Wall Street Megacaps: Limited exposure to Wall Street megacaps insulated us from the downfall: Arindam Mandal of Marcellus

“This positioning has insulated us from the recent reduction and volatility“Megacaps, which include not only the big tech names but also companies like Eli Lilly and Costco, have reached extremely high valuations due to their certainty around growth and earnings delivery in the near term,” says Arindam Mandal, portfolio manager at Marcellus Investment Managers.

Edited excerpts from a chat:

How has your Global Compounders fund performed amid all the turmoil around the world?

Last month was a volatile one for global equities. The turbulence started with a shift in momentum in US markets in mid-July, where mega-cap stocks suffered a pullback while laggards gained ground, leading the Russell 2000 (Small Cap) to outperform the S&P 500 by about 12% in 12 trading days, a rare event in the past 25 years. Following this, weaker than expected US employment data further weighed on the broader market. Weak demand signals, particularly from China, led to lower oil prices despite rising tensions in the Middle East. The Federal Reserve’s hint at a possible rate cut in September provided some relief, but the Bank of Japan’s unexpected rate hike disrupted the yen’s carry trade. market volatility Since the beginning of July, the Global Compounders portfolio has held up relatively well, holding steady compared to the S&P 500’s 4%+ drop and the Nasdaq’s 8%+ drop. It’s reassuring to see that the portfolio not only weathered this recent volatility, but also outperformed our benchmark, the S&P 500, by about 900 basis points since launch, accomplishing this without holding some of the most popular stocks, such as Nvidia. How are you coping with the stress in mega-caps on Wall Street? Will stocks like Nvidia recover? Our exposure to mega-caps is limited. The Global Compounders portfolio is more heavily weighted towards “non-mega-cap” stocks. If we define mega-caps as those with a market capitalization above $250 billion, the S&P 500’s allocation to these stocks is around 55-60%, while ours is less than 30%. This positioning has protected us from the recent downturn and volatility. Mega-caps, which include not only the big tech names but also companies like Eli Lilly and Costco, have reached extremely high valuations due to their certainty regarding growth and earnings delivery in the near term.

Interestingly, the S&P Midcap Index’s valuation discount to the S&P 500 is similar to that of the early 2000s, a period after which midcaps outperformed largecaps (S&P 500) over the next 12 to 24 months. While history may not repeat itself, it often rhymes, and in such a scenario, Global Compounders is well positioned due to its significant allocation outside of largecaps.

As for Nvidia, it’s hard to predict whether it will recover, but it’s likely to remain highly volatile. Nvidia’s long-term thesis is compelling, but at its recent peak share price (~135/140), it was trading at a multiple of ~20x FY26 EV/Sales. Paying such a premium for a cyclical, albeit secular, growth business that might be at its “peak growth” and “peak margin” offers a limited margin of safety. In a tight momentum-driven market, shares can reach incredible prices, but sustaining those levels is challenging. Some future growth may already be priced in.

Part of the market believes that AI stocks, particularly Nvidia, are in a bubble phase. Would you agree that the opportunity to invest in stocks with a pick and shovel has been overhyped?

We may be at a stage where companies that are investing in “picks and shovels” for AI must demonstrate their ability to monetize the hundreds of billions of dollars spent building the infrastructure. This monetization could come in the form of revenue generation, cost savings, or productivity improvements. The pace of this monetization will likely dictate where we are in the cycle, or what Gartner calls the “hype cycle.”

While the application of AI will undoubtedly be widespread (similar to the Internet in the late 1990s and early 2000s), adoption of large-scale enterprise uses will likely take time and there will be cycles. That said, the Nvidia of today is very different from the Cisco of the 2000s, but it would not be surprising to see the adoption process go through some lulls compared to the current exuberance. This is not a denial of AI’s role in the future – in fact, it is the future, just as the Internet was 25 or 30 years ago. However, a profitable monetization engine needs to be built over time to justify current investments – which will likely be done, but not overnight.

Do you think the impact of the reverse carry trade has largely ended? JPMorgan said 75% of the carry trade has been unwound

It’s hard to know for sure. Various brokerage firms have their estimates, but it’s hard to really quantify or “know” definitively. Estimates of the “size of yen carry trades” that are circulating range from hundreds of billions to a trillion dollars. There was certainly some leverage created by this trade, and most of it has likely been unwound by now.

What is your base case regarding Fed rate cuts?

It is likely a question of “when,” not “if.” Real-time inflation data are gradually easing. However, one surprising aspect of this rate hike cycle has been the resilience of US house prices, which have held up much better than expected. This resilience has likely provided some relief. The magnitude of rate cuts will depend on unemployment data, as the Fed continues to make data-driven decisions. We expect a 25-50 basis point rate cut in September, which is in line with consensus unless there is significant weakness in the data.

The budget adjustments have made overseas investment more attractive from a capital gains tax perspective. Do you think international investment will become more popular in India?

Global investing is likely to gain traction. As Indians become richer and more successful, their investment approach will likely evolve to consider the impact of diversification (geographic and thematic) as well as asset allocation and volatility on long-term wealth generation. GIFT City was a major step forward in turning India into a global financial hub. Allowing two-way traffic (both inbound and outbound) is the best way to do so. Recent changes, simplifying and aligning long-term capital gains tax with domestic equities and allowing resident Indians to open foreign bank accounts at GIFT City, significantly reduce friction. We thank the regulators and the Ministry of Finance for these changes.

In your opinion, is a 10% allocation to international equities sufficient for someone with an aggressive profile and a long-term horizon?

A 10% allocation would probably be a lower option. I would suggest that an allocation between 20% and 30% would be more appropriate. An interesting point to consider is that over the long term, the returns of the US market, which are the major component of global markets, are very similar to those of Indian markets. However, these returns come with much lower volatility and drawdowns. Also, during global crises, the INR tends to depreciate against the USD as the USD is considered a safe haven. Investors who regularly invest fresh money will benefit more from investing in assets with similar returns but lower volatility. A 10% allocation might not significantly change the situation in terms of diversification, while a higher allocation would better capture the value proposition.