scorecardresearchLook at low volatility mutual funds, instead of sector-specific bets, says

Look at low volatility mutual funds, instead of sector-specific bets, says Shalini Dhawan of Plan Ahead Wealth Advisors

Updated: 16 Jun 2022, 10:06 AM IST

The dampening effect of macroeconomic factors is evident on both the global and domestic markets. Every investor wants to invest in stocks at their cheapest valuations, but there is no way to know when and at what point the market would bottom out. Relying on fundamentals is one good way. Apart, investors must select assets that beat inflation in the long run. 

Shalini Dhawan, Co-Founder & Director, Plan Ahead Wealth Advisors explains to MintGenie how investors must not panic against investments in equities

Shalini Dhawan, Co-Founder & Director, Plan Ahead Wealth Advisors explains to MintGenie how investors must not panic against investments in equities

People are feeling apprehensive about investing in equities considering the continued bloodbaths in the stock market. However, this is all temporary as many had anticipated it considering the lofty valuations some stocks were priced at. Stock fundamentals then have a deciding edge as the effect of macroeconomic factors evaporates with time.

Shalini Dhawan, Co-Founder & Director, Plan Ahead Wealth Advisors explains to MintGenie how investors must not panic against investments in equities and that the money must be invested as per financial goals and risk appetite.

Q. Since the rate hike cycle has begun, what should be our strategy for equity investment? Should we avoid the rate-sensitive sectors and look at the defensives life the IT and tech?

Answer: Increasing interest rates do tend to have a negative impact on companies’ future earnings as the cost of capital increases and that pressurizes earnings, and the intrinsic value of a company decreases (as the discount rate increases), i.e., WACC increases.

In a rising rate environment, growth businesses are expected to be impacted, which means that stock markets will be impacted. This does not mean one should not invest in equities, investments must be made as per investors’ agreed asset mix.

The Information Technology services or tech sector in India has valuations that are at elevated levels and their earnings momentum is also slowing down. Amongst the BSE 200 pack, nine out of 10 IT services companies have seen earnings downgrades. Therefore, high valuations and decelerating earnings growth do not make IT a safer play, although it is less sensitive to interest rates compared to broader markets.

As central banks are reacting aggressively to control inflationary pressures, one may need to look at the category of low volatility funds/schemes, instead of sector-specific bets. Low volatility is a style of factor investing that has outperformed other factors and broader markets during bear phases of the markets, because of the defensive nature of the underlying portfolio. Usually, low volatile schemes are overweight on the consumer, and healthcare stocks, whereas underweight on cyclical like financials, energy, etc.

Q. Amid all the concerns, inflation seems to be the biggest one for investors because soaring inflation has triggered aggressive rate hikes which have the potential to hit economic growth. How can investors hedge their portfolios against the inflation risk?

Answer: Inflation numbers reported like CPI may either underestimate or overestimate an individual’s current scenario. The best way to calculate inflation is to first understand the big items in your spending basket and then calculate the monthly changes in these expenses. This delta shall provide a fair estimation for inflation changes for you.

For example, if you are in your 50s and want to beat medical inflation then constructing a portfolio with greater exposure to the healthcare/pharma sector could be relevant for this medical corpus goal to provide a hedge against healthcare inflation.

On the other hand, for a younger investor, increasing allocation to equities is a better proposition to beat inflation, as he /she has a longer time horizon, and this could help equities give inflation-beating returns to provide for aspirational and consumption-related goals such as new phones, cars, holidays, etc. for the young investor.

So, in all inflation is very personal, so investors would be better off personalizing their portfolio and investment decisions accordingly to beat that inflation.

Q. Gold this year has not been able to meet the expectations of investors? What has kept gold prices capped? Should one invest in gold at this time?

Answer: The dollar index and gold move in the inverse direction. The DXY or dollar index has been on an upcycle this year on the back of tightening underway in the US. This year’s strengthening dollar index (currently around 105) has resulted in gold’s subdued performance.

Gold has been doing very poorly as an inflation hedge; however, it still does a very good job in downside protection and shock absorption as it did in the recent geopolitical event. As it runs negative co-relation with equities, when equities and all other assets were facing a selloff, gold was up by more than five per cent and touched a new high.

So, looking at the importance of gold in adverse circumstances, one needs to keep some portfolio in gold assets, to the tune of five to 10 per cent of the portfolio. However, we caution against the added reliance on gold as an inflation protection tool.

Q. Rupee is at an all-time low. What does it mean for an investor?

Answer: Recently the rupee breached 78/USD with depreciation of approximately five per cent vs the USD. A declining rupee is a result of a strengthening dollar index which is up 10 per cent on a YTD basis. The rising crude oil prices and therefore higher CAD, and large FPI outflows from India are some of the causes. The Rupee has lost about five per cent vs the Dollar YTD but gained about four per cent v/s the Euro and GBP YTD, illustrating the dollar’s strength globally as investors search for safe havens. As per the REER valuation which measures INR against a basket of 40 currencies, as of April 30, the Rupee is still overvalued by around one per cent.

If you are an investor investing to fund a goal that is in USD, your rupee cost of funding is going higher as the movement has been quite sharp in the span of fewer than six months. Therefore, you might want to provide for that accordingly, like investing in USD-denominated assets so as to minimize foreign currency risk. If you have already invested in foreign funds through FOF or ETF routes, then your returns will be higher to the extent of the Rupee depreciation.

Q. In the equity space, analysts are now advising to stick to large caps only. Do you think it is time to stay away from mid and small-caps?

Answer: In a rising interest rate scenario, an increase in the interest rate causes the cost of capital to increase, thus it becomes challenging for smaller companies to raise capital for their businesses. An increase in the interest rate also has a direct impact on profitability. Accordingly, large caps may be able to better withstand this environment and therefore it would be prudent to stick to larger cap schemes and stocks. Investors with a higher risk appetite can hold mid and small caps provided their holding horizon is longer.

(In the current inflationary environment and supply chain issues, companies are facing input cost pressures, and therefore margins are coming under pressure. As per the recently reported Q4 number EBITDA margins have come down by around 200 bps YoY. In this environment, large companies have a better ability to deal with these pressures because of volumes and operational efficiencies, whereas smaller businesses are relatively less able to face these pressures.)

As markets start to struggle with their performance, retail participation may also come down, which has been instrumental in the small and mid-caps rally over the past many cycles. In addition, market valuations are not at comfortable levels yet. Therefore, we prefer large caps in this environment, however, there might be stock-specific opportunities in the small and mid-cap space for aggressive investors as well.

These are the investments you can make to beat inflation.
First Published: 16 Jun 2022, 10:00 AM IST