Harsha Upadhyaya, Chief Investment Officer at Kotak Mahindra Asset Management Company, has issued a cautionary advisory to investors regarding small-cap investments, citing significantly stretched valuations and disappointing earnings performance. The fund house, which manages assets worth nearly $6 billion, is recommending a strategic shift towards large and mid-cap stocks in the current market environment.

Small-Cap Valuations Remain Stretched

Upadhyaya highlighted that small-cap valuations are currently trading at levels 40-45% above their long-term averages, presenting substantial risk to investors. The concerning aspect extends beyond valuations, as small-cap earnings have consistently disappointed and even declined in some recent quarters, falling well short of growth expectations.

In contrast, large-cap valuations have moved closer to historical norms following a period of consolidation, making them more attractive for investment. Upadhyaya recommends that investors align their portfolios towards large and mid-caps based on their individual risk appetite, suggesting that a typical 5-10% allocation to small-caps within diversified funds remains adequate in the current market environment.

Market Volatility Expected to Continue

The market volatility witnessed in the previous year has carried forward into 2026, according to Upadhyaya's assessment. While the ongoing earnings season is expected to demonstrate decent recovery and provide support at lower levels, negative international news flow continues to act as a headwind for markets.

With broader market valuations hovering around long-term averages and earnings recovery still in its early stages, sharp market movements are likely to persist. This environment reinforces the need for careful stock selection and appropriate market cap allocation strategies.

Real Estate Sector Positioning

Kotak AMC has maintained an underweight position on the real estate sector for an extended period, a strategy that has proven beneficial given the sector's recent weak performance. Upadhyaya noted that Indian real estate is likely in the sixth year of an upcycle that typically spans eight to ten years, suggesting the sector is past the halfway mark of its current cycle.

While recent corrections could present selective buying opportunities, the fund manager emphasized caution and indicated the firm would avoid broad-based sectoral investments, remaining selective only if corrections deepen further.

Budget Expectations and Policy Outlook

Looking ahead to the Union Budget, Upadhyaya does not anticipate any major shifts in policy direction. The government's continued emphasis on fiscal prudence is expected to result in early double-digit growth in capital expenditure, with spending flows directed towards defense, renewables, and manufacturing sectors.

The policy framework is likely to maintain its current trajectory, with consumption continuing to benefit structurally from the goods and services tax (GST) system. This continuity in approach suggests sustained support for key infrastructure and manufacturing initiatives.

Precious Metals and Investment Strategy

Upadhyaya expressed a positive long-term outlook on precious metals such as gold and silver, supported by global trade tensions, geopolitical factors, and changing world order dynamics. However, he cautioned against chasing prices following their recent sharp increases, noting that assets moving in a vertical fashion typically experience subsequent volatility.

The recommended approach involves staggered investments with a long-term investment horizon to avoid fear-driven buying decisions. This strategy allows investors to benefit from potential opportunities while managing the inherent volatility in precious metals markets.

Foreign Institutional Investors (FIIs) are likely to remain cautious until domestic earnings growth catches up with elevated market valuations, according to Radhavi Deshpande, Chief Investment Officer at Kotak Mahindra Life Insurance. In an interview with Moneycontrol, she emphasized that while India continues to be a strong structural growth story, foreign investors are highly valuation-sensitive and currently see better risk-adjusted opportunities in other markets.

FII Investment Outlook

Deshpande expects FII participation to improve meaningfully only when domestic earnings growth begins to align with current market valuations. Until that visibility strengthens, FII flows may remain subdued despite India's long-term economic appeal. She noted that attracting foreign capital will remain a key priority, supported by policy continuity, capital market reforms, and improvements in the ease of doing business.

Union Budget Expectations

Regarding the upcoming Union Budget, Deshpande believes it is unlikely to show a major jump in capital expenditure. She expects capex growth to track nominal GDP growth broadly, noting that the government has already front-loaded infrastructure spending in recent years and now appears focused on sustaining momentum while maintaining fiscal credibility.

Some incremental capex increases are likely, but the key will be how effectively this translates into private sector investment. Markets will watch for clearer signs that government-led spending is supporting stronger corporate earnings and a broader investment cycle.

Employment and Economic Priorities

Job creation is expected to remain a key government priority in the Budget. Deshpande emphasized that durable income growth is essential for sustained consumption, making the quality and stability of jobs crucial for the economy. The government is expected to continue focusing on employment generation through:

• Infrastructure expansion projects
• Manufacturing initiatives
• Targeted welfare schemes that enhance employability

These measures can support long-term economic resilience while ensuring broader participation in growth.

Market Assessment and Earnings Outlook

Deshpande expressed a cautious stance on equity markets, noting that while domestic fundamentals remain resilient, equity valuations are hovering around long-term averages. With persistent global uncertainty, tight financial conditions, and an earnings recovery that is still uneven, she believes the risk-reward profile is gradually improving but selectively.

Regarding recent earnings announcements, she noted that results have been stable but not as strong as markets would have preferred. Management commentary has generally been stable to cautious, indicating that while some sectors may be bottoming out, a broad-based earnings acceleration is not yet evident.

Global Factors and Market Dynamics

When asked about geopolitical concerns, including the impact of Donald Trump, Deshpande stated that while geopolitical developments can influence sentiment and add short-term volatility, markets tend to react more decisively to changes in global liquidity, interest rate expectations, earnings growth, and valuations. She emphasized that these macro and fundamental drivers ultimately shape sustained market direction and are likely to remain more influential than any single political personality.

The CIO concluded that a balanced and disciplined approach remains essential in navigating the current market environment, as some segments continue to trade ahead of fundamentals while the earnings recovery remains uneven across sectors.