in the near term, the underlying earnings and economic fundamentals remain supportive over the medium term.

What will determine the fund’s net equity exposure at any point? Which variables matter most today — interest rates, inflation, earnings growth, liquidity, currency or geopolitical risk?

Net equity exposure will be determined through a combination of macroeconomic and bottom-up factors. At the macro level, we continuously evaluate variables such as economic growth, interest rates, inflation, currency trends, liquidity conditions and geopolitical developments. At the company and sector level, our focus remains on business fundamentals, management, earnings trajectory and valuation attractiveness.

The relative importance of these variables changes across market cycles. At times, liquidity and investor sentiment dominate, while in others earnings delivery and valuation become the key drivers. Our investment process is designed to dynamically adapt to these changing market conditions.

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The strategy allows net equity exposure to move across bearish, neutral and bullish market conditions. What is your current market posture, and what would make you materially raise or cut exposure?

Given the current macroeconomic and market backdrop, we are inclined towards a neutral net exposure stance. This reflects a balance between constructive long opportunities and selective short positions where valuations or fundamentals appear stretched.

We would consider increasing net exposure if we see an improvement in stronger liquidity support and better clarity on macro risks and earnings growth. Conversely, we would reduce exposure if valuation excesses re-emerged, earnings expectations deteriorated, liquidity weakens or geopolitical risks materially increase.

The flexibility to adjust exposure across market cycles is one of the key strengths of the strategy.

Where do you currently see the best risk-reward across large caps, midcaps and small caps? Are smaller companies offering genuine valuation opportunities or merely deeper drawdown risk?

The risk-reward equation today is influenced by a combination of economic growth, earnings prospects, valuations and capital flows.

Large-cap companies currently offer relatively better valuation comfort compared with parts of the broader market. However, domestic investor flows continue to favour mid- and small-cap segments, while foreign investors have remained quite selective in large caps.

Mid-caps continue to benefit from strong earnings growth and a relatively constrained investible universe, which supports valuations. Small-cap opportunities exist, but selectivity is critical. The segment offers both high-growth businesses and elevated drawdown risk, making rigorous company-specific research particularly important.

From a portfolio construction standpoint, we believe opportunities exist across market capitalisations, with allocation determined by the balance between fundamentals, valuations and risk-adjusted return potential.

Read more: Nifty valuations near post-Covid lows. Alchemy Capital’s Alok Agarwal explains what investors should buy now

Which sectors look attractive on the long side and which appear vulnerable on the short side?

Market leadership has become increasingly dynamic as investors react more quickly to earnings surprises, policy developments and news flow. The growing participation of leveraged and short-term capital has further accelerated sector rotations.

As a result, both attractiveness and vulnerability are becoming less sector-specific and more stock-specific. We believe the current environment rewards active management, where opportunities can emerge both on the long and short side based on dislocations between fundamentals and market pricing.

Rather than maintaining structural sector biases, our focus remains on identifying businesses where earnings expectations are either underappreciated or overly optimistic relative to valuations.

Shorting Indian stocks can involve liquidity constraints, crowded trades and sharp short squeezes. How will you control position sizing, sector correlation and the risk of being right on the thesis but wrong on timing?

Our framework incorporates disciplined position sizing, liquidity assessment, free-float considerations and continuous monitoring of market positioning. We also maintain differentiated exposure limits across large-cap and mid-cap stocks to ensure prudent risk control.

In addition, portfolio construction closely evaluates both inter-sector and intra-sector correlations to avoid unintended concentration risks. Recognising that timing can be as important as conviction, our approach emphasises diversification, risk budgeting, and gradual position building rather than relying on any single thesis.

How do you decide whether to hedge the portfolio through index or stock-level positions, or to express a negative view through a dedicated short position?

The choice between index hedges and stock-specific shorts depends on the source of the risk we are seeking to manage.

When risks are broad-based and market-driven, index hedges tend to be more efficient and cost-effective. However, when we identify specific businesses facing fundamental challenges, excessive valuations, or deteriorating earnings prospects, we may express those views through selective stock-level short positions.

Typically, in stronger market environments we would prefer index-based hedging, whereas in more challenging conditions we may employ a combination of index and stock-specific strategies to achieve the desired risk profile.

What should investors realistically expect from this strategy during a strong bull market, a range-bound market and a sharp correction? Is the primary objective to outperform the Nifty 500 or to deliver better risk-adjusted returns with lower drawdowns?

In strong bull markets, returns may trail fully invested long-only strategies as hedges and short positions could act as a drag. However, in a range-bound or volatile markets, the ability to generate alpha from both long and short ideas can enhance outcomes. During market corrections, the strategy aims to preserve capital more effectively by reducing net market exposure.

Over the long term, our objective is to outperform the Nifty 500 while delivering a smoother investment journey through lower drawdowns and improved risk-adjusted returns.