Hybrid Funds Outlook - Key Market Events & View - January 2021

Markets saw a see saw move this month as participants exercised caution in the build up to the budget. FPI were large sellers partly on account of hedge funds reducing global EM bets due to shocks in the US markets. Trading post budget saw a spectacular recovery as markets retouched psychologically important levels.

Notably, the S&P BSE 30 touched the 50,000 mark for the first time during the month. While this is cause for joy across the investment fraternity, Index levels are just numbers and are not indication of valuations, rather a leading indicator of economic growth and market expectations. The performance of the equity markets reinforces the fundamental long term view on growth in India and the potential of Indian equity as an asset class.

Key Market Events

• Budget 2021 – Go Go Growth
In a bold move the honourable finance minister, Nirmala Sitharaman, delivered a pro-growth budget. Spearheaded by government spending on long term projects including infrastructure, the government aims to get the economy out of the Covid shadow. The budget also aims to build on the work done during the lockdown in supporting growth and making structural reforms. Notably, the government extended its fiscal consolidation timeline in the process to reach a fiscal deficit level below 4.5% of GDP by 2025-2026.

• RBI Monetary Policy – As Expected
The MPC kept the repo rate unchanged and retained its accommodative stance. In an attempt to allay heavy bond supply concerns, the RBI acknowledged that gradual phasing out of CRR would allow for liquidity injection via market friendly tools. While we do not expect liquidity withdrawal measures to be undertaken immediately, the policy normalization of bringing the operating target rate towards the repo rate would play out during FY2022.

• RBI’s Repo Push
The RBI drained Rs 2 lakh crore worth of liquidity from the system via the 14-day reverse repo auction as it began the process of normalizing liquidity operations. The cutoff for the auction was set at 3.55%, 20 bps higher than RBI’s reverse repo rate of 3.35%. The aggressive cutoff was a clear signal to the markets that the RBI would nudge the markets to normalize market rates across the curve.

• Inflation – Finally Food inflation cools!
CPI inflation moderated to 4.59% in December as against 6.93% in November. Food inflation moderated to 3.4% (9.5% in November) led by vegetables ((-)10.4%). Core inflation came in at 5.2%. The MPC raised its target for inflation targets to 5.2% for Q4:2020-21, 5.0% -5.2% in H1:2021-22 and 4.3% for Q3:2021-22 citing food inflation and global crude prices. Rising rates, also give the RBI impetus to turn hawkish in its future policy actions.

• Around the world – Synchronous Global Growth
As the global economy enters a new phase of its V-shaped recovery entral bankers and policy makers anticipate a faster return to pre-covid GDP path. EM growth is likely to rebound on the back of both domestic and external tailwinds.

Market View

Equity Markets
The equity markets see the budget favourably primarily on 2 fronts – Higher capex spending by the government & status quo on direct taxes and no incremental taxes on capital gains. The booster shot by way of capex and a strong market signal to promote growth through structural reforms are key positives for domestic and foreign investors alike.

One of the key reasons for this revival is the successful transmission of lower interest rates to the economy championed by the RBI. Lower rates have started to show its impact on sectors like housing in select pockets where demand up until now had been lacklustre. With chances of vaccination improving in the near term, beaten down sectors like hospitality, travel & retail have seen a revival in the markets as participants have begun factoring the high economic multiplier effects of these industries.

Q3 earnings have been above consensus estimates. Cyclical sectors and companies who have proven market leadership have seen a good earnings quarter. We believe this is here to stay. While valuations remain elevated, equity markets are likely to continue to outperform as budgetary tailwinds aid economic growth and investors assign higher valuation premiums to FY22 growth.

Our portfolio stance has a distinct quality bias as we believe these companies are ideally suited to benefit from gaps left by weaker incumbents and capture growth opportunities. In line with the recovery theme as the economy returns to a mid-to-high growth environment, several domestic cyclicals are likely to be beneficiaries of the new growth cycle. The last 2 years have seen a large degree of cost optimizations and deleveraging play out and should further add a material fillip to growth stories in the post Covid environment.

While we anticipate volatility in the near term, this volatility is best served by staying invested rather than trying to time the markets. The longer term outlook for equities continues to remain intact. Short term volatility can be used by investors to top up their existing investments with a 3 to 5-year view.

Debt Markets
The budget was a surprise for the debt markets. The deviation in FY 21 fiscal deficit entails additional supply of Rs. 80,000 Cr of market borrowing. In addition, the FY 22 fiscal deficit estimates point to significant borrowing expectations. The gross borrowing target of FY 22 is pegged at Rs 12 lakh crore.

The G-Sec curve has already seen a ~40 bps sell-off since the budget as markets factored budget announcements and the proposed borrowing calendar for FY22. We believe we are ‘well and truly’ in a rising rate environment and investor portfolios should look to pivot accordingly. We have begun witnessing larger sell offs across the 1-5-year bond segments as accommodative monetary policy measures are being rolled back. We reiterate our stance that in the current environment 2-4 year assets are likely to underperform.

Across our schemes today, portfolio positioning looks to play the ‘reinvestment theme’ and barbell strategies. We have consciously reduced portfolio maturities across our products in line with our view. Select long bond strategies continue to offer opportunities for investors looking to lock in long term rates.

In our short and medium duration strategies we are following barbell strategies – a strategy where we mix long duration assets (8-10 year) with ultra-short assets including credits (Up to 2 years) to build a desired portfolio maturity. The ultra-short assets will help us play the reinvestment trade whilst limiting the impact of MTM as yields rise. Long bonds will likely add value in capturing higher accruals with relatively lower credit risk and lower MTM movement in the current context.