We launched the Core Portfolios in September 2021, with a scheduled quarterly review and/or rebalance. On October 1, 2021, we reviewed the lauched portfolios and skipped the rebalance given the fact that we were just a month down from launch, and nothing had changed in our views. We were content with the strategy and composition. That brings us to our first rebalance!
What Are We Changing?
We’re making a few changes to our strategy, and hence to the portfolios in light of fundamental changes seen recently.
We are maintaining the weight of all asset-classes as they are. However, we are changing the composition within.
Changes:
Debt
Replacing 10-year government securities with 5-year ones
Adding corporate bonds and SDLs (State Development Loans)
Equity
Increasing exposure to large caps
Reducing exposure to midcaps
Weights for Equity, Debt, Gold and International Stocks remain the same
Why Change - Debt?
A few things are changing domestically and globally, which makes us optimise portfolios for better positioning and potential returns.
Central to them is the fact that inflation globally has been persistently high. This is likely to result in monetary policy normalisation by central banks.
In English: Central banks have been pumping money into the markets, buying bonds, reducing rates, etc. in order to support growth. However, this causes inflation. Now that inflation is high and persistent, central banks may reverse these actions in order to reverse inflation.
Inflation and monetary policy normalisation can impact the market in several ways.
The US Fed starts raising rates in 2022. Foreign investors start getting out of emerging markets like India and start moving to the US. Why? Basically, they get a higer rate of return for much lower risk.
As a counter to high inflation and to reduce the impact of liquidity movement from India to developed economies, the RBI may increase rates in India in 2022.
Higher inflation usually means bond prices drop. Why? Because higher inflation erodes the present-day value of the future interest payments a bond will make, as well as the amount an investor gets back when the bond matures. However, the prices of longer-dated bonds tend to fall more. We are hence moving from Nippon India ETF Long Term Gilt to Motilal Oswal 5 Year G-Sec ETF. We essentially move the maturity from 10 years to 5 years and reduce sensitivity to interest rate hikes in 2022.
Since bond prices come under pressure in an inflationary environment, we also need to look for other avenues to increase returns on the bond portfolio. To give it that extra boost, we are also exposing all portfolios to corporate bonds and SDLs (State Development Loans) through Axis AAA Bond Plus SDL ETF-2026 Maturity. Here too, the maturity of 2026 is in line with reducing sensitivity to interest rate hikes.
Why Change - Equity?
Our exposure to equities has been at the maximum possible through all three portfolios. This has benefitted us over the last year as the Nifty 50 gained 23%. Along with this, midcaps rose 45% and international stocks were up 30%. Exposure to all of these areas helped all three portfolios beat their respective native portfolios.
While we acknowledge and pay a lot of attention to inflation and monetary policy normalisation above with respect to their impact on debt, they also affect equities.
Theoretically, equities have been a good hedge against inflation in the long run. However, over shorter time periods, stocks have shown a negative correlation to inflation.
Where we stand at the moment though is that we are on the right side of an earnings growth cycle. Demand revival has been strong, we’ve had two consecutive years of good monsoon and an upcoming election in 2024, which gives enough visibility for sustained (or better) earnings over the next two years.
However, valuations are at their peak. Typically in a rate-increase cycle, there is a de-rating seen in valuations. Future cash flows are discounted at a higher rate, and hence valuations go lower. With this, stock prices will depend more on earnings growth going forward.
To depend more on earnings (quality and visibility), we have moved a higher proportion of our equity exposure to largecaps, versus midcaps. This will shield us from potential shocks on valuations, or in the markets. We are hence adding weight on to Nippon India ETF Nifty BeES and reducing weight on Nippon India ETF Nifty Midcap 150, while maintaining the overall weight to equities.
What Next?
A lot depends on how things shape up in 2022. The timing and quantum of rate hikes, pick-up in earnings, intermittent disruptions by COVID, and a tonne of other things. At the moment, basis our understand and assumptions though, we reckon we are rightly placed. We shall reassess factors at the end of March 2022, and see if changes need to be made.
Our efforts across portfolios will continue to be aimed at beating the respective benchmarks while still minimising risk.