2017 The Good, and the Bad (and fortunately, not the Ugly)

The Good: The call to stay invested in equity

The reasoning used to arrive at the decision to stay invested in equities, even as the Nifty index made an all-time high of The NSE 50 (Nifty) Index made a life-high close of 10530 in Dec 2017, was explained in the Nov 2017 portfolio review.

Equity, with an up-move of 28.7% in 2017, has been the star of our portfolios.

The Bad: Dynamic Bond Funds

In hindsight, Dec 2016, when the 10 year government bond yield slid to 6.19%, on the back of demonetization, would have been a good time to exit dynamic bond funds (remember that NAVs of these funds go down, as yields go up, and vice-versa).

The worst did seem to be behind by July 2017, when this yield settled down around 6.4%, after rocketing up to 7% in May 2017.

A combination of ‘unforseens’, including uncertainty in GST revenues, the consequent expected deterioration of the fisc, RBI’s continued operations to take out excess liquidity, and finally, a sudden surge in oil prices saw the yield move up to 7.3% by Dec 2017, causing most dynamic bond funds to deliver flat to mildly negative returns over the last 6 months.

More Equity and less debt in 2018?

We would firmly advise against increasing equity allocation, especially at this time where the Nifty trades above 27 times its earnings, and the Nifty Midcap 100 is at 50 times earnings. We still continue to hold equity positions, but we believe every 1% on the upside increases downside risk exponentially.

At current levels of earnings (not factoring in Dec 2017 quarter results) and macro-variables, anywhere upwards of 11,000 levels on the Nifty would mean significant downsides, and reducing equity allocations to the lower end of our allocation range may be wise.

We will continue to monitor indices through our models and advise you on appropriate action.

But what about debt? Do we invest more into dynamic bond funds, when they have proved to be a disappointment last year?

We would first need to look to the government for the answer. If, (as I expect), the government, in its budget on Feb 1, demonstrates some intent to stick to fiscal consolidation in FY 2019, and delivers a lower-than-3.5% fiscal deficit, there may be a relief rally in yields, with current 7.3%-7.4% coming off closer to the 7% mark.

At present, our recommendation is to wait for the budget, and then decide on dynamic bond fund deployments.

Allocations to short and medium-term bond funds can be continued, in the interim.

Final word: Don’t rely on past returns

In the year 2000-2001 Sundaram BNP Paribas Growth Fund, an equity fund, gave a return of -28% compared to 10.6% for Sundaram BNP Paribas Bond Saver.
Here's what happened next. For the period April '01 to Dec '03 Sundaram BNP Paribas Growth Fund’s return was 118%, and that Sundaram BNP Paribas Bond Saver was 6.9%.
What worked in 2001 did not work in 2003. And the same may be true of 2018, when compared to 2017. We need to assess conditions through focused data analysis, and use a measure of prudence in deciding our actions in 2018.