"The first leg of recovery will come from consumption rather than investments"

After the initial euphoria in 2014, the current calendar year has proved to be an anti-climax, with volatility ruling the roost. The Sensex, at one point, came tantalisingly close to its May 2014 level. With the benchmark indices still in the red year-to-date and the other big asset class — real estate — in the doldrums, India’s rich are sticking to equities, even as they flirt with start-ups, the new alternative asset class in town. For the fourth year in a row, Outlook Business got the country’s top wealth advisors to talk about their outlook for various asset classes and their asset allocation advice to clients. Over the 90-minute roundtable, the wealth advisors sounded confident and hopeful about 2016.

Outlook Business: Last year, everyone was overweight on equities and to some extent, the bullish bet did play out. As we head into 2016, there is reason to be skeptical. There is the possibility of a Fed rate hike and the Chinese throwing up a surprise. Back home, there’s falling earnings, excessive leverage and its impact on banks and a stodgy reforms process. Against this backdrop, how do you see 2016 playing out?

Yatin Shah: If last year was all about Russia and Ukraine conflict, this year has been about the probability of a Fed rate hike and the surprise Chinese devaluation. But what is interesting to note is that compared with the last calendar year, FII investments have been lower in equities this year. Last year, total FII inflows stood at $40 billion; as we speak, we are only at $13 billion. From a macro view, GDP growth bottoming out, fiscal and current account deficits narrowing, inflation going down, repo rate going down and corporate earnings bottoming out is a great story for equities.

Last year, earnings growth was 2%, while revenue growth was flat. But going forward, things look promising. If you remove commodities from the picture, then earnings for the Nifty grew at 9% last year. What’s interesting is the uptick in domestic fund flows. Last year, the net flow in equity mutual funds was close to ₹71,000 crore. For the first six months of this year, it was ₹54,000 crore. So, the redemption pressure of FIIs was to some extent offset by domestic fund flows. The story continues to be promising, only that it is playing out in a slightly delayed fashion. In short, the bottom-up story continues to be strong.

Vishal Kapoor: Adding to what Yatin said, I believe that earnings growth is still a concern, but margins have improved. Things won’t change overnight; you need to be patient. A year later, if you are still looking at the same valuation, then it makes the story even more compelling. On the fixed income side, it is again a very interesting story. Now, it does seem that inflation is firmly and directionally under control for some time.

Fixed income as an asset class has introduced some opportunity already and there may be more going forward. So, two large asset class baskets have done well and continue to do well. Absolute returns for the customer have been quite positive, both in equity as well as fixed income. In other asset classes such as real estate and gold, I don’t think many of us were quite bullish a year back.

Atinkumar Saha: I agree with the first two panelists. If corporate earnings improve and interest rates go down simultaneously, valuations will start improving. If GST gets through and there is some push by the government to come out with a new land bill, with some leeway for the states to build on it, that will create a positive sentiment. The market is waiting for those signals. So, on the domestic side, it is about events and government action.

We are expecting 14-18% return for three to five years. So, if an aggressive client holds 60-65% in equities, we would maintain that and the balance 20-25% in the fixed income side. There is a lot of action happening in the alternatives space. HNIs are looking at interesting start-ups in which they can park their money. 

Rajesh Saluja: If you consider our prediction last year, being overweight on equity and pursuing a bottom-up approach really helped. Although the index has remained flat, investors have made 20-25% return. We continue to be overweight from a three- to five-year perspective, given the new government and the changes that are taking place. Indian corporates and promoters are facing the challenges of a slowdown in domestic and global economy, low urban and rural consumption, persistent corruption at lower levels and limited access to government.

If you look at earnings and profit growth, what we don’t realise is that even though the current series of GDP is growing at 7.5%, inflation is negative at 4.5%. And if corporate profits are considered on nominal growth, they are growing at 2-2.5% because of negative inflation. If you take into account the earlier GDP series, then profit growth is 1-1.5%. So, though margins have improved, profit hasn’t because of negative inflation.

On the economy front, the government is pushing up spending. For the first time, capital formation on a quarter-on-quarter basis has gone up from 4.1- 4.8%. It has brought ahead some of its expenditure related to roads, power, defence and railways. This year, large part of economic growth will be dependent on government spending including upward revision of payroll of government employees. Over the next 12-18 months, we might see better earnings, with the interim third and fourth quarters looking weak. 

Outlook Business: Is there no concern over a Fed rate hike?

Rajesh Saluja: Over the last 12 months, our in-house view has maintained that the US Fed will find it tough to increase rates. Even if it does, it will just be because of this consistent pressure to show that its economy is turning around. There may be a 25 bps increase. But the fact is that 40-45% of US corporate profit is coming from outside the US. These are mostly global companies and, hence, a rising dollar will hurt them more.

For them to be able to take action and strengthen the dollar when all the other countries are going through deflation or printing money is going to be tough. So, [a rate hike] will be nominal and won’t have too much of an impact. A small Fed rate hike is priced in when it comes to equity markets. In the last six months, the outflows from equity markets have primarily been from global emerging market funds and sovereign wealth funds from Middle East given the challenges in China and broadly in the commodities or oil space.

Atul Singh: India remains a great relative trade in the world. Even at 6.5%, India will surpass Brazil and Russia to become the second-largest emerging market after China. Now, the question is: where is the growth going to come from? We believe that the first leg of recovery will come from consumption rather than investments.

With excess capacity build-up, investment-led growth will take its time coming. But we are confident about consumption-led growth because of the rate cut and how it will influence consumer spending and the impact of the 7th Pay Commission. So, in the first phase of recovery, consumption will drive growth and investments will eventually kick in. From a fixed income perspective, real interest rates continue to be positive and high. So, it is a very attractive scenario for investors in India and abroad.

With inflation going down and nominal interest rates not going down to that extent, the real interest rate is positive. There is potential for that to go down, partly because of the transmission effect, as banks cut rates by 50-75 bps, and partly because of the RBI, which could cut rates by another 25 bps early next year. So, that way, fixed income is a reasonably attractive asset class.

Outlook Business: When the market went up earlier this calendar year, did you ask your clients to take some money off the table and reallocate within asset classes? 

Yatin Shah: We have set benchmarks to be used when revisiting an existing allocation. In equities, we look at growth and PE ratio. In real estate, we look at capital values. Carry is still negative in that the borrowing cost is more than the yield you make on the asset. Clearly, equity has not yet crossed the 23-25 PE mark. Our expectation for earnings (Nifty) is about 535 for FY17, so we are talking about 15-15.5X, which is the historical 10-year average. Hence, the probability of clients making money by staying invested far outweighs gains to be made by cashing out. Fixed income is looking attractive, barring a few blow-ups. But, clearly, your overexposure in the past 18 months would have been in gilts, given the anticipated rate cut. In real estate, nothing has changed. If you have invested, you continue to earn a negative yield. So, even if there is no price correction, there is opportunity cost. 

Outlook Business: Does this hold true for the rest of you?

Vishal Kapoor: At a client portfolio level, where the targeted equity allocation was around 20-25% through the year, we have booked some profit and deployed them into fixed income. Then, last year, we saw a lot of money actually exiting real estate and moving into organised financial assets. So, if someone sold an existing property, they would deploy it back into some other property, as they did not want to pay tax. So, in many portfolios, we saw clients taking a different call and saying they’ve had enough.

Atinkumar Saha: We follow a disciplined and strategic asset allocation approach keeping in mind the risk profiles of our clients. Last year, we did make a tactical move by being 10% overweight on equity; today, we are at less than 5%. With the market going up 30-40%, part of our investment was encashed. In debt, we rebalanced and our investors are very happy because we encashed correctly. On the real estate side, we are seeing HNIs borrowing against existing real estate and allocating that into financial assets.

Rajesh Saluja:We have always followed the bottom-up approach. Given the kind of domestic and global headwinds to the economy, we have 65- 75% invested in large caps and the rest in mid-caps. There have been no cash calls or asset allocation calls from a timing perspective. Asset allocation calls have been mostly at a client level, based on the triggers around exposure to equities. In the last three months, we have been neutral on equities. In a euphoric market scenario with good sentiment, small caps and mid-caps tend to rally. But given the challenges, both domestic and global, we prefer to create portfolios or recommend mutual funds that hold companies with good balance sheets and consistent earnings growth.

In real estate, we have advised clients to take exposure through a professionally managed fund route with proper risk management framework. The past two years have given real estate funds great opportunities to partner with quality developers, specially in the mid-income housing segment in the top five cities in India.

Our strategy of acquiring quality assets with good developers is working very well for us and has helped us generate returns of 25%+ p.a. We continue to be biased in getting into an equity deal with developers for residential projects rather than lending money at a fixed rate under a debt fund structure.

Atul Singh: There is a lot more confident allocation going on, rather than the more opportunistic allocation that happened before. In other words, there is no question of cashing out. I don’t think we have reached a level where valuations are at the point where you can just sell and sit on cash or fixed income. So, people who are fully invested should remain so and those who missed the bus should look at some serious allocation.

This is part one of Outlook Business' 4th annual roundtable, Upper Crest. You can read part two here.