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An Investment Strategy For 2019

By Nitin Singh and Vinay Joseph
January 10, 2019 08:40 IST
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Spread investments in equities, bonds, gold and cash to tackle volatility advise Nitin Singh, MD and head, and Vinay Joseph, director, investment strategy, Standard Chartered Wealth Management, India.

Photograph: Shailesh Andrade/Reuters

2018 was a challenging year for investors.

The equity markets had a rough ride with the benchmark Nifty index down by about 8% from its August 2018 high.

The selloff was sharper in both magnitude and duration for midcap indices, with the Nifty midcap index down by about 19.29% from its January 2018 high.

Other assets also came under pressure with the benchmark 10-year government bond yield rising above 8% for the first time in four years and the rupee depreciating by over 10% in 2018.

The Reserve Bank of India raised rates for the first time in four years in 2018, hiking the repo rate by 50 basis points (bps) to 6.50%.


Market volatility has increased after the past few years of calm as the markets adjust to the normalisation of global interest rates from a period of abnormally low rates in the aftermath of the global financial crisis of 2008.

Global central banks are also gradually stepping away from supporting the markets, resulting in tightening of liquidity.

Domestically, yields on traditional safe-haven income-generating assets such as bank deposits and government bonds fell sharply during 2016 and 2017 as the banking system was flush with liquidity post demonetisation.

This encouraged fixed income investors to invest in riskier assets to enhance yields on their portfolios.

The above scenario has now changed, with short-term rates rising over the past year and exerting pressure on government bond yields.

In volatile times, it is important to have a prudent asset allocation, ensuring consistency with one's appetite for risk.

This means having exposure to assets that have low correlation with each other, to help offset the losses in riskier assets.

The balance of risk and reward has shifted towards greater diversification.

2018 was a year that amply proved the value of staying diversified with a simple mix of equities, bonds, gold and cash offering stable returns with reduced volatility as compared to owning only equities.

In future, we are likely to see higher market volatility, tightening of financial conditions and pressure on bond yields and spreads.

India's economic outlook is still robust as lead economic indicators are pointing towards higher growth, albeit with some moderation from recent peaks.

On policy, the RBI is likely to stay on hold in the near term, taking comfort from recent consumer price index tracking below its own projected trajectory and a sharp correction in crude oil prices amid rupee stability.

However, macro headwinds are rising, with India's twin deficits (fiscal and current account) likely to weaken on crude oil price adjustment and past rupee weakness, amid still elevated domestic and global yields.

Currently, we are balanced in our asset class outlook.

We are overweight on bonds, and neutral on equity and cash.

Current bond yields are still attractive in our view, with the bond markets factoring in more rate hikes by the RBI (the one-year forward rate is about 50 bps above the repo rate), which are unlikely in our view.

Two, the difference between the 10-year government bond yield and the repo rate is at about 130 bps compared to a five-year average of 75 bps, even after two rate hikes.

And three, real yield (inflation adjusted) at 4.5% is attractive compared to its own history and among the highest in emerging markets.

Another positive for the bond markets is that the government bond demand-supply balance is turning more favourable as compared to the start of the year with a cumulative Rs 700 billion cut in government borrowing in FY19 and foreign investors returning to the bond market since end October after continued outflows since the start of FY19.

We continue to prefer short-maturity bonds over medium- and long-maturity bonds, amid liquidity support by the RBI through open market purchases.

There are opportunities in corporate bonds as the business cycle improves.

Within corporate bonds, opt for higher-rated bonds amid tighter liquidity and rising interest rates.

Accrual funds remain our preferred bond strategy.

The macro environment is still supportive for equities, with robust GDP growth aiding corporate revenue growth as evident in the past few quarters.

The earnings outlook remains robust, with consensus earnings growth expectations of 15 per cent in FY19 and 20 per cent in FY20 for Nifty likely to be achievable on favourable base effects, a broad-based growth recovery, rupee weakness (aiding export sectors), and better operating conditions for banks and the healthcare sector.

After the recent correction, valuations are now closer to longer term averages compared to peak levels just a few months back.

Currently, the Nifty 12-month forward P/E is down to 16.8x, compared to peak valuation of 18.5x when the Nifty registered all-time highs in late August.

However, risks are rising for equities with margin pressures on account of higher interest rates, rising input prices, and rupee depreciation likely to impact future profitability.

Equity valuations remain stretched relative to other asset classes.

Deposit rates and bond yields are at attractive levels compared to the low earnings yield for equities.

Domestic flows, which have been a key source of support to the markets over the past few years, are likely to moderate as the equity markets adjust to a higher interest rate environment.

Opt for a multi-cap equity strategy with exposure to both large-cap and mid-cap equities as relative earnings and valuations are increasingly at par.

Midcaps are now trading at a slight discount of 3% to large-cap equities, which is in line with its historical averages but has come down significantly from about 40% premium at the start of 2018.

Overall, diversification is the key.

Investors need to be selective in taking risk and they should maintain a greater margin of safety in volatile times.

They should focus on maintaining a prudent asset allocation that is consistent with their risk appetite, and gives them exposure to investments that can offset losses in riskier assets.

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Nitin Singh and Vinay Joseph
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