Last four years have been great for fixed income. Will it continue to be so in the coming year too?
Bhagat: Yes, interest in fixed income has been very high, and it’s a combination of both, market and sentiment. Good tax planning and 9-10% return seems to have been the mantra for the past four years. Within that, obviously, some innovation is possible, such as getting AAA or AA kind of instruments.
So are investors today really contended with a 9-10% return?
Bagga: Overall, Indians saved around 17 lakh crore last year, of which about 7 lakh crore went into bank deposits. If you are getting 10% on a one year deposit in SBI or HDFC, why will you go anywhere else? We are back to the mid-1990s where you were getting high returns on risk-free assets such as bank deposits, so why would you really go after the equity? Even tax-free bonds have been fabulous: in the past one year, if you put a 1,000 bond, it is worth 1,095 today, so you have 9.5% capital gains and a 8-8.3% coupon running. Besides, these are government of India entities. So, such instruments will keep getting oversubscribed as there is enough money in the system.
At present, the older segment is going largely with fixed income. Very high-risk people, such as actors or sportstars, are into real estate, either investing in instruments or buying 30-40 flats and putting them on rent. Even if that gives them 2% yield, they are more comfortable with that. Then there are clients worth 1,000 crore, who will invest 90% in fixed income but take very high risks with the balance 10% by lending to real estate developers at 25%, which could be secured against land.
Saluja: Yes, real estate NCDs (non-convertible debentures) with high interest rates, where the risk is much much higher than any other bond, have found favour. That apart, people are willing to take the risk of investing in real estate because they don’t see the volatility of equities. Otherwise, at least 50% of the equity allocation is now going into fixed income.
Do we see this trend changing in the coming year?
Aima: Logically, everyone will ask the question: What is the return on equity — 10% or, at best, 15%? So why should I invest in it? You really can’t argue with that. But it’s a matter of time, perhaps within a year, you will see the shift back to equity. I don’t know what is going to cause it — is it going to be because of some leveraged debt products taking a hit, or a sudden fall in interest rates, or will it have to do with people getting acclimatised to slower global growth…
You are sounding more hopeful than optimistic…
Aima: No one is hoping and that is the most positive thing. Where are your returns going to come from? Debt is looking downward as interest rates have peaked; real estates prices are too high. But equity is still where it was four years back. In fact, if you add the past four years’ earnings growth of 10-12%, logically, we should have been 40% higher on the index in terms of valuation in the most optimistic scenario. Whatever 10-12% returns you are getting from equity is in spite of government inaction, and if that cycle were to change, then the whole scenario changes. In any case, equities is an asset class where you have to discount in the future and, hence, hope does become an essential part.
Bhagat: For the past six months, my clients have definitely been willing to go long on equities. Today our asset allocation is 84-85% on the fixed income side, 10-12% on equity and the balance is a combination of commodities and real estate. Now, over the past six months, you have seen 70-80% going to debt and with that, mark-to-market allocations have moved from zero to at least 10-15%. A lot of interest rate compression on the corporate paper side has played out during this period and I think a larger part of the client portfolio will get allocated to mark-to-market instruments on the fixed income side and a bit more allocation on the equity side in the next few months. A year from now, you will see much more weightage relative to what it is now.
Aima: One has to understand that equities is one asset class where you cannot jump on the rise. It is different in debt, where you can take your call whether to enter at 7% or at 8%. But once equity starts moving, you cannot look to time it. In fact, those clients who were in equities and churned their portfolios have actually done pretty well. So, when you talk of asset allocation in terms of percentages, that is for passive investors. And it’s quite likely that we will see a majority sitting up and taking notice only when the index crosses its previous high.
Saluja: In March-April, we had gone overweight on equities because we strongly believe that this is the right time to build portfolio. Now, whether clients agree easily or not is a different question. In fact, in the past two years some stocks have delivered 60-100% return. And from a valuation perspective there are many good opportunities that continue to be available. We also believe on a macro front, the decision of implementing GST itself will add 1-1.5% to GDP and the government will try its best to implement some key reforms. Since you can’t time the market, we try to ensure clients remain in equity, irrespective of whether they get any return or not. So, our portfolio has equities and alternatives forming 65%, and only 35% is in fixed income.
Besides, over the past two years, we raised our own real estate and private equity funds. So, those too have taken a huge portion in a client’s portfolio.
But can current valuations be called cheap in the context of slow GDP growth?
Bagga: In 2008, the Sensex EPS was about 830; today we are forecasting 1,230- 1,250 and next year would be 1,450-1,500, so it’s a relatively cheaper market, 40-60%, depending on your estimate. Second, we have got 47% share of Asian FII flows this year. Third, domestic investors are totally absent from this market. In the early 1990s, their allocation was 11%, it is now down to 1-2% and that is also the case with HNIs. But there is money on the sidelines — the moment the market falls to 15,000, you will see buyers coming in. So, y-o-y, you are looking at 14-15% growth in the earnings per share on a very broad spectrum of companies.
Our portfolio is very much like Karan’s [Bhagat], so we have 15% allocated to equities. In Q42007, it was 60% equities, but by Q12008 we brought it down to 30% because of our sell call. We were extremely lucky our call went right, but today people have yet to revert to their asset allocations.
Saluja: People want to see if they can get 20% return on their investment; right now it is all looking so hazy. Until and unless the business climate improves, equity is not going to take off. Hence, over the past two years, real estate has been the big thing. Many people, especially ultra HNIs, have invested in the asset class directly or through funds.
Bagga: You have a $2 trillion economy and a 30% saving rate. Still, people have not allocated their savings into equities; they have gone into other assets, largely real estate. Now, real estate again has a very strong bias in its favour. On a 15 lakh crore Central budget, 20-30% of that is channelled out either by the bureaucrats or the politicians, which has to find a way to be invested. This parallel economy is so strong in India that it will keep the momentum in real estate going.
What is the risk to real estate then? The influence of the parallel economy after all becomes an undeterminable risk, especially in today’s political context where you have some many scams coming to fore and scaring away the people involved...
Saluja: Real estate basically can be divided in three categories: residential, which is either for consuming or for investment; commercial; and, third, products that are packaged around real estate. In the top five or six cities, there is demand for 24 million [residential] units. But you have to be careful while making your choice of residential. Take Mumbai as an example. If you invest in Lodha World or some Lower Parel flats at 10-12 crore, you will actually end up with returns even worse than fixed income. But in the mid-income segment, especially for apartments in the 40 lakh to 1 crore basket, the demand-supply gap is huge. Godrej launched a project in Gurgaon at 9,000-10,000 psf level… it sold out 100% in a jiffy. The higher end of the market — 8-10 crore — has come down completely. If you invest in the right asset — for example, on Palm Beach Road [in Navi Mumbai] — and keep it for five years, you may still get your returns.
Commercial is linked to the economy, so the past three or four years have been lukewarm. But if you were to take a view that India is going to look good five years from now, you may again land up making a decent investment. However, you have to be selective about the project in terms of the area, the social infrastructure and the physical infrastructure coming around the developer.
Aima: Today, 66% of the loans [in HDFC] are in the bracket of below 15 lakh. So that segment is going to keep growing, and if you pick and choose an asset class that you want to be part of, clearly you are quite safe as far as that is concerned. People start investing for rental yields only when they see 8% plus returns. Right now the average home-buyer is buying it for himself and yield happens to be just a subset.
Saluja: The high risk in real estate products arises when you lend money. You have to be extra careful about who you are lending money to, what the developer’s cash flows are and the legal framework, as it will be extremely difficult to sell the property in the event of a default.
So just as in fixed income, you have to be very sure of the developer’s credit history, track record and after-sales service, and do your homework before you buy any of these real estate products.
What is the outlook for gold and structured products?
Saluja: Over the past eight months we have asked clients to sell off gold because we believe that, overall, the US markets will do much better over the next two or three years. Besides, the depreciation of Indian rupee has really kept gold prices high. At best, gold will give fixed income type of returns at the upper-end. In the case of structured products over the past 1-1.5 years, we have done hardly any structured products. Nor are clients too excited about it.
Bhagat: I think we have cut down our allocation to gold over the past six or seven months. Structured products is now down to possibly just 1-1.5% of assets.
Aima: Gold, I think, has reached its peak. On structured products, there is not much in the market although some products are being sold; but that is more because in certain structures, commissions are not regulated
Bagga: Over the past six months, we have not sold any structures. We are selling our mutual funds schemes. Gold is 5-10% of the portfolio but our exposure was more a rounding-off effect since you can’t take much commodity exposure in India. Our house view on gold prices is about $1,900 an ounce, 12 months from now. That is a 10% upside in dollar terms; in rupee terms, you could probably do better. So, not really selling out on gold but not seeing much flows either.
What would be the equity allocations in 2013?
Bagga: My balanced ideal allocation is 35% on equities but today with the realities across, aggregate across all my portfolios is 15% in equities.
Aima: You can’t give a percentage. All I can say is most of my customers are underweight right now, I will tell them to turn equal weight in six months. Anyway, even at 50%, a client can still be underweight in equities, while someone would be overweight at 30%. It all depends on client portfolios.
Bhagat: Everybody reacts differently so it is very difficult to say with conviction. But it would possibly move up by 10-15% on the overall portfolio basis in the next 18-24 months.
What are the top three bets across asset classes for 2013?
Aima: Equities, and within that I would favour infrastructure stocks because interest rates are coming down and we also expect government to take some positive steps. The second bet would be the rupee as a currency.
Bhagat: Long-ended corporate paper and equities (interest rates sensitives such as auto, infrastructure and banks). The third would be the rupee.
Bagga: Right now, tax-free bonds will make good money. Second is the intermediate income fund, which can be a mix of both corporate and G-secs. Third is equity, I have maintained my personal allocation through the past four years because I believe in that story. But I would say selective equity, which means not through the mutual fund route but more direct equity buying. Buy stocks that have good cash flows, good management and good visibility. I would go for scale rather than trying to pick small caps or mid caps in this market. I think you have enough big caps that are not well valued and you can make money.
Saluja: My picks will be equities from a one- or two-year perspective with a bias for infrastructure, financials and domestic consumption stocks. Second, would be real estate with residential mid-income category as the focus for the next one or two years. The pockets to invest will be NCR, Chennai, Bengaluru and its peripheral areas, Mumbai from Andheri, Ghatkopar, Vikhroli and Palm Beach Road, indeed the entire belt along the Western Express Highway. Third, will be long duration tax-free bonds and products packaged around long duration bonds.