Big Story | 2021 — What’s in store for equity, debt, gold and real estate?

Large-caps | Pricing power is much better than expected in many sectors: Shreyash Devalkar, Senior Fund Manager, Axis AMC

The corporate world has been cautious in the last few years and, hence, we did not enter this pandemic-led crisis with too many excesses, both in terms of capacity and leverage. In India, we emerged superior on most macro-economic parameters such as CAD (current account deficit), inflation, interest rate, fiscal deficit (compared with the rest of the world); our forex reserves are at their highest. The most important delta during the year was, finally, substantial transmission of interest rate fall; mortgage rates currently are at their lowest in this decade.

As far as absolute movement of stocks is concerned, the sharp movement is backed by easy monetary and fiscal policies in major economies worldwide. Equity, in nature, being a long-duration bond, the money has flocked to the companies that have the highest FCF (free cash flow) yield, and quality stocks with low debt and high ROE have outperformed in the last one year.

Rotation in sectors, on a relative basis, was again observed based on a change in the pecking order of relative growth. Sectors such as pharma, IT and auto outperformed the wider markets, as these showed highest relative growth. Meanwhile sectors such as financials, capital goods and infra underperformed due to lower relative growth due to the pandemic. The resilience of many sectors during the pandemic-led disruption has resulted in the more broad-based rally.

Fundamentally, listed companies, which are mostly organised plays, have shown lot of resilience in margin management, FCF focus and market share gain. However, in the unlisted/unorganised space, the (pandemic) impact was more. While some sectors like auto and real estate have shown resilience, even asset quality of the financial services sector, so far, has been better than feared.

During the last two quarterly result seasons and based on the high-frequency data points during the festival season, it is being observed that pricing power is much better than expected in many sectors. It may be a result of both better-than-expected demand and lasting supply constraints in many sectors even now.

Sustenance of this, especially the demand outlook for 2021, is an important parameter. Sustenance of lower interest rate despite some signs of sporadic inflation (especially crude-led) would be crucial, to see long-term revival in important cyclical sectors such as real estate and auto — both having very high multiplier effect on economy.

On the other hand, valuations have more than captured the return to normalcy in most companies. The progress on vaccination and supporting low interest rates can lead to sustained returns.

The broad-based rally being observed now may continue at the sectoral level. As highlighted earlier, some sectors are showing demand resilience, some are showing cost control and FCF management, and some are showing better asset quality.

However, within sectors, the rally may narrow in a few stocks if there are any delays in pandemic control, or if interest rates do not sustain at low levels. As always, the returns from the markets have been in line with the nominal GDP growth, and one should expect that to continue on a 2-5-year basis.

Markets have ultimately rewarded quality and growth stocks on a one-, three- and 10-year basis. Even in this calendar year, the relative performance of sectors/stocks has been based on this observation, though from bottom of March 2020, it may appear that everything has worked across board. Our philosophy has been to follow quality-growth, and we have objectively tried to adhere to it to the best of our abilities, and we will continue to do so.

The passive story has been playing out very well in India over the past decade or so. While the absolute growth in AUM (assets under manangement) has been driven by pension funds and government agencies allocating meaningfully to equities through ETFs (exchange-traded funds), there has been a large awareness drive that has resulted in investors appreciating the benefits of low-cost investing. Investors today must look to allocate across both types of products to get the best out of their equity investments.

Mid- and Small-caps | Focus on quality stocks, long-term goals: Vinit Sambre, Head - Equities, DSP Investment Managers

The low base of 2018 and 2019 was in itself a good starting point. The earnings trajectory of companies within mid- and small-caps showed good recovery by the September 2020 quarter after having been hit in the March and June quarters due to the lockdown.

Global liquidity also played a role in pushing the prices higher. If we further breakdown the sectoral performance, it is observed that some sectors within the mid/small-cap space like banking, entertainment and retail space are still underperforming due to expectation of delayed recovery in their businesses.

Hence, it is not the case of ‘rising tide lifts all boats’, but whichever sectors have done well due to better performance, the valuations have gone through the roof in many cases, pushed up by heightened liquidity.

I would agree that valuations are seemingly high in a few sectors/stocks and, hence investors, should caution against excessive optimism and avoid investing in fundamentally weak companies. In the context of valuations, it would also be relevant to highlight here that in many sectors such as automobile, cement, engineering, banking and finance, valuations may be seem high, but they are on low cycle earnings. As the earnings cycle recover, the upgrades would be very strong, which would easily justify these multiples.

Our core investment philosophy is to build a portfolio of high-quality companies having a strong historical track record and superior future outlook. We buy with a long-term view of over 4-5 years, which is also reflected in our low turnover ratios for the fund. This allows us to reduce the external noise and focus on the core.

In our selection criteria, we lay emphasis on the quality of management, cash flows, ROCE (Return on Capital Employed), and companies having strong competitive advantages. We are happy to build concentrated positions in such companies where we have high conviction.

We also look at some cyclical businesses which are at the cusp of a turnaround, where ROCEs are slated to move up in the foreseeable future. We avoid stocks which do not meet these criteria.

In terms of sell decisions, we look to exit companies where valuations have become unreasonable, where the thesis is not playing out as anticipated or where we see mis-allocation of capital.

Given the valuations, we would advise investors to avoid investing in small- and mid-cap stocks with a one-year time-frame. Given the uncertainties we are experiencing, we feel it would not be prudent to make any specific predictions for 2021.

We can only say that we have strong confidence in the abilities of our companies we own in our DSP Midcap and DSP Small Cap funds to outperform over the long term, and, hence, investors with a long-term capital of over five years can look to allocate in these strategies.

We have a positive view on sectors such as Information technology — due to the benefit of technology adoption taking place globally; healthcare — due to rising healthcare needs, improved outlook for the speciality generics in the US market, and recovery in demand post pandemic; and consumer discretionary — as a beneficiary of the economy opening up gradually and rising consumer spending taking place from accumulated savings during the lockdown.

We also consider automobile, cement and engineering to see cyclical recovery and hence hold a positive view. Finally, we see better outlook for the agriculture sector and hence are positive on companies benefiting from the agri theme.

We would avoid sectors such as oil and gas, power utilities and metals due to too many uncontrollable variables and heavy balancesheets with excessive debt.

We are in an extremely uncertain environment with a lot of noise around. The business and economic cycles have shortened and so has the investors’ behaviour. Everyone is trying to react to every possible news, further adding to volatility. In such an environment, the right temperament itself is an edge, which means cutting the noise and remaining focussed on long-term financial goals.

Fixed Income | Say no to credit risk: Anurag Mittal, Associate Director - Fixed Income, IDFC MF

This year has been unparalleled for the Indian bond market and has been different from previous episodes of volatility like the 2008 financial crisis or the 1997 Asian crisis, which originated outside India and were not connected with the mainstream domestic economy. Moreover, the year started with the economy in a vulnerable position. Higher household leverage, impaired balance sheets of lenders and a high effective fiscal deficit (Centre + State + public sector) — these were some of the key concerns for the bond market pre-Covid.

While the market, assuaged by the fiscal consolidation plan in the FY21 Budget, initially rallied in February, the realisation of the extraordinary scale of the pandemic, coupled with local issues in the banking and mutual fund sector, caused severe dislocation in the markets.

The March 27 RBI policy was pivotal in stabilising the market with aggressive repo rate cuts, cutting of the Cash Reserve Ratio, introduction of Targeted Long-Term Repo Operations (TLTROs) and special TLTROs for non-banking financial companies (NBFCs) and a borrowing window for mutual funds. To support the unprecedented large borrowing programme, the RBI has been maintaining the momentum by regularly conducting Open Market Operations (OMO)/Twists, increasing the held-to-maturity limits and introduction of OMOs in State loans.

The reverse repo rate (3.35 per cent) has been the effective policy rate since April, given the persistently abundant liquidity post the RBI’s conventional and unconventional measures. While liquidity may remain surplus going into the next fiscal year, given the favourable balance of payment dynamics, we expect the short to medium part (up to five years) of the yield curve to reprice higher in the next 12 months as the RBI shifts from ‘crisis’ to ‘new normal’ levels.

This could commence in the form of the RBI narrowing the repo/reverse repo corridor (raising the reverse repo rate), ultimately followed by a move towards positive real repo rates over the medium term, albeit the level of real rates depends on the pace of recovery. Pre-pandemic, the rate corridor was at 25 basis points. With the added cuts in the reverse repo since March, the corridor is at 65 basis points now.

While the bulk of the adjustment might happen on the short-end, long-end rates (typically10-plus years) might remain on the higher side in the medium term given the envisaged fiscal gaps and borrowing needs coupled with the absence of aggressive RBI bond purchases.

However, it is important to note that policy adjustments are likely to be very gradual and the yield curve is already quite steep, and particular points on the curve (at 6-9 years currently) offer decent carry versus mark-to-market trade-offs. These points on the curve can offer attractive opportunities, but one must be investing for a longer time frame (over three yearsand be prepared for intermittent volatility.

CPI inflation has remained elevated mainly due to high food inflation driven by weather-related and supply-chain disruptions. Core inflation, too, has been sticky due to high fuel taxes, gold prices and cost-push pressures in health/personal care.

We believe that CPI inflation has peaked in the near term and is expected to average close to RBI’s forecasts (5.2-4.6 per cent in H1FY22) aided by restoration of supply chains, favourable base effect and weak aggregate demand amidst a lukewarm consumer sentiment as households look to repair their balance sheets in face of income/job cuts.

An archetypal fixed-income investor’s primary expectation from their portfolio is predictability and downside risk mitigation Hence, we recommend investors to align their time horizon and risk appetite by dividing their allocation between across buckets — liquidity, core and satellite.

While the liquidity bucket can cater to short-term cash needs, the core bucket should include funds that run high-quality credit or controlled duration strategies with an aim to provide steady returns over a period of time. These latter could range from ultra-short to medium-term funds, and that’s where investors should look to allocate a majority of their portfolio depending on their time horizon.

The satellite bucket can consist of funds in long-duration or credit strategies. These are suitable for investors who are looking for longer-term allocation (over three years) and can tolerate commensurate volatility.

However, given the uncertain macro environment and already narrow credit spreads, chasing credit-oriented strategies doesn’t provide the appropriate risk-reward in our view.

Gold | ETFs here to stay: Chirag Mehta, Senior Fund Manager, Alternative Investments, Quantum AMC

On the surface, risk and uncertainty seem to have ebbed, as the progress made on the vaccine front has spurred optimism about a return to normalcy. This has boosted risk assets and hurt gold prices over the last few weeks.

But gold prices seem stretched to the downside relative to the ground reality — risks still persist. Firstly, widespread access to a vaccine remains months away. There is no doubt that a successful vaccine’s impact on the health effects of the pandemic will be positive, as and when a large-scale roll-out is achieved. But it can’t undo the extraordinary economic damage caused over the last few months overnight.

The World Bank estimates that a full recovery will take five years.Thus, a return to ‘normalcy’ is a long way and prone to setbacks like the second wave of infections in the developed world, the new virus strain now detected in the UK, fresh lockdowns and the economic rebound losing steam.

The resulting risk and uncertainty over the next couple of quarters will bode well for gold.

Let’s remember that gold was already on an upward trajectory before Covid-19, with the pandemic being only one of the tailwinds for its incredible rally. And most of the macroeconomic conditions that supported gold are now being carried forward by the world to 2021.

Even before the pandemic hit the world, geopolitical and economic issues such as the US-China trade war and slowing growth plagued the global economy. This caused central banks worldwide to pivot to a more dovish stance in which they lowered interest rates.

Now, with the pandemic having exacerbated the existing macroeconomic weaknesses, we expect interest rates in the US, as well as the rest of the Western hemisphere, to be low for a longer time. This makes holding gold a more viable option than holding US Treasuries as the former successfully preserves purchasing power in a negative real rate environment.

With plenty of liquidity sloshing around and also seeping into the real economy, unlike 2008 — where liquidity remained bound to banks and financial institutions — the probability of inflation looms large. This is incredibly bullish for gold

With US national debt crossing $27 trillion in 2020 and amounting to 140 per cent of the nation’s annual economic output, the US dollar has naturally withered and weakened this year. Gold, which is priced in dollars, will be a big beneficiary if a crisis of confidence plagues the world’s reserve currency.

US-China relations are at their lowest point in decades, with the pandemic aggravating trade and technology disputes. The resulting uncertainty in equity, credit and currency markets will trigger a risk-off sentiment. This will push up investment demand for relatively safer alternatives such as gold.

Positive signs of economic rebound, FII (foreign institutional investor) inflows and dollar weakness have resulted in strengthening of the rupee this year, in spite of a larger fiscal deficit. For most of 2020, the RBI aggressively bought dollars from the spot market to counter the foreign fund inflows to equities and prevent a sharp rupee appreciation. This central bank intervention is expected to continue for the next few months as the RBI tries to maintain export competitiveness and support growth.

If we continue to see investment flows in India, the rupee could see some appreciation. And if the inflows slowdown or reverse, INR could be back to its gradual depreciating trend that we have seen over the last few decades.

Investors need to keep in mind the long-term depreciation of the rupee vs the dollar. Since the 1970s, INR depreciation has added around five per cent annually to gold’s returns in rupee terms, And this depreciating trend will continue over the long term and the magnitude of depreciation will depend on India’s ability to attract long-term flows.

Share of gold ETFs (exchange-traded funds) as an avenue for gold investment in India has increased to 25 per cent in 2020 from around 10 per cent levels previously. Some of this increase can be attributed to the physical limitations imposed by lockdowns.

But some of it is definitely a result of increased digitisation and appreciation of benefits such as purity, price efficiency and convenience that gold ETFs bring to the table. This makes us believe this shift towards gold ETFs is here to stay.

The outlook for gold as a risk-reducing, return-enhancing portfolio diversifier remains positive. If you haven’t already allocated 10-15 per cent of your investment portfolio to gold yet, now is a good time to buy. You can take advantage of the lower prices and benefit from the long-term prospects of gold.

Real Estate | Strong demand for residential realty: Shishir Baijal, Chairman and Managing Director, Knight Frank India

There has been a strong growth in demand for residential during the second half of the 2020. This is backed by some strong positive steps taken by the RBI and the Finance Ministry that have let end-users take purchase decisions.

Firstly, values of residences across most markets have either remained static or corrected in the last few quarters, making them more affordable. By the end of H12020, residential prices in key markets had seen correction of 2-6 per cent.

Mumbai recorded an average correction of 3 per cent, while Pune saw a correction of 5 per cent year-on-year. NCR (-6 per cent), Chennai (-5 per cent), Kolkata (-4 per cent) and Ahmedabad (-2 per cent) also recorded correction. This, coupled with factors such as home loan rates being at historic lows, increase in savings rates etc, led to demand growth.

In addition to this, specifically in Maharashtra, the State government reduced the stamp duty by 300 basis points for a period of six months, which has greatly stimulated demand in the markets of Mumbai and Pune.

The demand for homes will be highly dependent on a number of factors, including performance of other investment asset classes, the Budget announcements and financial sops by the Centre, State government policies and rate of interests for home loans.

Despite the positive trend in economic growth, the challenges created by the Covid-19 pandemic are far from over. Thus, the balance on which the current growth is based would have to be maintained by all stake holders.

The office segment had been witnessing growth y-o-y backed by continuous growth in the global and domestic IT and technology sector as well as expansion of Indian corporates. For the year 2019 (CY), transaction in office space registered a growth of 27 per cent versus the same period last year.

However, with the affliction of Covid-19, activities in the office sector saw a negative impact in the volume of transactions, especially in the middle of the 2020. Despite latent demand, transactions could not be completed in the months of lockdown, leading to low office space transactions.

As India starts its process of un-locking, we can see the corporates renewing their real-estate expansion plans. Key commercial markets have started to see a growth in transaction volumes, and are fast returning to normality. We expect office space to regain momentum as commercial activities return.

The Indian office market continues to offer value on the global platform. The weighted average rent in dollar terms is comparable over a 10-year period — while the weighted average rent in 2010 was ₹45 per square feet (psf), today it is approximately ₹75 psf .

The developer pedigree has improved remarkably over the last decade with an upgrade in construction quality, and India continues to have the demographic advantage to attract technology-based global companies. Thus, the fundamentals for growth of the office business remain sound.

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