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Dec 29, 2017 01:43 PM IST | Source: Moneycontrol.com

MFs had a terrific run in 2017, but can they create wealth for investors in 2018?

The outlook for the market seems bright, with portfolio managers remaining quite optimistic about their prospects in 2018.

Himadri Buch @himadribuch

After a fantastic year for Indian equity markets, domestic mutual fund industry experts are hoping for another blockbuster year in 2018.

The year 2017 was one of the best years for mutual funds in recent years as the industry matured and attained some level of sustainability. In fact, this was the best ever year for Indian retail investors because unlike most of the previous bull runs, which were led by FIIs, this one was led by domestic retail inflows.

The Indian markets were on a roll in 2017 with indices delivering around 27-28 percent return between January and December. Indices clocked fresh milestones frequently after Nifty first hit an all-time high of 10,000 in July. The Nifty has largely traded above the 10k-mark since then, running parallel to the Sensex, which hit 34,000 for the first time on December 26.

Domestic investors have really been the big drivers for this market, especially through the mutual fund (MF) route. In nine out of the 11 months till November, equity schemes saw more money coming in than going out.

In the year gone by, mutual funds witnessed equity inflows of Rs 178,878 crore.  In fact, equity inflows with domestic MFs in 2017 accounted for 80 percent of all inflows in the last 10 years, according to report by IIFL Institutional Equities. Their collective assets under management touched a record high of Rs 1.69 lakh crore this year.

Also, fund managers don't see inflows drying up any time soon and expect them to continue in the New Year as well. “The mutual fund flows continue to be heavy, especially because of systematic investment plans (SIPs),” said UTI Mutual Fund Managing Director Leo Puri. He added that the industry will see strong inflows into MFs for at least the next two quarters.

The outlook for the market seems bright, with portfolio managers remaining quite optimistic about their prospects in 2018. However, they are wary of changes in sector themes, which may affect their allocation to each sector.

The buoyancy seen in the year going by is likely to continue in 2018 as well, though returns may be less than in 2017 as eight assembly elections and the last full-fledged Union Budget ahead of general elections in 2019 may lead to some volatility.

Asset managers do believe that valuation-wise, the market is expensive, but over the next three years corporate earnings are seen growing at a CAGR of 15-20 percent, which is quite healthy. But considering that the returns for 2017 were stellar, they said that investors would need to mellow down their expectations for the coming year.

“Inflation is on the way up, though not as high as it was before in double digits. Interest rates are on the way up though it will not go as high as the previous cycle and most importantly, globally central bankers are withdrawing liquidity which will have an impact on asset value,” said Nilesh Shah, MD of Kotak Mahindra Mutual Fund.

“So, whichever way you look at it, inflation adjusted return, valuation adjusted return or simply liquidity adjusted return, 2018 will be a year of moderate return compared to 2017,” he said.

Sectors to bet on

Fund managers said that in the coming year, economy-facing sectors like construction, infrastructure, engineering and capital goods could prove good for investments.

“The trend if you notice from October has changed and if you see the rally in construction stocks and in rural oriented stock we have been phenomenal and it will last for some period of time,” said S Naren, Executive Director and Chief Investment Officer at ICICI Prudential Mutual Fund.

The NBFC (non-banking finance company) sector, which was among the best performing sectors in 2017, may not continue to perform in 2018.

Naren recommended shifting to defensive areas in the financial space like  insurance and asset management companies that are not leveraged. He said he was upbeat on upstream oil companies in 2018 as it is the only sector where very cheap stocks are available on both fronts -- price to earnings and dividend yield.

Concurring Naren’s view, SBI Mutual Fund CIO Navneet Munot said, “Next year, if the rural economy does well because of the government spending and everything that has happened in terms of road connectivity, digital connectivity, financial connectivity, crop insurance, etc. and higher government spending could be more widespread and some of the other segments within the consumption does well.”

In Nilesh Shah's view, there is a lot of value in mid-cap IT and pharmaceutical stocks. Portfolio managers also said that investors could look at agriculture-related sectors in 2018.

“Government will work on infrastructure projects to inflate economy and focus on rural economy as well. So combination of infra and rural and agriculture related theme can be played out before election,” Shah said.

According to Manish Gunwani, CIO at Reliance Nippon Life Asset Management, the sunrise sector of 2018 will be large corporate banks with high CASA and the ones with exposure to the corporate sector.

“Asset quality pain has broadly peaked out so over next 2-3 years as the credit cost comes down these banks will look attractive,” Gunwani said.

Meanwhile, Munot of SBI Mutual Fund said that next year will be a year of stock picking rather than going sector specific. “All the auto stocks may be at its peak but large auto stock you may get at a different valuation, all the consumer companies are at different valuations but one of the largest one is far cheaper than the others,” he said.

Sectors to avoid

Rising interest rates and increasing cost of wholesale funding, coupled with the fact that public sector banks have been given fresh capital, the outlook on the NBFC sector is deteriorating, according to fund managers.

“These (NBFC) stocks are no longer cheap, their market caps are pretty high, so the risk return reward is no longer in favour of the (NBFC) sector at this point of time,” Naren said.

Most fund managers said the rally in metal stocks may not continue in the coming year so investors can refrain from investing in them.

“This time growth of China will be led by lot more on the consumption side and we may not see same kind of metal rally as we saw in the last cycle,” opined Munot.

Last month, metal stocks rose after strong economic data in China raised optimism for demand from the world's largest commodity importer.

Biggest Risk

There multiple schools of thought when it comes to ascertaining the biggest cause for concern in the coming year.

While Naren said that going by past experience, the biggest risk or worry in the coming year could emanate from global markets, Munot said the biggest concern will be if earnings growth does not materialize.

“Last 5-7 years there has been an aggregate drought of earnings so next year for markets to sustain these valuations, we will need earnings growth,” Munot said.

Gunwani cautioned that one needs to monitor US economic data closely as the US economy may slow down or slip into recession.

Advice

As Nilesh Shah put it, investors can be overweight on equities in a bear market but cannot be 100 percent invested in them, while in a bull or bubble market, investors can be underweight on equities but not completely out of them.
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