India has emerged as an anomaly in the global economic landscape, experiencing a notable upswing in its equity market. This surge can be attributed significantly to the support extended by the government, Foreign Institutional Investors (FIIs), and a growing preference among domestic investors for Indian equities.
Despite the predominant focus on equities, the demand for Indian bonds has been comparatively modest. However, the recent budget in 2024 has brought about a significant upsurge in the demand for bonds.
As we have been readjusting your portfolio, shifting towards a higher emphasis on bonds and high-yielding large-cap equities, how will this relative increase in demand for bonds impact your portfolio? What additional opportunities does the Indian economy present with the Budget? How can you reallocate your portfolio with it? Let's explore.
There is a difference in perspective between economists and real businesses. While economists focus on macro numbers, business owners prioritize greater profits and turnover. In the case of India, there seems to be a positive intersection where macroeconomic management aligns with business interests.
The macroeconomic indicators, such as higher tax revenues (19.55% higher than the net collections for the corresponding period of FY 2022-23), a narrowing fiscal deficit (19.55% higher than the net collections for the corresponding period of FY 2022-23), and decreasing inflation(reducing from 7% to 5%), reflect a relatively well-managed economic environment, contributing to a stabler foundation for businesses to thrive.
Moreover, The Indian government is set to allocate an additional a record ₹11.11 trillion ($133.87 billion) for infrastructure development in FY 24-25. The government's capital expenditure as a percentage of the country's GDP is estimated to increase from 3.3% in the current fiscal year to 3.4% in the next fiscal year. However, the year-on-year growth is lower than the current fiscal year.
Focused strategies under the PM Gati Shakti National Plan, especially the three economic railway corridors for energy, mineral, and cement, port connectivity, and high traffic density, would further increase sustained economic activity. It underscores the idea that prioritizing 'good' expenditure and focusing on strategic investments can create a mutually beneficial relationship between macroeconomic management and business prosperity.
It’s worth noting that in the past year, small and mid-cap stocks significantly outperformed large-caps, with retail domestic investors dominating this segment. The inflows into equities by mutual funds in India reached record highs, and investors have reaped the benefits of staying invested regardless of market conditions.
Improved confidence in Capital Market: The mutual fund industry has achieved a significant milestone, reaching Rs 50.8 lakh crore in Assets Under Management (AUM). This substantial growth is a positive indicator for the market, showcasing investors' confidence in these funds. Moreover, it reflects a shift in investor behavior in India, where individuals are increasingly entrusting their money to capital markets and stock markets. This changing trend is crucial for beginners, highlighting that many people now view mutual funds as a reliable investment option to capitalise on.
The growing interest among Indian investors is further evident in the rise of SIP registrations. SIPs, involving regular investments of a fixed amount, provide a disciplined approach to investing. This trend indicates a willingness among investors to stay committed even in challenging times, portraying an overall positive outlook.
The interconnected rise in AUM and SIP registrations underscores a broader confidence in systematic and disciplined investment strategies within the mutual fund landscape.
FII Inflows: Foreign Institutional Investors (FIIs) turned towards India in 2023, with robust inflows of $21.2 billion. India stood out as the primary recipient of FII inflows among the emerging market nations. Among the sectors, industrials, consumer discretionary, and financials emerged as the key beneficiaries, experiencing the highest influx of investments. Conversely, the energy and technology sectors faced outflows during this period.
Fixed Income Market
Apart from the attention solely on India's equity, the Indian bond market is also gaining prominence. The Union Budget 2024 was well-received in the bond market, leading to a near 6-month low of 7.06% this has been due to the rise in the bond prices in the secondary market. This drop is attributed to the government's decision to reduce gross borrowing for FY25, projecting it to be lower than the planned market issuances of Rs 15.4 lakh crore in FY24.
How is this increasing the demand for bonds?
Lower Supply of Bonds: When the government announces a reduction in gross borrowing, it implies that the supply of government bonds in the market will be lower. With a decrease in the overall supply, the existing bonds become relatively scarcer. This scarcity often leads to an increase in demand for the available bonds.
Potential Lower Interest Rates: The reduced competition for funds can also contribute to keeping interest rates lower. When there is less demand for borrowed funds, lenders may not need to raise interest rates to attract borrowers. This can have a positive impact on the overall interest rate environment in the economy.
Impact on Yield: The drop in India's 10-year government bond (G-sec) yield to a near 6-month low at 7.06% suggests that bond prices have risen. Bond prices and yields have an inverse relationship – when bond prices go up, yields go down. The decline in yield could be a result of increased demand for bonds, possibly driven by the positive announcements in the budget.
Intelligent Investor Notes
The current Nifty index is trading at a lower valuation of 22X earnings, presenting a favorable market compared to its 5-year average of 26X earnings. This offers favorable opportunities in equity at a reasonable rate.
Given the current lower valuations in the stock market, considering an investment shift toward the infrastructure and energy sector seems prudent, given the improved recent government allocation. Hence, we suggest allocating your funds to select infrastructure and consumption-oriented funds.
However, exercising caution is crucial, as the upcoming 12 months leading to the 2024 elections could witness increased market volatility, historically speaking. When contemplating investments in equity options, it's suggested to proceed judiciously and remain mindful of the uncertain political landscape. Here, we've been reallocating funds to more secure options such as large-cap-oriented equity funds, as large-cap has the opportunity to yield better sustainable outcomes in market consolidations and any pertaining market volatility.
With higher interest rates, incorporating debt-oriented hybrid funds into your portfolio can help to potentially leverage by leveraging a blend of equities, arbitrage opportunities, & debt instruments. Along with the recent budget planning on the bond market, the demand for bonds is going to significantly increase, offering higher returns.
To mitigate the impact of fluctuations in interest rates, you can explore Medium Duration and Credit Accrual strategies. These strategies primarily concentrate on investing in securities with AA & AAA credit ratings while maintaining a portfolio maturity in the range of 3-5 Yrs. This approach can help in balancing risk & return in your investment portfolio."
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