Valuations, volatility and the velocity of capital: The new trilemma for investors

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From the foreign institutional investor perspective, a softening dollar is positive for emerging markets, including India, but the fragility of flows remains a risk. Globally, the sentiment remains one of apprehension with societies becoming increasingly divisive, far-right politics becoming mainstream and a level of warmongering last seen during WWII, perhaps.

This presents investors with a new trilemma: stretched valuations, rising volatility and fast-moving global capital. Navigating this requires not just optimism but informed strategy.

In the current environment, portfolio recalibration is essential. In equities, for example, despite the noise around mid- and small-cap valuations, investors should adopt a market cap-agnostic approach. It is not that the large-cap segment is safe—a quick look at index stock composition over the last 20 years shows how yesteryears' market darlings have quietly faded into oblivion.

Actually, it is growth that is safe. Investors need to focus on companies that show growth, resilience and nimbleness to disrupt in a large addressable market. Needless to say, they don’t come cheap. Hence, traditional valuation parameters may not be sufficient in the current investment environment. Conventional wisdom would never have led to the creation of the Amazon, Ubers and Meituans of the world, or a Zomato or Paytm closer home. Nor would anyone have believed in PSU companies leading the defence manufacturing resurrection. Or realise that de-globalisation can actually create an alternative capex cycle altogether. Regime changes and generational shifts require a more longer-term trend assessment approach.

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The same perspective is imperative in fixed-income portfolios. New asset classes have emerged slowly but surely, from real estate investment trusts and infrastructure investment trusts to structured credit. No longer are we constrained in our debt strategy by having to play a rate softening regime or parking money in fixed deposits or accrual-based mutual funds at other times. It is important to understand, evaluate and appreciate evolving trends and opportunities the fixed-income world presents today, with much of the action shifting to the capital market from the traditional banking domain. Accordingly, credit is no more a bad word but more a function of the returns investors are willing to take for the risk they are underwriting.

Gold has also broken out of traditional 5 percent insurance allocation in most portfolios to a more decisive 15-20 percent allocation today. Multi-asset allocation funds allocate even 25 percent of their corpus in gold, showing the emergence of the metal as an active investment asset class from the passive nature of the past.

The last three decades of market data offer enduring lessons. Indian equities have compounded at 13.8 percent, gold at 13.3 percent and US equities at 11 percent (in rupee terms). Debt and cash have returned 8.3 and 7 percent, respectively. Asset class leadership has rotated consistently.

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In a world of valuation extremes and global flux, the real differentiator is not timing the market but staying in it with the right structure, the asset allocation strategy suited to each investor profile. Strategy, discipline and a long-term lens thus remain the most enduring sources of wealth creation.

The author is the chief investment officer of Motilal Oswal Private Wealth.

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