Investing or the marathon track, Sandeep Kothari, portfolio manager at Fidelity Mutual Fund, prefers the long haul. He thinks such mode of long-term investing helps best capture the growth stories of India Inc. While Kothari believes the Q1 earnings was below expectations, he also expects the unfolding capex cycle in the second half of the financial year to help catch up on earnings. Chirag Madia and Muthukumar K caught up with him in an hour long interview. Excerpts:

What is your view on first-quarter corporate earnings ?

It is slightly below the consensus expectations, though not down by a huge margin. Sectors like auto, oil & gas and utilities have reported earnings below expectations while earnings were slightly above expectations for banks and the consumer sectors. But one has not seen a massive earnings downgrade cycle. Hopefully with the capex cycle picking up in the second half, we will see the earnings momentum also pick-up. While the expectations for the earnings growth (for 2010-11 for the Sensex) are still in the 18-22% range, this quarter was slightly weaker.

Does a weaker June 2010 quarter imply a lot of catching up to do for achieving the analysts? consensus sensex EPS target of 1,045 for FY11 ?

The big-swing happened last time when the commodity prices rose. If the growth in consumer and industrial sectors come through along with the start of the capex cycle, then 18-20% growth in earnings would not be a stretch.

Where are the commodity prices headed? Prices of some of the non-ferrous metals have gone up recently?

Commodity prices have rallied in the last one month. Over the medium term, China demand is a crucial factor affecting dem and for commodities like copper. And globally, if you look at the stock(inventory) levels across commodities, they are not very high. It is about how strong the demand recovery is and that how the global macro factors come into play. The other challenge is also that of the rising cost of extraction of these commodities.

Is it true that the current higher prices have brought them above the marginal cost of production for many metal producers ?

The marginal cost is also a moving target; diesel and labour costs play an important role here. And the cost curves have moved up in the last few years. A lot would depend upon how the demand plays out.

Oil has touched $80 per barrel. Can it spook equity markets?

If oil moves above $90 per barrel, then it is a worry for India because it is a large importer of oil and it would affect its current account. An oil price up to $82-85 is still digestible and the break-even oil price has moved up from $ 55-57 few years back to $ 65.

If oil prices move above $65, then you have to increase the oil prices domestically so that there is no burden on government finances. And if higher oil prices are passed on to consumers at market prices, there are worries of inflation. So higher oil prices as such is not good for India.

How does the equity valuations look at this juncture?

Equities market have done well and the valuations are trading at above 16 times one-year forward earnings. They are neither towards the lower end nor in the bubble territory.

Mid-caps and small-caps are in the limelight ?

We don?t bucket stocks as large cap or small, as we focus more on stock picking. As long as there is a good management that could deliver, it doesn?t matter if it is a mid-cap or large-cap. Good mid-cap companies are those with high- quality management that can scale up their activity over time rather than worry about the business cycle. It?s more of bottom-up stock picking for us than just rotating from large-cap to mid-cap.

Put differently, do companies in mid-cap indices look more valuable than those of large-cap indices ?

If the business and earnings cycle continues to play as expected, then potentially there can be more value in the mid-cap space. Large-caps are fairly valued now. But on the other hand, if the earnings cycle is not as strong and if the macro risk increases globally, then liquidity risk comes into play. And the liquidity risk is relatively lesser in large-caps.

What sectors you are bullish on?

Construction companies is expected to scale up over the next 4-5 years with the unfolding of the capex cycle. As India invests $400-500 billion in infrastructure, construction orders will flow. Also companies in IT, banking, pharma and NBFCs, where the management is looking for scale and has a strategy in place, would be our favourites.

Equity fund managers in the mutual fund industry are raising cash levels. Why is that so ?

Rather funds have remained range-bound than moving up. There has been equity outflows, post-regulatory changes (entry- load ban). To manage that, fund managers are keeping more cash. It is more of liquidity management than taking pure ?cash? calls . It is different now from the past ( in March ?09) when massive cash calls were being taken as the global economy was coming out of the recession. As a fund house, we don?t take aggressive cash calls and prefer staying invested.

If FII flows don?t come in, will it be a worry ?

At the end of the day, capital will chase growth and valuations, and as long as these two factors are there money will flow. There is both short-term capital and long-term capital and the latter will flow into the structurally positive markets, whether it is India, China or any other market.

However, predicting short-term volatility and flows is difficult as there are multiple factors affecting them. Having said emerging markets is also where growth will be. Growth and valuations will play an important part in influencing inflows.

But don?t you think higher interest rates could raise capital costs and derail the capex cycle ?

I don?t believe that there will be an interest rate shock. While food inflation will come down, manufacturing inflation may remain high for some more time. Another 50-75 bps hike in interest rates from here will not derail the capex cycle.

Which are the global cues to look out for, going forward?

In the last six months, there has been a lot of market volatility. From a long-term prospective, high sovereign debt levels in europe is a worry. Six months back we started with worries in Europe, then the US recovery looked rickety. While European conditions have picked up a bit, US housing and unemployment data still look weak.

Then China started tightening liquidity, which has led to a bit of economic slowdown. Potentially the growth in Western economies would be lower and emerging markets growth will drive growth for the world economy. At this stage I am not taking a very strong view whether it is deflationary or going to be big inflation coming through. But I am not yet raising the alarm bells for the Western economies.

What is your advice for mutual fund investors ?

We have been constantly saying that rather than timing the market one should believe in equities and have reasonable long- term horizon and do the right amount of allocation to equities.

I think equity will give reasonably good returns versus all the asset classes. The markets are also not in the bubble territory.

At 8% GDP growth rates, do you believe that the coming decade will be that of equities ?

If we take these growth rates as a given, then there are many powerful factors for equities. One, you would have many corporates with quality management that will be able to scale-up. Second is the saving factor itself. There will be a need to invest the pension money and insurance money as saving rates go up. More and more people will then start investing into capital markets.