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The India stock markets are blazing a hot trail - but are investors ignoring something fundamental? Image Credit: Bloomberg

Mumbai: Investors in India's $2.8 trillion equity market are underestimating the economic impact from the world's worst coronavirus outbreak, which will delay any recovery and could trigger a "correction" in stocks, according to the country's top-performing fund manager.

The benchmark S&P BSE Sensex climbed in each of the last two weeks, a period during which the nation's tally of daily virus infections as well as related deaths have hit records. Domestic institutional investors, including mutual funds and insurers, poured a net $1.5 billion into stocks in April, helping offset a similar outflow from foreign funds. That trend has continued so far in May.

The market "is completely ignoring the present situation," said Samir Rachh, who oversees 130 billion rupees ($1.8 billion) of assets at Nippon India Mutual Fund in Mumbai. Recent gains have been "driven by a huge amount of liquidity," he said.

90%

What the premier index, the Sensex, has gained since its March 2020 low

Overlooking the crisis

India has imposed numerous restrictions on people and businesses, many on a state-by-state basis. But as the outbreak widens, Prime Minister Narendra Modi is under pressure to tighten rules nationwide, which would slow an economy that, according to several forecasts, is poised for double-digit growth this year.

While the country is rolling out vaccines, the virus has spread to places that "do not have adequate facilities or the medical infrastructure to handle it," Rachh said. "If we don't see it peaking, as estimated, and given how the stocks have gained from last year, there could be a market correction," he said.

The Sensex slipped as much as 1 per cent in early trade on Tuesday, tracking a broad decline in global equities amid growing concern about inflation. The Indian gauge closed at its highest level since April 29 on Monday.

The Nippon India Small Cap Fund managed by Rachh has returned 28 per cent so far this year, the top performance among funds that manage at least $500 million.

Small caps

The Sensex has surged about 90 per cent from its March 2020 low, boosted by foreign inflows of $23.3 billion last year and optimism that stimulus measures will help engineer a strong economic revival. Even as businesses were disrupted most of the year, small-cap shares were among the biggest winners, rallying faster than the broader market. That outperformance has widened further in 2021, helping Nippon's small-cap fund shine.

The fund, which allocated 11.3 per cent of its assets to the chemicals sector at the end of April - the largest for any industry - has returned about 113 per cent over the past 12 months. Consumer non-durables and software are the other top sector holdings.

"Picking up the right small-cap company is like searching for the ideal son-in-law," Rachh said. "There is a lot of effort and due diligence," including frequent visits to companies and their dealers and vendors - which have been made more difficult by the COVID-19 protocols, he said.

"If an investor is coming into the [small-cap] category looking at last year's gains, the returns this year will be nowhere near it," he said. "Still, the long-term view is that the economy will see a faster recovery once we have dealt with the pandemic."