How To Place Your Mutual Funds Portfolio Ahead Of Election Results
May 10, 2019

Author: PersonalFN Content & Research Team

(Image source:pixabay.com)

'In the short run, the market is a voting machine; but in the long run, it is a weighing machine.'

Benjamin Graham, the legendary investor and the father of value investing, compared markets with voting machines and weighing machines.

Doesn't this quote precisely encapsulate the current market situation?

If you are a serious investor, reading famous quotes coined by legendary investors isn't enough. You must acknowledge their uncanny conciseness by applying the wisdom in real life.

Weighting machine v/s voting machine

The perceptions voters carry have an immense bearing on the election outcomes. Sure, there could be several explanations as to why a political party wins or loses an election, albeit in hindsight.

The fact is that voters' sentiments power voting machines.

However, this doesn't hold weight about weighing machines. Unless you tamper with it, you can't influence the machine to lie about your weight. Based on the scientific calculation of Body- Mass Index, you know with certitude whether or not you are overweight/underweight. Based on scientific studies of nutrition and weight management, you can create a corrective action plan.

This stands true about equity markets as well.

In the short run, sentiments and expectations drive stock prices.

In the long term, only fundamentals drive markets.

More than the outcome, the election narrative is important...

At present, markets are behaving like voting machines and investors like voters.

Amidst the high-voltage drama of the non-performing assets of Indian financial institutions and mundane growth, major equity indices are claiming new highs.

Isn't it a confusing situation?

In 2014, the Lok Sabha elections were fought on the growth agenda. The so-called choice for voters was a corrupt government v/s a government that would lead India on a growth path. Perhaps voters took the electoral promise of receiving Rs 15 lakh too seriously.

Over the last five years, we've debated until the (holy) cows came home and thoroughly documented the conduct and operations of the elected government.

This time the 2019 election narrative is entirely different --- keep the opponents out of power. Would it be appropriate to say that previously the elections pivoted on "new hope" and this time around negative campaigning has assumed centre stage? For instance, voters are being asked to choose the correct 3G: Rahul Gandhi, Sonia Gandhi, Priyanka Gandhi or Gram (village) Gaumata (holy cow), and Ganga (river).

Markets and elections...

The consensus view is that markets will stage a rally if the Modi-led-NDA government secures the second term with thumping majority.

And if the mahagathbandan led by the Congress comes to power, markets will fall. Experts also predict that the outcome of the NDA-led collision government would confine gains.

Although the quantum of gains/losses divides the opinions of market experts, nobody seems to be disputing the market's direction under a particular scenario.

At present, mutual fund investors are facing a dilemma. The pre-election rally has made many of them believe that they have missed the bus. Actually, the uncertainty around who will form the government is keeping them on the fence.

Time to mind valuations...

In the last five years, markets have run up despite the corporate earnings haven't been able to justify the rally and thus look very expensive. And as you know, market valuations, growth in corporate earnings are the weighing machines of the market.

Graph: On a Modi-high, market valuations go off the roof


#upto May 08, 2019
(Source: BSE)

In the pre-election time during the last two Lok Sabha elections markets had tailwinds of reasonable valuations. This time markets don't have that advantage. Thus, a pre-election rally of 8%-10% during the last two-three months has driven valuations further northwards.

What to expect?

For the time being forget about which party you have voted for. If India has to progress hereon, it must be able to reap the benefits of tax and other reforms it has implemented over the last few years.

Factors such as the credit behaviour of big institutional borrowers, risk management of major lenders, and recovery in the private sector capex are also crucial. Stable Rupee, benign inflation, fiscal prudence, and creation of new infrastructure could be abetting factors too.

Unless all these factors translate into higher corporate earnings, there's little scope for the market upside further.

No rhetoric will work now; time for real action

The impact of election outcome won't last beyond the next two-three months. Thereafter, the market will be a weighing machine. Trade wars, de-globalisation, global economic stagnation, and lack of scope for further monetary stimulus could limit the upside potential.

The Price (P) has gone up substantially in the last five years. Now, unless Earnings (E) go up, i.e. they justify the valuations --the P/E -- the downside for the Indian equity market cannot be ruled out.

How should you construct your mutual fund portfolio now?

Don't invest in any mutual fund scheme with the perception that any particular government will push India's competitive position up or down.

If you are investing in mutual funds now, consider these possibilities:

  1. If the Modi-led-NDA government wins the second term and earnings grow as expected, the markets may rally unwaveringly. Mid-cap funds, small-cap funds, focused funds and multi-cap funds might do well under such a scenario.

  2. If the Modi-led-NDA government is re-elected but corporate earnings fail to grow, markets will remain sideways and may even fall. Large-cap funds, large & mid-cap funds, value funds, and aggressive hybrid funds might do well.

  3. If Mahagathbandan sarkar comes to power, markets may initially fall, but if corporate earnings pick up markets might still rally. Aggressive hybrid funds and large-cap funds might work well under such circumstances.

  4. If Mahagathbandan sarkar gets a term and if earnings fail to revive, the market might go into free fall. Possibly none of the categories may do well. Given the possibility of a sharp Rupee depreciation in such a case, gold ETFs might assume importance in portfolio allocations.

If you assume each of the above outcomes will have a 25% probability, you will realise, you need to prepare for a crash landing situation while simultaneously thinking about accelerating your returns as well. At this juncture, you might want to revisit your equity allocation given that fourth outcome is also a possibility.

Note: Chances of Congress winning the elections on its own are remote; hence, we have not considered that possibility. Still, if it forms the government with the support of non-NDA parties, markets may not do too badly, provided the reforms go on for the overall progress of the economy and corporate Inc. delivers a steady performance.

To conclude...

Investors should watch out 3G trends: GDP, Growth (in corporate earnings), and Global cues.

There's no short cut to building a balanced-yet-solid portfolio of mutual funds. You need to invest across all categories, viz. aggressive hybrid funds, large-cap funds, mid and small cap funds, multi-cap funds, value funds, and focused funds. Your personalised asset allocation based on your financial goals and risk appetite should guide all your portfolio decisions. Investing in direct plans through SIP route would help.

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