We are relative investors; in 1-3 years, we are 20% underweight equities: R Srinivasan
Synopsis
R Srinivasanattributes the market's performance to the abundance of liquidity. Srinivasan also shares his views on commodities, stating that they are bullish in the long term due to negative real rates. He advises investors to be negative on equities from a short-term perspective and emphasizes the importance of asset allocation and relative valuations.
Srinivasan says: We are relative return investors. We really do not bother about where the market is going largely for a very large part of the portfolio. We just put our heads down and try to figure out what stocks or sectors will do well within that frame, so that makes our job easier. But having said that, we do have a market timing model on which we run a dynamic asset allocation fund. ”
Srinivasan further says: “Despite all the market timing, talk about earnings, valuation and regression and all that, I do not do any of it. 100% of my money is in equity. So this is one way to look at it from a long term perspective, there is another way to look at it from a relatively short term perspective. And to manage your asset allocation and then not really worry about, think in terms of relative valuations again.
R Srinivasan: I would not have been able to predict this if you had asked me this question two years back and if you had told me there is going to be a war and all the uncertainty and rates would have gone to like 5%, I would have definitely been negative on markets. So, I think the only thing that explains it, I guess, is the huge liquidity and that is true for India also…
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R Srinivasan: It is easier for us to be very honest. We are relative return investors. We really do not bother about where the market is going largely for a very large part of the portfolio. We just put our heads down and try to figure out what stocks or sectors will do well within that frame, so that makes our job easier.
But having said that, we do have a market timing model on which we run a dynamic asset allocation fund. That model has been negative on equities for the last 18 months or so and by and large, that model has gone right because the underlying for that model is the Nifty and till the recent rally, Nifty has done like 5%, 6% but what has really done well is that the stocks go down the capitalisation curve and the model does not try to predict that because the data there is not clean enough.
The model has been negative because earnings are good. We basically look at three factors -- valuation, earnings and sentiment. Earnings are fine. I think they are better than expectations for sure. Valuations, we look at inverse of the Shiller PE and we take out bond yields from it, so that is somewhere in the 77th or 78th percentile and when you kind of regress that with real forward returns, real forward returns indicate an equity risk premium of like 1.25%, 1.3% which I think is not good enough. One needs closer to 5.5-6%. And we also put sentiment on top of it.
Stocks Recommendations
R Srinivasan: Because that dispersion is very visible where the smallcap index is down 50%, largecap is up like 17-18%, 30-32% outperformance in a year so.
R Srinivasan: That is definitely one way to look at it but we are actually bullish on commodities from a longer term perspective. Basically, the long term view is that because of the high debt to GDPs across the world, you are entering into a phase of or a period of financial repression and negative real rates will be positive for commodities.
Perhaps we are moving away from the principles of investment management which we learn at CFA or CA or whatever. What are your thoughts on this?
R Srinivasan: About buying an 80 PE stock?
R Srinivasan: We are in a relative game, honestly.
Are you saying that the right prudent strategy in this kind of a market in the environment which you have drawn is to have moderate return expectations?
R Srinivasan: Let me put it this way. As an investor, you should think obviously in terms of asset allocation. So there, I am making it very clear that we are negative equities, that too from a relatively short-term perspective. When I say short-term, I am talking about one to three years.
One to three years, one should be negative equities.
R Srinivasan: Negative equities, 20% underweight equities. That is the view. That view is very clear. Now, the problem with that kind of a view and investors should do that. let us start with that presumption. The problem with that view is that you have to make up for that carry on equity. Equity aaj ke din me bhi I think will probably give 9-10% which is not good enough. You want 13-14% for that risk premium.
The premium over risk, correct.
R Srinivasan: And what do you get in debt? So that 2-3% that even on expected return is something you need to catch up on market time, which is like a low probability outcome. Now having said that you have to be, let us say 40% equity or 60% depending on your asset allocation, then you just go and find the best stocks out there and not worry about what is going to happen over the next two, here years. Meaning over a longer term perspective, this is the only asset class I think will make money.
Despite all the market timing, talk about earnings, valuation and regression and all that, I do not do any of it. 100% of my money is in equity. So this is one way to look at it from a long term perspective, there is another way to look at it from a relatively short term perspective. And to manage your asset allocation and then not really worry about, think in terms of relative valuations again.
If valuations get really expensive, again, I am making it very clear we are 20% underweight equity. And the model kind of lets us go 0% equity. We are not there yet. We are not even 40% underweight. So the market is clearly not as expensive as at least this conversation is making it out to be.
We will get there when you go completely low...
R Srinivasan: So then you kind of go zero on equity.
We have not reached there yet.
R Srinivasan: Definitely not. So 20% theek hai yaar (20% is alright).
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