Returns from equities likely to be lower in FY22, say market experts

Advise sticking to shorter duration debt funds and using correction for accumulating gold

Despite the Sensex’s 74 per cent run up over the past year, the Indian equity market could still reward investors if the expected revival in earnings materialises, according to market experts. Returns during the coming year are more likely to be in line with longer-term trends (the Sensex’s five-year return is around 14 per cent currently).    

Several factors are expected to aid the market’s performance this year. “Moderate interest rates should aid demand recovery. Factors like production linked incentive (PLI) schemes, high government capex, and recovery in a sector like real estate that has vast linkages are expected to support earnings recovery,” says Shailesh Bhan, deputy chief investment officer-equity investments, Nippon India Mutual Fund.

While valuations may appear higher compared to the last three-year average, they could normalise if the expected recovery in earnings growth materialises.

“We are positive on themes like domestic consumption, pharma, chemicals, auto ancillaries, capital goods, defence production, and select public-sector names where valuations are attractive,” says Ankit Jain, fund manager, Mirae Asset Investment Managers. Investors could also hunt for picks in sectors that will benefit from the government’s capex cycle and IT services, where demand is rising and which is being supported by the trend towards digitisation.

Since the markets have rallied so much, there could be some consolidation, and that could produce intermittent volatility. Risks could also appear in the form of high inflation resulting from a sharp rise in commodity prices (especially crude prices sustaining above $70 per barrel), and steeper-than-expected rise in yields internationally. A second Covid wave is another risk that investors need to watch out for.  

The large-cap segment, which contributes around 75 per cent of market cap, is expected to continue benefiting this year from the shift in market share from the unorganised to the organised sector and the consolidation among larger businesses in various sectors (telecom, banks and NBFCs, industrials), which could result in enhanced pricing power and profitability. The deleveraging of large-caps has improved their risk profile.

While mid- and small-caps may have outperformed large-caps over one year, they are still underperformers over a three-year horizon and could continue doing well. “When the macro-economic scenario is improving, mid and small-caps tend to do well,” says Jain.

Longer-duration funds if you have risk appetite

With inflation on a higher trajectory, US Treasury yields have risen. They should have risen in tandem in India also, but the Reserve Bank of India’s (RBI) interventions have led to a lesser increase. This trend is likely to continue. Owing to the government’s heavy borrowing programme, the RBI is expected to try and prevent a steep rise in yields at the long end of the curve.

Investors with moderate or low risk appetite should invest according to their investment horizon. Those with a three-month horizon should invest in liquid funds while those with six months to one year may go for ultra-short or low duration funds.

Those who have a higher risk appetite, and an investment horizon of more than three years, may invest in longer-duration funds like gilt funds. The yield curve is steep. The one-year treasury bill is at 3.75 per cent while the 10-year G-Sec is at 6.15 per cent—a 240 basis points spread. “The spread is quite high and that will offer protection in case of a rise in yields,” says Dwijendra Srivastava, chief investment officer-fixed income, Sundaram Mutual Fund.

Use correction in gold to build allocation

Yields in the US are normalising from very low levels. Flows into the US have led to appreciation of the US dollar. Both these factors have contributed to a steep correction in the price of gold from its August highs. “We do not expect yields in the US to move up significantly from here onwards,” says Chirag Mehta, senior fund manager-alternative investments, Quantum Mutual Fund. The US economy is not out of the woods yet, so the central bank there is unlikely to allow yields to rise much as that could hamper the economic recovery. The US government’s high fiscal deficit means the dollar will continue to be under pressure.

Investors who don’t have at least a 10-15 per cent allocation to gold should use the current correction in its price to build their allocation. Those who already have an allocation should maintain it to safeguard their portfolio against future risks. 

Real estate: Poised for gradual recovery

With developers adopting a more rational attitude towards launching new projects, the inventory overhang that had plagued many micro-markets within the country is normalising. According to experts, the residential real estate market may have bottomed out, and one can expect moderate price rise this financial year. 

With tighter regulations since 2015 onwards, speculative activities have nearly vanished. “At least 80 per cent of the market today consists of end-users and only 20 per cent is investors. Hence, growth is likely to be more steady,” says Santhosh Kumar, vice chairman, Anarock Property Consultants.

Those who invest in residential real estate now will have to do so with at least a five-year, or higher, time horizon to earn returns of approximately 8-10 per cent from a residential property investment, says Kumar.