It is time to rejig portfolios

In the last six months, foreign portfolio investors (FPIs) pulled $19 billion out of Asia's Emerging Markets. That included FPI selling of rupee debt to the tune of Rs 400 billion and sales of Rs 57 billion of rupee equity.
 
The FPI sales were more than matched in the equity space by Domestic Institutional inflows of Rs 597 billion. Taking the five month period, January-May 2018, equity mutual fund (MF) inflows amounted to Rs 356 billion, which is a large proportion of the Rs 597 billion contribution by all domestic institutional investors (DIIs). In the first two months of 2018-19, equity inflows totalled about Rs 211.7 billion, that is much more than the Rs 140 billion that flowed in during April-May 2017.

 
MF inflows are heavily driven by retail and HNI investments. Assets held by individuals increased from Rs 9.2 trillion in May 2017 to Rs 12.2 trillion in May 2018,  that is roughly 33 per cent increase. Individual fund holdings now equal 52 per cent of all AUM.
 

The Nifty rose by about 11 per cent during the 12-month period (May 2017 closing value of 9621 to May 2018 closing of 10,736). So long as inflows remain healthy, major market indices will most likely, stay up. A large proportion of fund subscriptions are via SIPs, which are committed for a minimum of six months, or longer, with six months the most common period. There is often a surge in SIP commitments in a new fiscal. We may therefore, expect inflows to remain healthy till September 2018 at least.

 
While equity inflows stayed strong, the composition of fund inflows has changed. In April-May 2018, there was redemption of Rs 152 billion from income funds compared to Rs 397 billion inflows last year. There were inflows of Rs 697 billion into Liquid/ Money Market schemes in 2018-19, compared to Rs 347 billion in 2017-18. 
 
The shift from midterm and long tenure debt to shorter tenures is a defensive measure taken when the rate cycle is expected to turn. Indeed, the interest rate cycle has turned, with the Reserve Bank of India (RBI) hiking in June and indicating that it’s prepared to hike again. There will be more inflows out of mid tenure/ long-term debt to liquid funds. Note that this is essentially corporate action - this segment of the fund space is dominated by corporates.

 
There is a near-guarantee global monetary policy will tighten through 2018. Apart from the RBI hiking rates, US bond markets are signalling the peak of the current economic expansion with rates rising, and the yield curve close to inversion. The US Federal Reserve has an ongoing quantitative tightening (QT), which will shed over $4 trillion from the Fed's balance sheet in the next two to three years. The European Central Bank (ECB) will taper its ongoing QE (quantitative easing) by December. Japan will maintain its current easy money policy but it won’t expand QE. So, it won’t compensate for the ECB taper and the Fed’s QT.

 
If money supply tightens, and rates increase, banks and other financial entities won't do well. Rate-sensitive corporates, with high working capital needs, may also come under pressure.  If SIP investors cut back commitments and fund inflows dip, big stocks could come under pressure.
 
We are already in an “undeclared” bear market. Over half of NSE500 stocks have lost ground since January. That’s a sign of retail investors becoming wary and booking profits. If DII support eases off, big indices would be affected.
 
Long-term investors should seek defensive value, looking for companies, with moderate working capital requirements, low debt:equity ratios and decent net cash-flow. The traditional FMCG sector could be a beneficiary since good FMCG companies have low debt:equity ratios and manage working capital needs well. Export-oriented stocks may gain purely as plays on a weaker rupee, even if export volumes don’t rise much due to the trade war.