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How To Invest Wisely

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As we welcome 2012, I see investors being nervous and negative, influenced by weakening growth, falling investments and a worrisome global situation with enhanced systemic risks.

The Indian equity markets were one of the worst performing last year. In fact, the BRIC nations (Brazil, Russia, India, and China) saw equity markets fall 26 per cent in 2011 in US dollar terms, which, surprisingly was worse than the 25 per cent fall in the troubled European equity markets of Portugal, Italy, Ireland, Greece and Spain. Global headwinds and domestic issues have led to record pessimism in the Indian market. Add to that the underperformance of both equity and fixed income instruments and we have a daunting prospect for Indian investors.

However, we must remember the words of Warren Buffett, arguably the most famous investor in modern history. "Be fearful when others are greedy, and be greedy when others are fearful," Buffett wrote in The New York Times. With one of the worst stockmarket performances over the past 20 years hitting India in 2011, compounded by a sharp 17 per cent depreciation in the rupee, investors are understandably fearful and negative.

My investment advice for 2012 is very simple. Investors should follow safety first as the guiding principle. Preserve capital first, and then look for returns. The second mantra is diversification across asset classes to avoid any concentration risks. Third, asset allocation cannot be static now; it has to be dynamic, as market moves are fast, volatility is high and opportunity windows are small and sharp. Fourth, invest in simple products and avoid complex products. Fifth, I want to remind investors that serious money is made not by following the herd, but by doing the opposite of the herd. Such contrarian thinking needs courage and conviction. And finally, and most importantly, "if you wait for the robins, the spring will be over", as Buffett says.

Not taking any decisions is a very risky way to act, as rampant inflation and high taxes are destroying purchasing power on a daily compounded basis. Procrastination of decisions is a huge value destroyer, which investors have to be wary of. Markets will move up much before the economy or sentiment moves up, so the cost of not being invested has to be factored in.

So what do we expect in 2012 and what is the best advice for investors?

The Indian economy is expected to grow 7 per cent in FY2012 and 7.5 per cent in FY2013. And I expect the BSE Sensex to end 2012 near the 18000-level, implying a 14 per cent return from current levels. Record pessimism is the most positive variable for India. The burden of expectations is now shifting in India's favour after a long gap. As state elections get over, the Union Budget following these will have a chance to take bold steps because there are no elections to be worried about in the next 15 months. Along with this, I expect a 19-month monetary tightening cycle to reverse in 2012, with policy rates being cut by around 1 per cent to 1.25 per cent in 2012. This will provide an impetus to the economy, with the classical rate sensitive sectors such as banking, real estate and infrastructure benefiting.

The outlook on the global economy is also mildly positive. I see greater clarity emerging on the Eurozone front by March. Similarly, I expect the US economy to chug along at a low but positive growth rate, with an expected Presidential election year rally in the US equity markets. And for China, I expect an increased focus on building domestic consumption and monetary easing to help the economy soft land. Unlike the 2008 slowdown, commodity prices will hold up; so commodity dependent countries will continue to benefit.

I anticipate attractive returns from global equities in 2012. However, I am still cautious as lingering macroeconomic risks remain, particularly related to Europe. As a result, I favour US dividend yielding stocks as they may offer partial downside protection in uncertain and volatile environments. The dividend yield of S&P 500 on 11 January 2012 was 2.25 per cent as compared to 1.91 per cent on 10-year treasury papers. I also favour US technology sector. Asia ex-Japan (the countries located in Southeast Asia, excluding Japan) should eventually perform better thanks to its relatively strong growth outlook, and greater scope for expansionary fiscal policy if needed. Latin America should benefit from the strong cyclical support from monetary policy easing.

The recent downwards correction in international gold prices may prove short-lived as the underlying fundamentals remain supportive. Negative real interest rates, continued gold buying by central banks, and concerns about the Eurozone may encourage a limited recovery in gold prices. Precious metals will perform better than industrial metals, which are expected to face headwinds on account of slowing global growth.

I expect the US dollar to strengthen against the Euro. Currencies of countries having good fiscal prudence will do better than those of the profligate ones.

While any investment advice has to be personalised to an investor's time horizon, risk appetite and financial goals, a broad, balanced portfolio should be allocated across cash and saving account to about 5 per cent of one's portfolio. This is basically to keep quick liquidity. In this market environment, I would keep 45 per cent in fixed income be it mutual funds or bonds or deposits. My preference would be for mutual funds for tax efficiency, liquidity and diversification with the following allocation — 30 per cent in short-term mutual funds, 10 per cent of the total money in long-term income funds and 5 per cent of the portfolio in long-term Gilt funds (a mutual fund that invests in different types of medium- and long-term government securities). I would keep 40-45 per cent of my money in equity and equity mutual funds. Twenty-five per cent of the total money will be in large cap equity mutual funds as they have visibility of earnings, cash flows and scale, while 10 per cent will be in mid-cap and micro-cap equity mutual funds. Good quality mid-caps tend to outperform in growth cycles so they are good to hold.

Today, only 5-10 per cent of one's money should go into global offshore funds. I am most bullish on US equities. Exposure through offshore funds gives diversification of markets, geographies and currency exposure through the underlying foreign fund. The rest of the money, which is 5 per cent of the total portfolio, will be in gold. The preference will be to go through the ETF (exchange-traded fund) route, since it is liquid and has no storage risks or wealth tax.

Over the past 24 months, investors have been largely investing in cash equivalents and fixed deposits. These give predictable returns, safety of principal but are poor long-term assets. Post inflation and post tax returns on these are negative, implying a falling purchasing power of this asset class. Hence, I suggest that cash and equivalents should be limited to an emergency pool of six months' expenses.

In the fixed-income category, I would suggest investing in short-term mutual funds, which are invested in underlying papers with two or three years' duration. Also, long-term income and gilt funds can be invested into over the next two-to-three months to benefit from the rate reduction part of the cycle. Investors have the potential to make capital gains on these funds as the rates fall and the value of their underlying bond holdings rise.

In the equity asset allocation, I favour diversified equity mutual funds as the core investments. The positives for equity markets are based on valuations being cheap across sectors and stocks, moderating inflation and the possibility of deep interest rate cuts. The negatives are in the form of deceleration in growth, strong credit linkages with a weakening Eurozone, significantly less fiscal ammunition than in 2008 and the twin deficits, fiscal and current account. Consequently, I believe that equity markets will continue to remain volatile over the next two months up to the budget session. By the second half of 2012, there is an expectation of better domestic and global environment helping equity markets to rebound.

Finally, I would recommend a 5 per cent holding of investor's portfolio in gold as a risk hedge and a safe haven. 

The author is the managing director and head of private wealth management at Deutsche Bank India.
The views expressed here are the author's personal views and do not reflect those of Deutsche Bank

(This story was published in Businessworld Issue Dated 30-01-2012)