Diwali is as good a time as any to take stock of annual portfolio performance and to consider changes in asset allocation. The festival season provides a natural break from the daily grind. Investors can take a little time out from celebrations to tot up returns and contemplate changes with a cool head.
The last year has been great for equity investors. The major indices have yielded returns of about 25 per cent. Many small- and mid-cap stocks have done even better than large-caps. A large number of active diversified mutual funds have beaten their respective benchmarks. So equity-based fund investments have also done well. This comes on the back of a positive return between October 2012 and October 2013, a period when the Nifty gained about 11 per cent.
Returns over the past year have been more up and down for debt investors. Interest rates have remained high at the RBI's behest despite inflation dipping in the last few months. Real returns, as opposed to nominal returns, from fixed deposits have improved in the past 3-6 months as inflation has reduced. Prior to that, real returns from FDs were negative, or hovering near zero.
Inflation beat debt for much of the last two years. Long-term debt funds have not done so well in the past two years. The one-year nominal return for this category averages out at about 8 per cent while the two-year nominal return averages out at 4 per cent. Among other traditional investment avenues, gold has lost ground. It is down by about 8 per cent in the last 12 months. Silver has crashed by almost 25 per cent in the same period. Gold is down due to a low inflation scenario whereas silver has been hit by poor industrial demand, as well as low inflation.
Real estate has been soft through the past two years. There is over-supply of commercial space and incomplete projects dot much of the country. Most realtors are cash-strapped. Demand from the housing segment has been muted due to high interest rates and generally poor sentiment.
The formation of a new government has led to a lot of optimism. The stock market is up because that optimism is expected to translate into growth. The economy seems to have bottomed out but its recovery has not been very strong.
GDP growth should improve in 2014-15 and inflation should reduce if the fiscal deficit is forced down as promised. Most economy watchers expect growth to accelerate sharply in 2015-16. In the near term, the business community expects interest rates will be cut either in January-March 2015 or in April-May.
On the other hand, global growth is expected to be slow through calendar year 2015. The IMF has cut its 2015 estimates for global GDP growth. China is in a slowdown with its GDP growth rate down to a five-year low. Europe's growth is stagnant. Germany is on the verge of recession and France, Italy and Spain are all in trouble. Japan will see positive GDP growth but the economy has structural problems, with government debt at 255 per cent of GDP. The US could be the only strong growth centre through 2015. This scenario of slow global growth may mean lower investment inflows to India, lower exports and cheaper raw material imports, including crude and gas at lower prices.
Putting all that information together, it's likely that plays on the domestic economy will do better than export-oriented sectors. Also, FII buying could taper down and that would affect stock valuations. Rather than reducing equity exposure, the investor could consider switching within equity: Go with rate-sensitives and plays on domestic consumption and investment. If interest rates are reduced, there would also be a bull run across debt funds. Exposure to debt funds could be a good strategy for the next 12-18 months.
The real estate market should also rally. Here, exposure via the stock market may yield higher returns with fewer risks than direct exposure. NBFCs such as HDFC and LIC Housing, where offtake and profits would be driven by lower rates and rising mortgage demand, could see outperformance. A low-inflation scenario is usually bad for gold. Silver will rally only when global industrial demand picks up.
Looking at overall asset allocation, the investor should maintain equity exposure. But those who have active strategies should look for higher exposure to domestic rate-sensitives. Among other assets, shifting allocation from precious metals to increase exposure to debt funds looks reasonable.
