Semi-Annual Update June 2023
In our January update, we forecasted a year of uncertainty for investors in 2023. As we’ve journeyed through the year, it has indeed proven challenging for pundits to predict and for investors to strategically position their portfolios. The themes popular in 2021, such as investing in international technology stocks and momentum, have come back. Investors who held gold, bonds or the simple Nifty 100 have seen positive, albeit modest, returns. Indian large-cap equities, which shone brightly in global equity markets in 2022, have performed relatively poorly compared to mid and small-caps, which have experienced significant drawdowns.
India’s growth has demonstrated remarkable resilience so far. Still, we anticipate a likely moderation later this year due to various factors and risks, including the uncertainty stemming from El Nino risks. Historically, growth has moderated in a pre-election year, with momentum picking up post-elections. We expect a steady moderation in inflation, measured by CPI, on an annual average basis (from around 5.2% YoY in FY24 to around 4.25-4.50% in FY26). However, the uncertainty premium arising from increased volatility in inflation resulting from weather-related risks is elevated.
We estimate that India’s real GDP growth to slow down to 6.0% in FY24 due to: i) the delayed impact of monetary policy tightening; ii) the general global growth slowdown; iii) the fading of pent-up domestic demand; and iv) potential weather-related adverse factors. Deutsche Bank estimates India’s “beta” to global growth is about 40bps: every 1% downgrade to US + EU growth from the baseline could potentially reduce India’s growth by 40bps. Our estimate has factored in the prospect of continued global headwinds.
Consumer confidence is waning. Inflation and high youth unemployment are issues affecting confidence, and we don’t foresee any short-term solutions for policymakers.
On a brighter note, the government’s push for public investment (INR10trn allocation for FY24; 3.3% of GDP and 33% YoY) and any incremental pick-up in private capex investment could help support growth at around 6%, in our view. Private Capex has been stagnant for many quarters, and we hope the “Make in India” initiative will finally result in increased private capex.
In our previous updates, we have been highlighting the increased risks and potentially lower future expected returns of asset classes over the previous decade. The forward multiples for India are high both on a historical basis and when compared to other international markets as of the end of June 2023. Research has shown that high starting valuations tend to be associated with lower forward returns.
Given this backdrop, we have slightly modified our long-term capital market assumptions (expectations of returns and risks) for our five asset classes. The elevated valuations for equities and more challenging growth dynamics imply that forward return expectations should be lower. So we have reduced the expected nominal returns of equities by one percentage point to 12% (close to long-term average returns) while keeping volatility the same. This reduction in nominal returns for equities also lowers our expected returns for Mixed Assets (assets with equity and fixed income like Balanced Funds) to 11%. Despite the higher uncertainties of future returns, a well-diversified portfolio remains a good alternative for most investors. Chasing returns increases portfolio risks significantly, as 2022 demonstrated. Consult your financial advisor and review your portfolio against your financial objectives.
Our long-term expectations of returns and risk serve as the basis for building the baseline “desired zone” of expected Return and Risk for different risk profiles in the Qfinr platform. Our approach generates over 3 million portfolios of varying allocations to the five asset classes from which we select risk-return trajectories for each of our five risk profiles. For a medium-term investment time horizon (3-5 years), the asset allocation investors could consider is shown in Table 2. As a result of the changes to the capital market assumptions, the asset allocations have changed slightly, providing a range of portfolio construction choices for investors. In the main, mixed assets play a more central role.
Users can compare their portfolios’ expected returns and risk characteristics against ‘ideal’ portfolios in Qfinr as input for discussions with their financial advisors. We caution that inflation will reduce real returns, especially for long-term portfolios. India experiences a higher inflation rate than most developed markets, and investors should hold portfolios that generate real returns long-term.
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PS: To know more about historical returns of asset classes in India, read ‘Nominal and Inflation-Adjusted Asset Returns in India: A Historical Survey, 2022’. Our team has also published a paper on the valuations in the equity markets and the forward returns titled ‘Shiller’s CAPE and Forward Excess Returns in India’ that might be of interest. For a detailed review of international diversification from an Indian perspective, see ‘International Diversification in Equity Portfolios: An Indian Perspective.
Important Disclaimer
Qfinr is not a financial product advisory service and does not provide any financial product advice specific to your circumstances. We provide numeric analytics and information only based on data entered by the user and/or data otherwise available to us. The output presented is derived from that information due to calculations using our methodology. This output, in itself, is not a recommendation or a statement of opinion. It is not a solicitation or attempt to effect transactions in securities or the rendering of personalised investment advice. As such, the information should not be construed as personalised financial, investment or professional advice, nor should it be deemed an offer or provision of such advice.