When equity market near all-time high, investing in ad-hoc manner dangerous

Despite the slump in India’s gross domestic product (GDP) growth rate, Foreign Portfolio Investors (FPIs) have continued to invest in India. Since the time the finance ministry took a number of measures to provide an impetus to the economy’s growth rate, they have engaged in spirited buying. But retail investors need to bear in mind that a strategy that works for may not be suitable for them.

Reforms such as the Goods & Services Tax (GST), Bankruptcy Code, Digital India, Start-up India, Make in India, skill development, affordable housing, and steps like a timely boost to the realty sector, emphasis on better infrastructure (Bharatmala Pariyojana), bank recapitalisation, measures taken to boost consumption, to name a few, have been viewed positively by

In addition, the Reserve Bank of India (RBI) has remained accommodative in its monetary policy action and stance to address growth concerns. The US Federal Reserve has refrained from increasing interest rates–in fact, it has cut them. And the trade war-related tensions between the US and China have eased. All these factors have encouraged FPI

continue to perceive India as a promising investment destination that has a stable government intent on bringing about reforms. Cumulatively, during calendar year 2019, FPIs’ net purchase of equities was to the tune of Rs 1.01 trillion. This figure makes up for the net selling in 2018, which was to the tune of Rs 32,628 crore, and is greater than the net purchase activity worth Rs 49,729 crore in calendar year 2017.

Buying by both FPIs and domestic (institutional and retail) investors has pushed the Indian equity markets to stratospheric levels. The S&P BSE Sensex is currently trading above the 41,000 mark, and is close to its all-time high of 42,273.87 (recorded on January 20, 2020). The trailing 12-month price to earnings (P/E) ratio of the S&P BSE Sensex and the S&P BSE Large-cap Index is currently at 25x and 27x, respectively.

Will FPI buying push markets further up?

FPIs do recognise that there are growth-related concerns. Most agencies have downgraded India’s GDP growth forecast for this year. Moreover, consumption is slowing down, inflation is ticking up, the unemployment rate is high, there are non-performing asset (NPA) related concerns, tax collections are falling short, disinvestments are way off the mark, and fiscal slippage can also not be ruled out.

A number of forecasts point at GDP growth rate dwindling this fiscal year, but one can expect some improvement in the next fiscal. The real GDP growth across 10 governments has been 6.3 per cent per annum over the past 39 years.

In future, while FPIs will continue to be positive on India, they will also look forward to more structural reforms that can bolster investment activity, result in optimal capacity utilisation, generate employment, provide a boost to consumption, and leave higher disposable income in the hands of people. They will also want enabling tax policies, improvement in exports, and so on, which can eventually help India clock higher growth. Many of these concerns were addressed by the Union Budget of 2020.

Don’t fall prey to over-exuberance

With the markets soaring high while the economy slows down, investors need to be careful and not get swayed by exuberance. Even as earnings estimates get re-rated upward for certain companies, it would be pointless to get carried away by forward statements or earnings outlook. Sadly, the oldest trick in the book of estimating earnings is that near-term estimates are toned down while longer-term estimates are hiked. For several years, the market has initially projected ambitious earnings growth, but the actual growth has turned out to be lower. So, do not get carried away. The impact of corporate earnings on investors’ mutual fund portfolio will hinge on the portfolio of schemes they build.

Legendary investor Warren Buffett said: “Be fearful when others are greedy and greedy when others are fearful.” Clearly, the current trail P/E levels, particularly in the large-cap space, are not cheap. In fact, they are in the overvalued zone and offer limited margin of safety. On the other hand, the mid-cap and small-cap indices are attractively placed at lower trailing P/E level than before and offer a reasonable margin of safety. Nonetheless, investors need to know that they are assuming very high risk when investing in the Indian at this juncture.

Bouts of high volatility in future cannot be ruled out. Investors’ patience could be tested. Discontinuing SIPs in volatile times would be a bad idea. Volatility is intrinsic to equity markets. It’s our ability to perceive the situation sensibly and devise an efficient investment strategy that ensures success.

Follow a core and portfolio strategy

In such times, investors should build a portfolio of equity-oriented mutual fund schemes based on the “core and satellite” approach to investing. This approach can offer investors the best of both the worlds—short-term, high-reward opportunities and long-term, steady-return investing.

The term “core” applies to the more stable, long-term holdings of the portfolio, while the term “satellite” applies to the tactical portion that can help push up the overall returns of the portfolio, across market conditions. Core holdings should form a major portion of the mutual fund portfolio. They should ideally consist of a large-cap fund, a multi-cap fund and a value-style fund. The rest, say, around 35-40 per cent, can be “satellite” holdings consisting of a mid-cap fund, large- and mid-cap fund, and an aggressive hybrid fund. If the investor is willing to take the risk, a small portion can be allocated to a small-cap fund as well in the satellite portfolio.

The art of cleverly structuring the portfolio by assigning weights to each category of mutual funds, and then picking the right schemes for the portfolio can help the investor clock optimal risk-adjusted returns.

At the current levels, when the Indian is already near its all-time high, getting blinded by supernormal market returns and investing in an ad-hoc manner based on current euphoria or news flows can be extremely dangerous. Investors could end up burning their fingers.

Devising a sensible strategy, and astutely constructing a mutual fund portfolio based on thorough research and analysis (using both quantitative and qualitative parameters) is essential at this juncture. As the market outlook changes, the weights assigned to each category of fund needs to be revisited, especially in the satellite portfolio. Unless this is done, clocking superior, inflation-beating returns over the long term could prove to be a challenge.

While there may be euphoria on Dalal Street, remember that the Indian economy currently faces several headwinds. For the market to move higher, the positives need to outweigh the negatives.

The writer is MD & CEO, Quantum Mutual Fund