Indian equities are on a tear. The Nifty50 index has returned about 18% year-to-date, after delivering a compound annual average growth of 11% over the last five years ending December 2016. India’s mid-cap and small-cap indices have done even better, delivering 22% and 24% year-to-date, respectively. As equity indices set all-time highs, equity volatility has treaded close to its all-time lows – arguably suggesting some complacency in the markets. This begets a set of questions – is this equity rally sustainable? Should I invest in equities at current levels?
While equity values look elevated in historical terms, the answers to these questions are more nuanced that we may think. To answer the first question first, it is important to take a step back and analyse some of the key drivers of Indian equities and assess whether they are likely to sustain.
First, capital flows trends remain, on balance, positive. India has been a key beneficiary of global inflows amid a global ‘risk-on’ environment, having attracted about $20 billion so far this year. However, the pace of these inflows has deteriorated of late. While we believe global environment is likely to remain conducive for equities given the outlook for stable global growth, with soft US dollar and US Federal Reserve (Fed)’s plans to only gradually raise interest rates, India’s share of the wallet could decline in the near term. In contrast, inflows into local equities from domestic investors are likely to gather momentum in the near-to-medium term as the relative appeal of Indian equities grows with the downturn in real estate and gold.
Second, corporate earnings in the quarter ended March surprised positively, partly as a result of last years’ lower base effect and partly due to subdued expectations after India’s remonetization exercise. Going ahead, we see limited scope for such positive surprises, with markets setting the bar much higher.
Third, government policy remains supportive. Prudent budgeting, constructive policy reforms and favourable election results have helped lift sentiments. While we believe these reforms are directionally positive, equity markets may have been overtly swift to discount future benefits.
Finally, valuations look stretched after the strong run-up in stocks this year. Price-to-earnings’ multiples of Indian equities are now close to their five-year highs, up from closer to historic average at the beginning of the year. This does not preclude searching for value. For instance, the sharp rally in mid- and small-cap equities have made them relatively more expensive (in terms of forward price to earnings’ multiples) compared with the large-cap equities, suggesting a relative margin of safety in some large-cap equities.
Overall, we believe in India’s structural growth over the medium-to-long term. However, India’s equity markets have likely priced in most known catalysts in the near-term. Going ahead, returns from Indian equities could be more measured.
To answer the second question on whether we should invest in equities at current levels, it is important to remember the time-tested disclaimers that no one can accurately time the equity markets and that there is no ‘one-size-fits-all’ approach – each investor is unique in her risk tolerance, investment horizon and other determining factors.
Thus, it is important to follow certain broad principles and stick with it. Discipline is a critical factor in determining investment returns.
Research shows mundane, but time-tested ‘cost averaging’ method of investing remains a successful means of investing that reduces ‘market timing’ risks. One can either opt for a systematic investment plan (SIP) or a systematic transfer plan (STP) wherein funds are periodically transferred from money market debt funds to equity funds. It remains a popular and efficient mode of investment in equity mutual funds.
More conservative investors could also consider a blend of debt and equity - this allows for restricting allocation to equity, while adding exposure to debt. For example, a balanced mutual fund would invest up to 65% of its portfolio in equities and the balance 35% in fixed income instruments. Mutual funds also offer plans with tighter equity restrictions of even up to 15% of the portfolio.
All in all, investors have varied investment choices available, even at elevated market levels. But in our opinion, one should lay greater focus on ways to ‘stay in’ the market than ‘timing’ the market.
KNOW THE RIGHT MIX
- Each investor is unique in her risk tolerance, investment horizon, among others
- Discipline is a critical factor in determining investment returns
- SIP, STP remain efficient mode of investment in equity mutual funds
The writer is director-investment strategy, Standard Chartered's Wealth Management unit
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