Markets have done well over the last 12 months with the NIFTY up ~ 25%. A common question we encounter at present is whether one should add to their Equity exposure at present.
We believe that valuations at present are high relative to historical multiples and are pricing in a strong earnings growth in the next couple of years. There are clear pockets of exuberance. We don’t see opportunity to participate enthusiastically. In fact, in accounts started in the last six months or where partners have added more money, we have meaningful cash positions.
However, we must caveat that using historical multiples as a guide can be misleading, especially at the current juncture
- There is “Darwinism” at play in many sectors (Consumer, Banking). The strong are becoming stronger gaining market share from the weak and earnings growth could become stronger as this effect combines with the tail wind of an economy picking up steam. Hence, multiples for quality franchisees can be justified as the market is pricing in many years of strong growth.
- While Domestic flows are strong, they also reflect a fundamental change in customer behaviour as Real Estate investments lose attractiveness
Investing in current conditions is akin to batting on a tricky wicket. You don’t want to start smoking the ball from the first delivery but take time to get a feel of how the wicket is playing. At the same time, you will get the odd mispriced opportunity which one should be prepared to capitalize on. Hence, having a long time horizon and cash ready to deploy is a huge advantage.
On additional capital deployment, we offer the following lens as a guiding framework to help you make a decision
- Time horizons
- Return expectations
- Existing Asset Allocation towards Equities in overall mix
- Behaviour during corrections
If one has a 5 year time horizon, reasonable return expectations (~15% CAGR incrementally over this period given current high valuation levels), low allocation of Assets to Equities at present, and will not panic if there is a 10-15% mark down, this is a good time as any to deploy Capital. There are always pockets of value where one can find opportunities. One can mitigate the risk of entering at a peak by investing systematically over time and give your Investment Manager the flexibility of holding cash. If however you are over-weight in Equities, you are perhaps better conserving capital for entry during the next correction. If markets continue to run up, you don’t lose much via opportunity cost. And it is always good to keep some dry powder for entry at lower prices which will offer higher incremental IRRs