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BW Businessworld

Equity Is Good Bet

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The beginning of a new year is the perfect moment to reflect upon our investment game plan for the rest of the year. While specific investment plans for each individual need to be customised around his/her willingness and ability to take risks, as well as life goals, one can be guided by the broad contours of the various opportunities available. Here I present a synopsis of the same for different traditional asset classes of debt, equity and real estate.
Debt’s The Way
A high interest rate scenario thanks to stubborn inflation has ensured that the running yield or the current yield available on debt securities of various maturities continues to remain high. Bonds with a high credit rating and with maturities in the range of 2-3 years are delivering a current yield of around 10 per cent. Moreover, there is the possibility of an upside in bond prices in case of a correction in interest rates by 50 basis points. These bonds could deliver a gross return of up to 12 per cent over the next one year.
Given this background, it is good to build a debt portfolio across two strategies. First, accrual, which means locking in with a high current yield before any downward trend in interest rates. Second, duration management, which means proactively playing with the maturity period of the bonds to take advantage of an upside in bond prices in case of any downward movement in interest rates.
While in the case of the former, a basket of 2-3 good medium-term debt funds should suffice, the latter concern can be addressed by investing in dynamic funds which undertake active duration management in line with the anticipated interest rate direction. Currently, medium-term funds are offering an attractive yield of around 10 per cent, while dynamic funds have positioned themselves for an average portfolio maturity of around 4-6 years.
Advantage Equity
Equity markets are currently trading at around fair market valuations, which means that they are neither cheap nor expensive. In other words, if we expect the country’s gross domestic product to grow at 6 per cent annually over the next five years, then growth in the earnings of corporate India should be around 14-15 per cent every year.
Over a longer period of time, markets are followers of earnings. Given this fact, at current market valuations, such returns (14-15 per cent) could be earned from equity markets over the next five years. However, in the face of encouraging economic data and the reform agenda being finally pushed by the government, the price-to-earnings (PE) ratio of stocks may witness multiple expansion.
In such a case, one can expect 15-20 per cent returns from the equity markets in 2013. Currently, there are limited avenues for growth in the global economy; if the Indian economy is able to gather momentum, then this magnitude of return could certainly happen.
The odds are in its favour as the current government would be inclined to move towards the elections in 2014 with a sense of euphoria and optimism about growth. Although it’s early days, there are already signs of a revival in investments in manufacturing.
Having said that, one must not forget that the risk on account of global cues is a reality of current times. Hence, stock markets will continue to be highly volatile and investors will need to manage their portfolio risk fairly well. This can happen at two levels — a suitable allocation in favour of debt which will ensure that the overall investable wealth isn’t skewed towards higher-risk equities and, secondly, building equity allocation around a fair market valuation band of 17-18 P/E for the Sensex.
Any accumulations at levels higher than that will not only make it harder to make money in equities but will also increase portfolio volatility for the investor. Within equity, since small- to mid-caps have run up their valuations faster than large caps, one could look at a 70:30 mix between large caps and mid- to small-cap segments. Again, the most efficient way to build this could be by way of a basket of steady diversified equity funds.
Watch Out For Real Estate
In any growing economy, growth gets mirrored in asset classes such as equity and real estate. While in the case of equities, the growth gets monetised through growth in earnings, in the case of real estate, it happens through demand expansion. When corporate earnings grow, business needs to be scaled up and more people employed. This leads to greater demand for both commercial as well as residential space. And when this happens, it leads to higher spending power, which percolates to a higher scale of retail space. However, in response to this demand, supply catches up.
Therefore, the demand-supply matrix is an important determinant of real estate prices in the short to medium term. This demand-supply matrix could vary from one location to another within the same city and even one product to another within the same location.
Therefore, investors should take care in choosing the right real estate after a careful assessment of the product and location parameters.
In most of the prime markets, prices of residential properties have seen a bull run over the last three years, while those of commercial office space have stagnated due to lower offtake. It may be prudent for investors to choose newly launched residential projects by developers with a proven track record rather than buying completed projects at current market prices which are at their peak. It may be better to take the construction risk with established developers than taking the price risk.
The author is the founder partner of Client Associates, a private wealth management company
(This story was published in Businessworld Issue Dated 14-01-2013)