A balanced approach to a buoyant stock market

As investors second-guess themselves before investing in equity, Nimesh Shah, MD and CEO of ICICI Prudential Asset Management, has a suggestion.
By Guest |  31-01-18 | 
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Morningstar invites thought leaders from the investment community to share their insights. Views expressed are personal and should not be construed as investment advice.

The Indian equity market has witnessed unprecedented domestic flows despite high valuations and tepid corporate earnings growth. The domestic institutional investors, or DIIs, have ploughed a record amount of money into equities in 2017, more than double of what they invested in all of the previous year.

The local insurance companies, pension funds and mutual funds together were net buyers of shares worth Rs 74,728 crore till about mid-November 2017, against Rs 35,526 crore in all of 2016, according to data from the Bombay Stock Exchange.

However, amidst all these positives, there is a chance that a new market entrant may not recognize the complete risk of equity as an asset class. As Warren Buffett aptly describes - Be fearful when others are greedy and greedy when others are fearful.

With Indian shares trading near life-time highs, the valuation have turned rich, calling for prudence when investing at current levels. Investors are advised to exercise cautious approach in these market conditions while participating in equity as an asset class.

Should investors keep away from equities and risk earning returns that can be lower than inflation?

Not necessarily.

Today, the investor has the option of opting for balanced advantage category of funds that offers exposure to stocks while limiting risk by investing substantial money into debt securities as well. These funds aim to buy stocks at lower valuations and sell at higher levels, and gain from market volatility over the long term.

Currently, Indians are under-invested in equities relative to gold and real-estate. The lack of alternative investment opportunities in other asset classes and low yields in real estate and commodities has led to massive migration amongst domestic investors to consider equities. The systematic investment plans or SIPs, which has been the preferred route for retail investors witnessed monthly collections growing to Rs 5,621 crore in October 2017 from Rs 3,434 crore in October 2016. The number of investor folios also rose to a record 6.20 crore at the end of September 2017 from 5.53 crore in March-end, a gain of 66.5 lakh, according to data from the Securities and Exchange Board of India (SEBI).

Taking a cautious stance on the equity market

  • Price of crude

Oil prices have touched a two-year high and have risen by about 20% just over last 1-month (Data as on January 23, 2018). The markets are concerned about rising crude prices which could have adverse macro implications and challenge India’s economic recovery over coming quarters. The ascending oil prices may have serious implications on inflation, currency, current account deficit (CAD) and fiscal deficit. Some estimates suggest that with every $10 per barrel rise in crude prices, India’s fiscal balance may worsen by 0.1% and current account balance by 0.4% of GDP.

  • GST

The challenging macroeconomic landscape along with some transient glitches with the goods and services tax (GST) could pose some concerns to the current rally in equity markets.

  • Valuations

Corporate earnings are currently not in-sync with stock market performance, leading to rich valuations. The benchmark, S&P BSE Sensex’s price to earnings (PE) multiple is trading above 24 times, making Indian markets one of the most expensive among all major global markets. The market valuations appear elevated even when compared to historical values. Bloomberg shows that S&P BSE Sensex firms’ consensus earnings per share (EPS) forecast for the current financial year has been reduced by 5.8% since April 2017, and by 10.97% for the next year. In the light of these, the current valuations suggest that medium term market returns form equities are likely to remain moderate.

Have a 'balanced’ approach to asset allocation

Investors often hear about how asset allocation is the cornerstone of long-term wealth creation. All major financial assets invariably exhibit a certain degree of volatility in due course of time. One should always reminisce that no asset class is designed or programmed to move in one specific direction, say, in a straight ascending line. However, an average investor finds it difficult to implement this strategy in their personal investments.

For such an investor, the mutual fund industry offers a solution in the form of dynamic asset allocation/balanced advantage category of funds, which will help address this dilemma. By investing in such a fund, one gets exposure to both equity and debt asset classes, all within a single portfolio. Such funds are geared toward investors who are looking for safety, income and capital appreciation for their investments and tax efficiency.

The debt component of balanced advantage category of fund serves multi purposes – creating an income stream and tempering portfolio volatility. Hence, a conservative investor looking to invest money for long-term financial goals can consider investing in balanced advantage category of funds that aims to gain from market volatility over the long term.

As Warren Buffett said, “Successful investing takes time, discipline and patience. No matter how great the talent or effort, some things just take time.”

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