The BSE Sensex is 6 per cent below its peak hit in August 2018. With General Elections looming in four months, and the inevitable unpredictability of what the electorate would throw up, investors should ask themselves what are the risk factors they should be on the look out for. Here are a few of them:

Earnings growth versus valuations: A recent study by UBS has compared growth in corporate earnings with trailing PE multiples, over four time periods, viz, NDA 1, UPA 1, UPA 2 and NDA 2 governments. The findings are interesting.

Whilst corporate earnings growth has fallen over these four periods (18 per cent, 22 per cent, 13 per cent and now 5 per cent, approximately), the PE multiples have gone up (14, 15, 17, 21 times trailing earnings). How so?

This is primarily because of the structural shift in saving and investment pattern of domestic savers. In earlier years, over 80 per cent of household savings used to go into fixed income, mainly bank deposits. Investment in equity was under 5 per cent. The rest was in real estate, gold, etc. But there has been a huge shift of savings from fixed income towards equity, via mutual funds. This is for a number of reasons, including lower fixed deposit rates (whilst the stock markets were booming, leading to FOMO, or a Fear Of Missing Out) and the continuing saga of non-performing loans, creating doubts.

In each of the past two years, domestic savers have pumped in ₹1.2 lakh crore into mutual funds, mainly via systematic investment plans (SIPs), driving up the stock market and propping the index even as earnings growth slowed. The job of an equity fund manager is to invest in the best available stocks, irrespective of his personal belief, and so, when money flows in, as it is doing at the rate of ₹8,000 crore a month, it gets invested. Stock prices go up. Simultaneously, valuations get stretched.

And there lies the risk.

Forthcoming general elections and growing populism: Subsequent to loss by the BJP of three main, populous, States in the heartland, there is a growing tendency of all political parties to resort to populism, unmindful of fiscal discipline.

The newly-elected Congress-led Government of MP has, for example, launched a ₹50,000-crore farm loan waiver scheme. The BJP Government of Maharashtra has waived off loans to marginalised farmers.

The risk in such populistic schemes is that, post elections, there will be little money for investment. How, then, will the investment cycle, crucial to achieve an 8 per cent GDP growth rate, pick up? It can’t.

What should investors do in such uncertainties? Diversifying investments.

One option is soon to open up in India, viz, Real Estate Investment Trusts (REITs) with the first REIT soon to be launched by the Embassy-Blackstone group. Some 33 million square feet of rent-collecting office space will be sold to a REIT, which will offer units to retail investors. Some equity mutual fund investors may consider diversifying a bit of their savings into REITs. Office rentals are not at risk of rent control legislation, and corporate tenants are sticky, with a high renewal rate.

There are other risk factors to the markets, too. So, it’s better to get a bit light and diversify into other asset classes as well.

(The writer is India Head — Finance Asia/Haymarket. The views are personal.)

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