What we make of this current situation

 There is a lot of material already available on the current financial situation of India and global and what can or rather will happen  in next ( financial pundits behave like God ) few months to a year. Herein we are trying to bring out what we understand and what should one do under such situation.While there was no doubt looking at the way money was printed and found place in some risky assets that there was going to be correction sometime in calendar year 2022. Also inflation was coming ,was also certain, however Russian invasion of Ukraine and the fact that the war has lasted for so long had come out of blue and just accelerated the pace of inflation.

Every economy is facing their worst inflation in many many decades, thanks to oil prices which is not showing any symptom to cool off. Top priority of any economy currently is managing to bring down their inflation and rightly so. While they acknowledge that rise in crude oil or some commodities agri/ metal is more of a supply side issue then demand but it’s not possible for them to wait anymore since the war which is the prime reason after the evil of covid is not showing any sign to end. All what they are left with now is to use monetary tools.

Fed has clearly said that their inflation target is 2% and they will keep on raising the rates untill they  reach there.Post 75 bps rate hike which they did 2 days back they’re mostly doing 150 to 175 bps more hike in next 3 meetings to reach at 3.4/ 3.5% .Most other economies are either following the same footsteps or have already started doing it long before so that they also don’t fall behind the curve.

 Now with this kind of clarity disseminated and uncertainty of crude oil price ,agri commodity and supply chain disruptions it is very very obvious that equity markets and all other risky assets would correct. Higher the risk in the asset class more the fall . Assets not backed by cash flow predictability are and would be severely affected as end of easy money has left the money pool dry for them .US IT companies mainly startups  and cryptos are experiencing their worst nightmares.

Now what happens from here?

Our guess is we have seen a lot of correction, too fast but maybe still we have more to go . There may not be vertical falls as we saw in last 2 months, but more of a grind.Of course we will have bounce backs, but may not sustain. What makes us think like that? Last decade we had crazy money printing, all this didn’t hurt until the inflation was within control .For every economy that was an excuse to print more but now economies have realised that if they don’t crush the head of this devil now, it will be too late and  damage will be  far more severe. While much of this is a supply created one but then how much they can wait ? If and when the crude and other commodities fall post war and inflation starts subsiding, they can always stop and re-assess the situation. So for next 4 to 6 months we clearly have quantitative tightening, means at least no more free /easy money. Liquidity is always been mother of all bull markets. Most of the global funds are hit big time by the correction and are either raising cash or looking for opportunities to raise cash. Retail and HNI’s have also lost a lot of money and all these guys will come back only after adjusting to the new realities and  after taking losses and gathering money and courage for the next round of bull run. Any big stock market fall of such magnitude accompanied by strong reasons take a lot of time to come back, 2001 to 2003 ,2008 to 2010. We don’t see it very different this time. Whether we are in recession or getting into it I am not even touching upon it, but history says all financial market meltdowns are followed by recession. Recessions are short lived phenomena but very painful. Early we have truce between Russia and Ukraine,fall in oil and supply chain normalcy resumption… recession can be avoided.

So is this a case, where all our money invested in equity instruments in India ( because we cover only Indian equities) will face a permanent loss and we should stop doing any SIP mistake?

                Let’s try to understand this from a 2008 to 2010 recession if at all we have one this time. When we exited 2007-08 financial year, we were a heating economy with GDP in real terms also close to 9%, balance sheet of big corporates were levered, bank lending was already in double digit in last 2 to 3 years and large capex were going on. As a result when recession hit and demand cooled off we had over capacities, unsustainable levered balance sheet of corporates, rising NPA levels in Banks  and it took us almost 5 to 7 years to come out of it even though we were growing at 6 percent plus every year.

                Now let’s look at this time ,we are entering recession (if at all it is )with clean bank balance sheet, unlevered large corporates and capex just announced but not executed. On top of all these we have a vigorous government, GST in place, strong forex reserves and good foreign ties. In short we are entering the den much much more stronger and once the dust settles we world emerge much stonger and bigger. So if we have seen higher prises post 2008/2010 recession, this time it will not be very different.

                Action we are suggesting.

                In every financial meltdown or corrections we have small caps doing poor mainly if they are levered ,mid caps and large caps have stronger balance sheets to with stand such difficult time. While  mutual funds have become smart in identifying good small caps, generally the fund allocation towards small and mid caps reduce during such time. So our advice would be continue SIP in them but don’t increase. If you don’t have an index SIP, time has come to add or increase allocation to them. Depending on one’s risk appetite allocation to large cap can also be increased. We may have  6/12/18 mts of rough period and any action should be taken with a clear mindset that we will continue to do this ritually till we are out of this. If someone is seriously panic then we would recommend reduce your SIP but don’t stop.

Good news

                Good news in all this is that fixed income rates will rise maybe at least 100 bps more from here ,for eg for say Bank FDs can go to 6.7/7 % by year end for say short period of 12/24 mts also and that should bring cheer to our senior citizens. Our advice here is don’t lock your fixed deposits etc for longer period now and maybe wait for 3/6/ 9 months because we are going high. That’s why our recommendation is stay away from bond funds. May be time to be active there will be in December or March.

                Our hypothesis can go wrong if we have a truce very soon between Russia and (West ) Ukraine and oil which is the most worrisome element for Indian economy cools off to say 90/100 $ per barrel. Let’s hope for the best and be positive.

KNOWLEDGE CENTER

How different hybrid funds help in asset allocation

Hybrid funds are mutual fund schemes which invest in multiple asset classes e.g. equity, fixed income, gold, real estate investment trusts (REITs) etc. The main benefit of hybrid funds is asset allocation. Asset allocation diversifies investment risk by spreading the investment of two or more asset classes. The risk profile of a hybrid fund depends on the asset allocation of the scheme.

Categories of Hybrid Funds

There are different types of hybrid funds with different asset allocation profiles. SEBI has categorized hybrid funds in the following categories:-

1. Aggressive hybrid funds: These hybrid funds invest 65 - 80% of their assets in equity and equity related securities and 20 – 35% of their assets in debt and money market instruments. In terms of risk profile, these funds are the most aggressive compared to other hybrid

2. Balanced hybrid funds: These hybrid funds invest 50% of their assets in equity and equity related securities and 50% of their assets in debt and money market instruments. An AMC is allowed to offer either aggressive or balanced hybrid fund, but not

3. Dynamic asset allocation funds: Also known as Balanced Advantage Funds, these funds dynamically manage their asset allocation; there is no upper or lower limit for equity or debt Dynamic asset allocation or balanced advantage funds are usually less volatile than aggressive hybrid funds.

4. Equity savings funds: These hybrid funds can partially hedge their equity allocation using derivatives, while maintaining gross equity allocation of at least 65%. These funds must invest at least 10% of their assets in debt and money market instruments. Equity savings funds must mention their minimum hedged and un-hedged equity exposures in their Scheme Information Documents (SIDs). A big advantage of equity savings funds is that they enjoy equity taxation even with fairly low net long equity exposures because of the arbitrage

5. Multi asset allocation funds: These hybrid funds can provide exposure to three or more asset classes e.g. equity, debt, gold, real estate investment trusts (REITs) and infrastructure investment trusts (InvITs). Multi asset allocation funds must invest at least 10% each in three asset classes

e.g. minimum 10% in equity, minimum 10% in debt and 10% in gold.

6. Conservative hybrid funds: These hybrid funds invest 75 - 90% of their assets in debt and money market instruments and 10 – 25% of their assets in equity and equity related securities. These funds can be suitable for investors with moderately low to moderate risk appetites and at the same time get equity kicker for inflation adjusted

7. Arbitrage funds: These hybrid funds can fully hedge their equity exposure using arbitrage Arbitrage funds must maintain gross equity allocation of at least 65%. Maximum investment in debt and money market instruments is capped at 35%. These funds are suitable for parking your surplus funds for a few months since the risk is low. The main advantage of these funds compared to liquid or ultra-short duration debt funds is that arbitrage funds enjoy equity taxation.

Why invest in hybrid funds?

1. Risk diversification: Different asset classes e.g. equity, fixed income, gold etc have different investment cycles. There is low or even negative correlation in returns of two or more asset The chart below shows the annual returns of different asset classes viz. equity (represented by Nifty 50 TRI), fixed income (represented by Nifty 10 year benchmark G-Sec index) and Gold. You can see in the chart below that equity and gold are usually counter-cyclical to each other, i.e. Gold outperforms when Equity underperforms and vice versa. Further there is low correlation between fixed and the other two asset classes. Diversifying your portfolio across asset classes limits downside risk when a particular asset class underperforms.

                                                        Source: National Stock Exchange, Advisorkhoj Research. Period: 01.01.2011 to 31.03.2022.

                                                        Equity is represented by Nifty 50 TRI and fixed income is represented by Nifty 10 year Benchmark G-Sec Index. Disclaimer: Past performance may or may not be sustained in the future.

2. Portfolio Rebalancing: Hybrid funds provide the benefit of periodic portfolio Rebalancing of assets ensures that the asset allocation of your investments do not deviate from the targeted asset allocation despite market movements. Portfolio rebalancing is aimed to reduce risk and help in generating relatively better risk adjusted returns over sufficiently long investment tenures. Please note that different funds follow different rebalancing strategies. You should read the scheme information document before investing.

3. Tax efficiency: Hybrid funds can be much more tax efficient compared to a portfolio of equity and debt schemes. Hybrid funds whose average gross equity allocation (including hedging or arbitrage) is more than 65%, enjoy equity

Taxation of hybrid funds

                                           Note: Investors should consult with their financial advisors about the taxation of their hybrid scheme before investing.

Points to consider before investing -

1. Different hybrid funds have different asset allocations and risk You should always invest in the appropriate hybrid fund category according to your risk appetite and investment needs. Consult with your financial advisor, if you need help in understanding your risk appetite.

2. Investors should understand that different schemes within the same hybrid funds category may have different risk You should refer to the scheme Risk o meter to understand the risk at the scheme level.

3. Different hybrid funds have different tax consequences. You should know the tax consequence of your investment and make informed decisions. However, in our view, one should not make investment decisions based on only tax considerations; your financial goals and risk appetite are more important

4. Since hybrid funds are less volatile than equity funds, they may be suitable for new investors. However, you should always have long investment horizons (e.g. 3 years or longer) for hybrid funds (except arbitrage funds).

5. You should always consult with your financial advisor if you need help in understand the risk / return characteristics of a hybrid scheme.

MUTUAL FUND SIP RETURNS

CATEGORY AVERAGE RETURNS

   - CA JAYESH GANDHI

 Disclaimer: This is an informative document and opinions expressed in it are our own and not any advice. We are certified investment advisors yet to be SEBI registered. We are AMFI registered MUTUAL FUNDS DISTRIBUTOR.