From Equities To Eldorado

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From Equities To Eldorado
Devangshu Datta - 02 August 2019

The much-anticipated first Budget of NDA-II did little for the economy. There is no sector, which has received significant benefits.

Higher customs duties imply many goods will become more expensive. This in turn might dampen consumption demand. In addition, a surcharge on the super-rich affects Foreign Portfolio Investors who often work through trusts, which are now liable to taxation.

Put it together and disappointed investors have started selling down stocks. This bearish attitude is quite likely to continue. It is not an unusual situation in terms of business cycles but it means that short-term returns from the stock market are unlikely to be good.

If you are a long-term investor with the patience to hold for several years, this should not bother you. Keep investing via diversified mutual funds and your acquisition costs will average down. As and when the market recovers, your returns will more than compensate for the period when you suffered capital losses. But you must be prepared to hold your equity portfolio for several years.

In the shorter term, there are three possibilities worth considering. One is, moving a certain amount of assets abroad, into hard-currency mutual funds. If the rupee falls and that is likely, your returns will be automatically boosted.

A second option is to invest in gold, via either ETFs, or by buying the metal directly. Gold is a currency hedge, and also a more general hedge against inflation and geopolitical uncertainty. It has already hit record levels but it could well go further if you look at the global picture. Slowing global economy, US-China Trade War, US-Iran faceoff affecting energy supplies and finally Brexit impacting growth in UK and Europe. Gold is a traditional haven under such circumstances.

A third option is to increase exposure to rupee debt. It’s worth explaining the pros and cons of this in more detail. The most likely responses to a slowing economy are interest rate cuts to stimulate activity. The RBI has cut interest rate in its last three policy reviews and it is likely to continue doing so.

The policy interest rates set by the RBI rates directly concern the central bank’s lending and borrowing from banks. But indirectly, this affects the yields on government treasuries and eventually, it affects commercial rates. Since lenders receive a lower return from safe treasuries, they are willing to accept lower returns from commercial borrowers.

As interest rates fall, the value of loans made earlier at higher interest rates rises. This makes it possible for lenders to book capital gains on their portfolios. For example, consider a loan of Rs100 made at let’s say, seven per cent interest, for one year. The interest rate drops to six per cent.

The creditor can now sell that loan for Rs100.75 to a buyer who is happy with an effective return of 6.2 per cent (`107 on an investment of Rs100.75), a year down the line.  Meanwhile, the seller of that loan receives a return of 0.75 per cent in a single day. That annualises to a big capital gain. Debt mutual funds and banks book capital gains when interest rates fall. They also gain in terms of business volumes since there is more borrowing when interest rates are low.

The retail investor loses out in one way because banks will offer lower interest on deposits and Provident Funds rates could be reset. But debt funds can be a good investment when interest rates are  falling and there is a good argument for increasing debt fund exposure when you expect lower interest rates.

Balanced against this, there have been a lot of defaults in the recent past and there is a real danger of more defaults. In a slow-growth scenario, corporates will struggle to service debt. In that sense, debt funds are more risky investments than at first glance.

Summing up, this is the post-Budget scenario.  The stock market will not go up in a hurry. Maintain your equity exposure but look at alternatives like gold and overseas investments in hard-currency assets to create hedges.


The author tracks economic, behavioural and corporate trends, hoping to gauge good avenues of returns

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