New generation of investors started in a bull market and that isn’t a great teacher: Kanika Agarrwal of Upside AI

Kanika Agarrwal, co-founder and chief investment officer, Upside AI, is of the view that the new generation of equity investors has a lot to learn. They started in a bull market and that isn’t a great teacher, she says.

The fintech startup, inspired by Benjamin Graham’s book The Intelligent Investor, was founded on the belief that technology makes better decisions than humans since machines are unbiased and unemotional.

A big votary of fundamentals when it comes to picking a stock, Agarrwal in an interview to Moneycontrol’s Kshitij Anand says the market seems to be rotating sectors heavily and cyclicals may increasingly see interest, given relative undervaluation in some pockets. Edited excerpts:

The first six months of 2021 were exciting for the stock market where the rising tide of liquidity took all boats higher. Do you think we will see a repeat in the second half?

Yesterday, someone sent me a graph of how 90 percent of stocks were trading above 200-DMA (day moving average). I responded with a three-year graph of the smallcap index, which has now reached the same levels as peak 2018, i.e. 0 percent growth in three years.

There is a graph for every story we want to tell/believe. The point I’m making is that the shorter the time frame, the more difficult to predict market direction.

For H2, while there are sufficient headwinds, even the whiff of liquidity drying up (let alone reversing) even years down the line is enough for the market to be spooked. The market is pricing in a lot of future growth at extremely discounted rates.

Any downward pressure on either of those two factors and the stock market’s point of view will change very quickly.

Retail investors emerged as a big theme, and support for Indian markets in the first half of 2021 when FIIs turned net sellers. Investment in mutual fund and equities has picked up. Do you think we have just scratched the surface when it comes to the financialisation of household savings?

In the long term, yes absolutely, we are just scratching the surface. Every statistic points in that direction—the exposure of Indian households to equity assets is among the lowest in the world at 14 percent (the US is at 45 percent).

Like we skipped landlines and went to mobile, the Indian household is going to see some leapfrogging of investing products as well.

I believe in the long term, we may skip human expert-led mutual funds and go directly to rules-based investing, ie ETFs/ index funds, products like ours at Upside AI, etc.

In the short term, of course, this is far more difficult to predict. For the new generation of equity investors, they started in a bull market and that isn’t a great teacher.

Not only that, a strong third wave might once again put pressure on middle-class households and reverse some of the MF inflows seen this year.

My advice to retail investors has consistently been to keep an eye on asset allocation and not get swayed by heady equity returns of 2020.

Your PMS scheme performed well in 2021. Do you plan to launch a new product in the next few months?

FY22 has been great for us so far—our flagship product has delivered 23.5 percent for the April-June quarter versus 10 percent for the benchmark.

Further, we have doubled our AUM in three months and raised our first round of funding from marquee investors like Endiya Partners, Vijay Kedia, and others.

Over the next couple of quarters, we plan to use the funds to grow our team and launch two-three more products. The long-term vision for Upside AI is to be a tech-led investment management platform.

All our products stand on two legs – (1) systemised rules are superior to human investors in the long term; (2) rules do not imply passive investing, ie there is still alpha to be made in the markets.

Therefore, every product we launch is a differentiated take on existing asset classes.

For example, the next one we plan to put into beta is an asset allocator that will read macro signals to dynamically allocate between equity, debt and gold. Idea is to target mid-teens returns at <5 percent standard deviation, ie very low risk.

Are you seeing a big change in the way retail investors are investing now compared to what they were doing 10 years ago? Do you think Robinhood investors are more of traders with the focus on options and not much of investors with long-term horizon?

Discount brokerages have definitely opened the floodgates for retail investors–that coupled with the bull market and lots of downtime.

But, as always, with new investors, there is a continuum of the type of investor. Its classic behavioural psychology. While certainly there are many who get enamoured by the promise of trading, there are plenty of people who recognise the importance of long-term investment.

Although our clientele is more on the HNI side, we still see that range of trader to an investor. Some of our investors ask why we don’t trade less frequently so that we cut down our transaction costs, while others ask why we don’t trade more so that we can generate more alpha.

Recently, Nithin Kamath was quoted as saying that 20 percent of active traders on Zerodha generate 80 percent of the transaction costs. Therefore, although trader-related news catches a lot of eyeballs, the silent majority is more on the investing side of things.

Which sectors are likely to lead the next leg of the rally on D-Street?

Since December 2020, our largest allocation has been metals and commodities. As the world’s engine restarts, it looks like we could be entering a commodity supercycle. Our portfolio consistently has had some IT and pharma in it.

This market seems to be rotating sectors heavily–it is very likely we will see cyclicals increasingly come into favour given relative undervaluation in some pockets. We are actually rebalancing this month, so ask me again in August.

Do you think there is further room for rerating in small and midcaps?

Only now are we seeing smallcap indices reach the levels that were reached three years ago. So there is still room, but as the fears around COVID recede, there have to be some solid company results to back it up.

Markets are always jittery at peaks or troughs, so expect greater than normal volatility in your portfolio.

What should be the strategy of investors for the next six months – go overweight on largecaps, and underweight on mid and small-caps?

Be systematic. Don’t chase what has done well in the last six months but follow an asset allocation that is reasonable for your risk profile.

If I were to personally buy largecaps, I would not stock pick but only buy ETFs. In the mid/small cap, find a manager whose approach resonates with you and allocate to her.