Mutual fund managers turn cautious, pare exposure to equities

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The markets may be scaling new peaks, but mutual fund managers remain wary of the upbeat mood on the trading floor. In an indication that political considerations could trump market sentiment, fund managers are increasingly drifting towards debt instruments, which are considered a safer bit in the run-up to general elections next year.

Fund managers of balanced advantage funds – a financial product that allows capital allocation to be shifted between equity and debt – are reconfiguring their portfolios to favour debt instruments, portending a price correction in the stock market. The higher valuation of shares in the recent months could be threatened by political volatility on the domestic front or by global headwinds such as a fallout of a global trade war or high crude prices.

The ICICI Prudential Balanced Advantage Fund has trimmed its equity allocation to 32 percent from 42 percent in the space of a year. It manages assets worth Rs 28,600 crore, making it the biggest such fund in the category.

Source: Value Research

Caution is the catchword doing the rounds at present in fund-management circles. L&T Dynamic Equity and Aditya Birla Sun Life Balanced Advantage have cut their exposure to equities by 39 percent and 28 percent, respectively. L&T Dynamic utility reduced its debt exposure to 28 percent from 67 percent, while the latter now holds 46 percent equities as opposed to 74 percent in the year-ago-period.

After slipping to their lowest level in March, the Sensex and Nifty have gained 17.9 percent and 16.3 percent, respectively. The Sensex is trading above the 38,000 mark and the Nifty touched 11,600 for the first time in intraday trade on August 23.

A depreciation in the rupee versus the dollar has not stopped the MSCI India index from gaining 7 percent since the turn of the year. It outperformed most global markets despite the currency rout. A few companies such as HDFC Bank, Tata Consultancy Services, Reliance Industries, Kotak Mahindra Bank and Hindustan Unilever have been at the vanguard of the bull run.

Valuations have skyrocketed on account of the robust performance of Indian indices. The Sensex had a price-to-earning (P/E) ratio of 24.88 times reported earnings. The index hit a historical high in January when the P/E ratio was 26.38.

Empirical evidence suggest that the markets are overheating. When stocks are valued at artificially high levels, fund managers and veteran investors turn their attention to debt. The transfer of capital between equity and debt in the portfolios of balanced advantage funds provide an accurate snapshot of market conditions.

Equities usually dominate such funds, with their share of total investment ranging between 30 percent and 80 percent. When fund managers throw caution to the wind, sensing a price correction, funds’ exposure to equities fall.

Aditya Birla Sun Life Mutual Fund’s Mahesh Patil told The Economic Times that trade wars and rising oil prices remain a worry. He added that a correction could be some way off and the market could post further gains.

However, some fund managers beg to disagree. Edelweiss Balance Advantage Fund is the only outlier, increasing its equity allocation from 65 percent to 74 percent. The fund adheres to a pro-cyclical model where the equity exposure is increased when the index is performing well while reducing it when markets are in the red.

Corporate earnings are picking up. India is among the best performing emerging markets.