04 May, 2013

A tactical allocation away from equities

“Why should I invest again in equity, when I have got just 5% annualized returns, over the last five years?”, asked my client, irritated. I told him that I’m not suggesting that he invest in equity now and that I’m actually suggesting that we should relook at the portfolio and do a bit of rebalancing. I told him that we will actually be moving away from equities.

Assuaged, he was willing to listen. I now told him that I have not lost faith in equities; in fact, it is quite the opposite. But then, I told him, I was willing to make a tactical call.  Equities keep going up and down. It may be due to the FM talking up the markets with possibilities of reform or based on the employment numbers in the US – but that is not something one needs to worry about.

We need to worry when the economy goes into a tailspin due to a combination of factors that would not get addressed in the near future. Interest rate being high is only part of the problem.  An adverse investment environment is hampering new investments coming in. Difficulties in getting environmental clearances, changing regulatory environment, uncertainty in policy framework, retrospective taxation evoked by income tax department and general bureaucratic problems abound, have started weighing on the economy. 

Industrialists are vocal about going abroad for investments. There have also been the usual, known problems of skills shortage, power woes across the country, coal & iron ore shortages and other such problems. 

Government has launched a lot of populist programs which completely plays havoc to the finances of the government. In a election year, it could get worse. Current account deficit is high too and we do not have much control over it. Add to this the continuing challenging environment abroad and an impending election.
All these point to the fact that things are not going to improve in a hurry. The FIIs have also started retreating in the recent past after investing continuously in the past year. Equities hence may not do well this year and hence the need to take a measured tactical call.

What are we suggesting ?
We are suggesting that those doing SIPs can continue with a longterm focus. However, if one is looking at needing money in 2-3 years and want to accumulate through monthly investments, we are suggesting investing through debt funds to do that . Short to medium term debt funds with upto three year maturities are suggested for those who need access to their funds, in less than three years.

We are suggesting a reallocation of equity assets to debt funds as required, in specific cases. This is a tactical call. We are suggesting between 10-20%  reallocation based on the specific requirements in client’s portfolios, in view of the conditions explained earlier.

Debt portion of Mutual funds are expected to have a good run in the months ahead. It is offering good returns now  and is expected to give decent returns going forward as well. It is also expected to benefit from a falling interest rate scenario that is expected to be there, for the next two years atleast. The weapon of choice would be actively managed debt funds or dynamic bond funds, which allows the fund manager to take the duration calls as well as managing the composition of the portfolio. For the normal investor, this seems like a good bet. The other investment which smells of roses is the Short term fund as the return potential is more visible here. 

Debt funds get better tax treatment. They can take advantage of indexation benefit and are subjected to capital gain treatment, which essentially ensures that one may pay an effective tax of just 5% overall. This is another reason why debt MFs are recommended. They would offer better post-tax returns than the traditional Bank FDs, Company EDs and Small savings instruments.

The dividend distribution tax hike in the budget from 12.5% to 25% has brought down the returns one can expect from Ultra short term funds. Hence, it’s attractiveness for liquidity purposes has diminished. Still, it is offering rates higher than bank FDs of short tenures and can still be used for parking short-term money. Since the returns they offer today are comparable to somewhat higher tenure debt funds, smart investors would want to invest in Ultra Short term funds and start withdrawing them for liquidity purposes, after a year only.

Contingency funds are also better kept in medium term funds, as they may not be required for long periods. Liquidity funds are best kept in a mix of ultra-short term and Short-term funds, to ensure that money can be accessed based on requirements, without exit loads. 

What is suggested here is what one could do in this financial year. Ofcourse each person’s financial situation is unique and they should look at what they should do with their portfolio. But a tactical allocation into debt investment options seems to be a good idea in the next one year atleast.

Article by Suresh Sadagopan   Published in Moneycontrol.com 
For  Comprehensive Financial Planning come to the experts - Ladder7 Financial Advisories

No comments: