Will Rain God Be Kind On Your Investment Returns?

Why southwest monsoon is so much important to India?

Monsoon and agriculture

Nearly 60% of India's population depends on agriculture for a living. Approximately 55% of Indian farmlands are rain-fed that provide a livelihood to 61% of India's farmers. Moreover, over 2/3rd of agriculture allied activities such as animal husbandry happen in rain-fed areas.

In 2020, the monsoon is expected to be not just normal but excess rain is probable as well.

According to IMD, some have models indicated that weak La Nina conditions in the Equatorial Pacific might develop in August and September. The Department has predicted 30% chances of getting above normal to excess rain as well. The second-stage forecast, which is expected to be announced in the first week of June, might throw more light on expected rainfall and its spatial distribution.

According to the Central Water Commission (CWC) water storage in 123 main reservoirs of India as on May 28, 2020, was 170% of the storage recorded on the same day last year and 167% of the 10-year average. When the country approaches monsoon with high storage in the main reservoirs, it bodes well for agriculture, especially when the monsoon is normal or slight above normal. Higher water storage in reservoirs post-monsoon helps Rabi crops immensely.

India's agriculture sector expanded at 4% in FY20 (5.9% in Q4) --- thanks to the highest rainfall received in the last 25 years! This helped India clock 4.2% GDP growth in FY20 vis-a-vis 6.1% growth witnessed in FY19. Last fiscal year, i.e. FY19 farm output had come lower at 2.4% in FY19 due to a below-average southwest monsoon (91% of long-term averages in 2018).

If the monsoon turns out to be normal in 2020, as expected, the agriculture sector might continue to do well in FY21 too.

Monsoon and inflation

According to the Reserve Bank of India (RBI), the inflation outlook is uncertain. Towards the end of 2019, food inflation was in double-digit (12.6% in December 2019) and retail inflation, at 7.35%, too was above the comfort level of RBI. However, in the first three months of 2020, inflation eased a bit. In April 2020, the unusual spike in food inflation is expected to moderate, as supply lines get restored in the coming months. And the forecast of a normal monsoon portends well for food inflation, the central bank observes. Depressed demand and lower crude oil prices might also help keep inflation under check.

Abetted by lower inflation readings, the RBI since February 2019 has reduced policy rates by good over 250 basis points (bps) and maintained an accommodative monetary policy stance since June 2019 to address growth concerns. Over the last few monetary policy meetings, the RBI has mentioned that it will continue with the 'accommodative stance as long as it is necessary' to revive growth and mitigate the impact of COVID-19 on the economy while ensuring that inflation remains within the target (of 4.0% within a band of +/- 2.0%).

Lower inflation and lower borrowing rates can spur household savings as well as shore up slacking demand.

Impact of monsoon on personal finances

A normal monsoon positively impacts the personal finances of people not only directly depending on it but also the economic activities of the rest of the population indirectly dependent. Monsoon has bearing on savings, investment preferences and wealth creation journey of a majority of the population.

A normal monsoon forecast and its timely arrival are likely to provide some sigh of relief to certain businesses, household savings, and capital markets.

Latest data as of March 2019
(Source: www.ceicdata.com)

As evident by the graph above, India's domestic household savings have plunged sharply over the last one decade -- partially due to high inflation (particularly in healthcare and education over the last few years), low wage growth, and unemployment woes. To improve the gross domestic savings rate, India needs to create enough, deserving, and well-paying jobs, along with a normal monsoon in 2020.

With a normal monsoon, the key sectors that benefit are agriculture and allied industries. Besides, it keeps food inflation in check, supports broader economic growth and can allow interest rates to remain low. All these factors bode well for the capital markets.

(Image source: pixabay.com; photo courtesy pexels)

What's in store for mutual fund investors?

Lower inflation, lower interest rates and higher agriculture sector growth would be encouraging factors for the equity markets. But, factors such as the performance of manufacturing and real estate sectors, social distancing norms post-lockdowns and the success in containing the spread of COVID-19 among others, shall weigh heavily too.

Lower retail inflation might allow RBI to hold policy rates lower and even go for another round of rate reduction, as and when permitted by incoming data. This would translate into gains for bondholders and potentially for those investing in equity markets.

As you may know, PersonalFN, especially after the Franklin Templeton Mutual Fund fiasco, has been extremely critical of debt funds - particularly credit risk, corporate bond funds, and duration funds that compromise on the underlying portfolio characteristics: quality debt papers and incline their holdings to private issuers; in the hunt for yield.

Only funds that own a minimum of 80% in Government of India or PSU debt papers may be considered. Given that interest rate almost seem to have bottomed out; you will be better off going with a pure Liquid Funds and/or an Overnight Fund that does not have exposure to private issuers. That said, keep in mind, investing in debt funds is not risk-free.

'Core and Satellite' investment strategy to invest in equity mutual funds under tough market conditions

I believe if you have a time horizon of 7-8 years, the present volatile market conditions would offer some exciting investment opportunities, especially given the strong performance of the agrarian economy and forecast of normal rain. Valuation-wise we seem to be attractively placed and there is a decent margin of safety available.

Nonetheless, how you build your portfolio under tough market conditions like those prevailing today is extremely crucial.

The 'Core and Satellite' approach is one of the most successful and time-tested investment strategy followed by some of the most successful equity investors.

The term 'Core' refers to the more stable, long-term holdings of the portfolio; while the term 'Satellite' applies to the strategic portion that would help push up the overall returns of the portfolio, across market conditions.

The 'Core' holdings should form a major portion (around 65-70%) of the mutual fund portfolio and ideally should consist of a large-cap fund, multi-cap fund, and a value style fund.

The rest, say around 30-35%, can be 'Satellite' holdings consisting of a mid-cap fund, large & mid-cap fund and an aggressive hybrid fund. If as an investor you are willing to take the risk, a small portion could be allocated to small-cap as well in the satellite holding.

The higher allocation to 'Core', stable funds with a long-term view is expected to add a stability factor to the portfolio, while the 'Satellite' funds generate alpha by seeking high-growth opportunities as when available with the impulses.

And how to build a strategic portfolio?

To build a strategic portfolio of mutual funds, here are a few set of rules:

• ✓ The selected mutual fund schemes should be amongst the top scorers in their respective categories. The portfolio should be built with a time horizon of at least five years.

• ✓ It should be diversified across investment styles and fund management.

• ✓ Each mutual fund scheme should be true to its investment style and mandate.

• ✓ The mutual fund schemes should be managed by experienced and competent fund managers and belong to fund houses that have well-defined investment processes and systems in place.

• ✓ Each fund should have seen outperformance over at least three market cycles.

• ✓ The portfolio should contain an adequate number of schemes in the right proportion. In short, it should carry the most optimum allocation to each scheme and investment style.

• ✓ The number of schemes in your portfolio must be limited to seven.

• ✓ Not more than five mutual fund schemes should be managed by the same fund manager.

• ✓ Not more than two mutual fund schemes from the same fund house should be included in the portfolio

Following the 'Core and Satellite' approach will bring with it six key benefits:

1. Optimum diversification across market capitalisations and investment styles;

2. Reduces to need to churn the portfolio constantly;

3. Reduces the risk to the portfolio;

4. You potentially gain from a variety of investment strategies;

5. Aims to create wealth limiting the downside risk;

6. Hold the potential to outperform the market

I expect Indian markets to remain extremely volatile in the remaining seven months of 2020. Depending on how the pandemic situation shapes up in future, especially immediately after lockdowns, might give some cues on the direction of the market.

Hence, prefer Systematic Investment Plan (SIP) route while you build the portfolio the equity mutual fund portfolio the 'Core and Satellite' way and don't forget to align your investments with your risk appetite, broader investment objective, financial goals and time horizon to accomplish the envisioned financial goals.

Sow the seeds of a sweet fruit this monsoon.

If you wish to invest in a readymade portfolio of top recommended equity mutual funds based on the 'Core & Satellite' approach to investing, I recommend that you subscribe to PersonalFN's Premium Report, "The Strategic Funds Portfolio For 2025 (2020 Edition)". This premium report will help you build your optimum mutual funds portfolio for 2025 without any effort on your part. If you haven't subscribed yet, do it now!

Happy Investing!

Warm Regards,
Rounaq Neroy
Editor, Daily Wealth Letter

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