How do you analyze the investment landscape – both debt and equity? You’ve managed close to $ 30 billion on both sides of the market. Let’s start with equity.
Let me give you an overview of how we look at the stock markets as well as the investment landscape when it comes to the stock markets. I don’t think I’m going to add value for you by saying they’re at an all time high and there valuations are higher because we all know this cash-driven rally is something we’ve been seeing since Last 15 months, thanks to widespread easing carried out by central bankers around the world. This is how valuations are higher.
However, there are some finer points that I want to highlight here. First, inflation, as we all know, has gone up. While most of us follow the CPI which rises above 6%, the WPI is actually more of an indicator of the inflation that companies are seeing or experiencing which is 12% and we all know that inflation usually leads to higher profits in a high inflation environment. environment. There will be companies that report better numbers and a high WPI is actually a sign of better purchasing power in the hands of companies. In a way, this is how we got the wind in our earnings estimates for the entire corporate sector, led by commodities.
Second, if we look at other avenues of investment, especially term deposits in India, the rates are below 5% compared to the inflation we are seeing. So in a way more and more fixed deposit or fixed income savers are entering the stock markets and that is what we are seeing not only in this country but around the world. This is why we are seeing a constant flow of money entering the stock markets and that is also responsible for keeping these markets at higher valuations.
As a house, we’ve always been a believer in managing your asset allocation with great discipline. This regardless of the view on the markets. This regardless of market levels. We always look at the risk and income profile as well as the age. One should carry a mixture of debt and equity. In this type of environment, stocks look attractive, but what we can’t take away is the fact that stock markets will always remain volatile and it is important to manage and balance this volatility by carrying a small exposure to debt.
Given the tax paradigm, where equity-focused or pure-equity products are taxed less, I would suggest to most investors who invest in stocks directly or through institutions like us that probably two-thirds of stocks and a third of debt is a good asset allocation.
What’s your take on the macro environment purely in terms of inflation data versus the path of rates? Do you see a case for a bit of tightening in home yields because the pricing power is coming back? Do you think it will be taken positively and in the medium to long term, is the major break in rates over?
Let me throw in a perspective here. Inflation data points not only in India but around the world, including the United States, have been surprisingly negatively, meaning that actual inflation data points are higher than originally expected. or evaluated. However, most central bankers call it a transitory phenomenon. Our belief is that this may be partly transient due to supply bottlenecks, but there is also a structural component and the only reason central bankers have delayed this tightening or reduction is because they wanted an appropriate normalization of their respective economies.
Our belief is that in September we will begin to hear discussions on reduction. In fact, at the Fed’s September meeting, it is likely that they will come up with a phase-out plan that could start from the start of the 2022 calendar. Likewise in India, while the CPI has been surprisingly negatively, we saw a fairly easy position by our central bank and that’s understandable. However, as the signals start to come in from the United States, other countries including India will start to respond in the same way. So is there a case for gradual shrinkage and tightening? The answer is yes. Are we expecting a gradual rise in medium-term interest rates? This answer is still yes.
Much of finance has done nothing in the past six to eight months. Some large oil and technology conglomerates have been restricted. This is a rally on metals and midcaps. Where do you see a margin of safety in this kind of market?
When we look at, say, mid-cap or small-cap versus certain large-cap names or themes, we need to have a time horizon in mind. Over the past six months, mid and small caps have outperformed some of the large caps. But if you go back to last year, some of the names you were probably referring to were extraordinarily successful. They had therefore increased by more than 100% in just a few months.
Typically, a market rally starts with the leaders and some of the larger companies initially, then it is usually followed by mid and small caps and this is how the scale of the market expands. On top of that, for the past month or so, the FIIs have been selling for the past three days. Typically, when FIIs sell, they are selling the holdings where they have maximum weight and these are usually large cap holdings.
On the other hand, national institutions have been buyers and many of them have received money in so-called flexi cap or multi cap funds. So naturally, because of that, there was more strength in mid and small caps. On top of that, a phenomenon that we know and are all aware of is the fact that retail investors have been extremely active in the financial markets and generally tend to trade more in this space as well. This is why we are seeing this kind of behavior where initially large caps have done well and over the last six months mid and small caps have done better.
Coming to where we see a margin of safety, we think there are some large caps where there will be a greater margin of safety, but it won’t just be a function of market capitalization. The overall build of the business, resilience and the ability to generate predictable returns quarter after quarter and year after year will be more important. Some areas like tech and even FMCGs that haven’t been in the rally so much can act as good defenses right now.
What type of asset allocation would you recommend to first-time investors in the 25-35 age bracket with a horizon of more than 10 years and with reasonable investable cash flows?
If the profile of investors is young then their ability to take risks is high. At the same time, if the person has a 10-year horizon, which is a typical profile for investors who come to institutions like us, then their ability to resist volatility is also high. It is good to carry an equity-focused portfolio, so this is point number one.
Second, we also need to understand that right now valuations are not on our side. It’s on the higher end of the range that we’ve seen historically, so it’s good to balance that exposure with some sort of exposure to debt and that’s why two-thirds of stocks and one-third of debt are a good starting point given that there is a 10-year horizon.