The year 2022 was a challenging one for investors as major Indian asset classes gave poor returns with central banks undertaking the most aggressive pace of rate hikes in history to curtail multi-decade-high inflation. This drove a spike in bond yields and dampened risk sentiment.
For 2023, the macroeconomic environment would be a key factor to determine one’s investment strategy. In our view, we see three broad macro trends.
First, the global macroeconomic backdrop is likely to be challenging given the heightened risk of a slowdown as lagged effects of monetary policy tightening leads to a weaker demand scenario and lower corporate earnings performance.
Next, India’s growth-inflation dynamics remain superior to its major peers, with economic growth staying above its long-term trend backed by supportive government policies, sustained revival in services and a pick-up in private capex. Inflation could trend lower compared to 2022 on easing food and commodity prices, fading pent-up demand pressures and lagged impact of monetary policy tightening.
Finally, as the monetary policy rate cycle peaks given receding inflationary pressures in the second half of the year, the growth outlook could stabilise.
Against this backdrop, we are more balanced in our asset class outlook by being selective in taking risk, while keeping a greater margin of safety. We see a SAFE strategy as the more attractive way to navigate 2023. SAFE stands for:
• Secure your yield,
• Allocate to long-term value,
• Fortify against further surprises,
• Expand beyond the traditional.
Secure your yield
In our view, a balanced portfolio with a mix of bonds and equities offers an attractive income opportunity.
We see increasing value in bonds, especially relative to equities with the likelihood of bond yields peaking in the coming months as central banks move closer to the end of the rate-tightening cycle. Within bonds, government and high-quality corporate bonds are attractive as they have seen a significant widening of spreads.
We are also overweight on short-maturity bonds as a flattening yield curve has improved the yield carry for them and given their lower sensitivity to rising interest rates.
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Within equities, we are overweight on large-cap equities as they have a greater margin of safety, both on valuations and earnings, compared to mid-cap and small-cap equities and perform better during tightening financial conditions.
Allocate to long-term value
We believe the tactical income opportunity should be balanced by exposure to structural equity themes that have a long runway for growth. We see attractive value in
• Financials: We see greater confidence in earnings delivery of financials driven by lower credit costs, improvement in asset quality ratios and better credit offtake with bank credit growth accelerating strongly after years of dormancy. Further, the risk-reward remains favourable for the sector, with ahead-of-market-earnings growth and cheaper valuations relative to market.
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• Domestic cyclicals: In our view, domestic cyclicals are likely to outperform global cyclicals, given stronger domestic macro fundamentals and greater resilience to a global growth slowdown, superior earnings expectations and better valuations.
• Investment-led themes: Multiple structural drivers are in place for a sustained revival in the domestic investment cycle with the leadership likely to be driven by manufacturing and infrastructure. The government’s continued focus on capital expenditure coupled with incentives to private investments is likely to boost the ecosystem for these sectors, improving its efficiency and competitiveness.
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Fortify against further surprises
While attractive bond yields and long-term value offer room for optimism in 2023, we believe investors should be prepared for downside surprises given the challenging global macro backdrop. Further, the Indian market has significantly outperformed its peers, indicating a very low margin of safety.
Thus, in our view, having a defensive portfolio allocation through cash, gold and adding a defensive tilt among equity sector positioning (via consumer staples) is a prudent approach to ride out any unexpected jump in volatility.
Expand beyond the traditional
The unusual rise in stock-bond correlations in 2022 is unlikely to last into 2023.
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Nevertheless, the experience means having exposures to relatively uncorrelated assets, or less-volatile substitutes for traditional asset classes, is a prudent allocation. Liquid alternatives and market-neutral strategies are potential routes to such allocation. Long/short strategies that offer lower target exposure to risky assets (for example, net equity exposure of 0-50 percent), tend to be relatively less volatile ‘substitutes’ for equities, with variants of these strategies likely to do well during periods of increased volatility and slowing growth.
These strategies fit well into our preference for a diversified asset allocation and a relatively balanced view on performance across asset classes.
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