Looking Back

The table below traces the returns of different fixed income indices through the past years:

Calendar year CRISIL GILT Index Crisil Liquid Index CRISIL Low Duration Index CRISIL Short term bond Index CRISIL AAA Long Term Index
2015 7.39% 8.23% 8.94% 8.66% 8.61%
2016 14.97% 7.50% 9.04% 9.85% 13.29%
2017 -0.05% 6.66% 6.80% 6.05% 6.25%
2018 6.03% 7.58% 7.69% 6.65% 3.34%
2019 10.46% 6.86% 8.60% 9.53% 13.90%

Source: Bloomberg |Data as on December 31, 2019 | Past performance may or may not be sustained in future.


We would like to touch upon certain important events which dominated the headlines

The Challenge of transmission
The Monetary policy committee (MPC) through the calendar year 2019 did a cumulative rate cuts around 135 basis points(bps). However, the transmission to the end-borrower in form of lower borrowing cost was around only a third of that, which effectively blunted a growth catalyst in terms of lower interest rates
An Unconventional rate cut
The capital markets had got used to repo rate changes in multiples of 25 bps. The convention was broken this year by MPC when it cut repo rates by 35 bps in its August 2019 meeting.
Growth the focus
While the construct of the Monetary policy was traditionally focused on price stability, in 2019 we saw a drift towards reviving economic growth through a “whatever it takes approach”.
Operation twist and a steep yield curve
As the MPC cut rates, we also saw the systemic liquidity dramatically improving through the year. With the deluge of liquidity, the short term rates in the 1 year and below tenor saw a steep fall and mirrored the drop in repo rates. However, with the long term rates not dropping equally, we saw one of the steepest yield curve in recent times. As the year drew to a close, RBI announced a move to buy the 5 and 10 year Gilt and sell the 1 year in order to correct the steepness. Such a move was earlier done by the US Fed and it was monikered then as “operation twist”. Reshaping the term structure explicitly was a big move from RBI the last year.

Crystal gazing has always been a difficult ask. We attempt a peek into the future through an approach called Occam’s razor. Occam’s razor states that when competing hypothesis have similar prediction, the hypothesis with least assumptions should be chosen.

We present two visual representations as an approach:

Graph of rolling three-year month end SIP returns of Crisil Dynamic Gilt Index

Source: Bloomberg, Data period: 1-Dec-1999 to 1-Dec-2019 | Returns are XIRR returns Past performance may or may not be sustained in future.

As we look at the graph above. what comes out is since September 2018, the gilt yields started a downward journey and the rolling SIP returns moved up from a low of around 4.50 percent to around 8.50 percent. While we believe a large part of the downward movement has been accomplished (returns at 1+ standard deviation), the market may witness a final hurrah through a bit more downward movement.

Graph of three-year AAA and AA bond spread

Source: Bloomberg | Data period: 6-Jul-2012 to 31-Dec-2019

As the credit events swelled last year, spreads between AAA and AA credits widened creating an outlier spread event. We believe that such spreads may mean revert, giving possibility of a better risk adjusted returns in the credit space.

End Note

The last year was a difficult one for the credit markets; it almost looked like a battlefield as investment managers tried to side-step the landmines in the form of credit events. Our credit assessment of Risk Guard process also evolved with an objective to look deeper into the following aspects:

A deep dive into financial statements of companies under assessment through a forensic-like approach
Understanding of the industry structure or the business of the company
Analyze and integrate the social media noise of credits

Consensus is a powerful market behavior, but consensus has a fundamental flaw -- it may choose to lag. The year gone by has been challenging; yet as we go through the journey of managing money, we keep a constant vigil on the human behavior aspects and an alternative view to interpret markets.

From The Equity Desk

Howard Marks an investment guru has described “Investing consists of exactly one thing: dealing with the future. And because none of us can know the future with certainty, risk is inescapable.” This is quite a concise and precise description that also subtly conveys an important message that investing carries its own risk. The future outcomes expected at time of investing may or may not materialize; both on upside or downside.

This mismatch between initial expectations and actual reality creates the volatility in equity markets. And yes, we have seen enough volatilities over time with the most recent period looking most puzzling. The investing community is eager to understand the reasons behind the same. This helps one rationalise the past and prepare self for the future course of action. Understanding the prevailing realities help one make their own assumption about continuation thereof or changes going ahead. Needless to add, either of the two assumptions are also dealing with future !!

The outcome of equity market’s behaviour in CY2019 period has been termed as “Polarisation” by many participants. One way to analyse this behaviour is a typical “Large cap v/s Mid cap v/s Small cap”; the other perspective is that the year divided companies into two segment loved and unloved based on stock price performance. Let’s look at the divide in data terms.

* Absolute Returns for the period Jan 1 – Dec 31, 2019. Source: Bloomberg | Past performance may or may not be sustained in future

While the performance clearly shows Nifty index having done significantly better than Midcap index and Small cap index in 2019; the reality is that each indices has its own set of winners and losers. Mid cap and Small cap indices while having done badly, have nearly equal number of winners and losers within the respective index. Also, there are many large-caps that have not fared well in 2019 and quite a few mid- and small-caps that have been big winners. We believe this behaviour can thus be looked as Loved stocks v/s Un-loved stocks; as the table shows some interesting set of data.

Index CY-19 Index Returns* Number of Companies / Index Constituents No. of Index constituents providing returns above Index Returns No. of index constituents providing returns below Index Returns
NIFTY 50 12.0% 50 18 32
NSE Midcap 100 -4.3% 100 50 50
NSE Smallcap 100 -9.5% 100 52 48

* Absolute Returns for the period Jan 1 – Dec 31, 2019. Source: Bloomberg | Past performance may or may not be sustained in future

A detailed analysis shows that not all large caps have done well and not all mid and small caps have done badly. Also, some mid and small caps have done better than the best performing nifty companies and some nifty stocks have done as bad or worse than many mid and small cap companies.

We highlight some of the key trends that influenced the equity markets in CY2019. Few of them could be continuation of CY2018 but with a different intensity.

  • Negative interest rates
  • Re-rating of “Quality” stocks:

    Intuitively, a negative interest rate means risk-aversion is high and preference for equity as asset class goes down. In reality it was reverse with almost every equity market globally up in CY19. The “Quality” companies with stable business model and dividend yield became investor’s favourite as a “bond proxy without that certainty of loss”. This led to ever rising valuations for those companies..

    Global Equity Market CY -19

    Country NAME 1 Yr Performance*
    US S&P 500 INDEX 28.7%
    France CAC 40 INDEX 27.5%
    Germany DAX INDEX 25.2%
    India Nifty 50 12.7%
    Hong Kong HANG SENG INDEX 12.2%
    UK FTSE 100 INDEX 12.0%

    * Absolute Returns for the period Jan 1 – Dec 31, 2019

    Source: Bloomberg Past performance may or may not be sustained in future

  • Passive Investing

    Passive investing through ETFs emerged a big winner with passive funds overtaking active funds in assets in USA. While passive investing started with rationale being lower costs of managing funds, now its perceived as inability of active investment style to outperform. Passive investing however suffers on two key counts.

    • mere inclusion of a company in the index makes it a compulsory investment without any recourse to the company fundamentals and business outlook. Thus, the index inclusion/exclusion becomes a primary reason for stock performance for companies in the index vis-a-vis those not in the index.
    • stocks with higher weight in index tend to do better as it attracts more money flow as a % of fund assets.
  • ESG Investing

    ESG: Environmental, Social, Governance.

    A focus on ESG creates essentially a set of investible and non investible companies from investor perspective. Globally, some sectors like oil, coal, thermal power etc have been identified as non-compliant on ESG and that has impacted the stock price performance of these companies.

We believe that the polarisation in markets in 2019 is an outcome of some trends above that made companies classified into investible or un-investible on any or all of the trends. The performance divergence among the two sets of companies is sharp and not in line with the fundamentals. History suggests that every trend undergoes reversal and we believe that the history may be proven right again. While it is really tough to predict the precise time/event catalysts for reversal of some of these trends, we may look at these aberrations in valuations as an opportunity for long term investments!!!

Equity Market Outlook
Debt Market Outlook

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