Investing in financial assets could be the winning strategy in 2016

"The financial markets are at the cusp of a revival"

This is a compounding market and, for the next 3-5 years, we would see earnings recovery driving stock prices, while debt investments seem attractive for the next one year

Nimesh Shah, MD and CEO, ICICI Prudential AMC

The financial markets are at the cusp of a revival. The Indian household, which was so far underweight in financial assets, has made some progress in 2015. Investors, both big and small, made a small beginning by investing in financial assets. Therefore, we are positive that a more meaningful shift will take place in 2016.

Under performance of physical assets, such as gold and real estate, was largely responsible for this strategic shift. The inflows into mutual funds in 2015 were at Rs2.15 lakh crore - by far the best year in recent memory. 2016 is expected to do equally well, if not better.

There are signs of an economic recovery with the latest GDP growth at 7.4 per cent. The government is increasing capital expenditure while demand in the consumer segments has been good. Therefore, it is expected that the consolidation will continue in the first half  of 2016 and, by the second half, there could be a turnaround in the economy.

This positions the equity market quite well for the long run, say, 3-5 years, while debt investments seem reasonably attractive for the next one year. The economic recovery, however, is more likely to be a gradual uptick rather than a V-shaped spike. In one word, this is a compounding market and, for the next three years, we would see earnings recovery driving stock prices.

The current account deficit is low and inflation is likely to be short of the RBI's target. This will keep interest rates low in 2016, and this bodes well for the debt market.

After two good years between 2013 and 2014 for equity, we had spoken about moderation in returns in 2015. Individual companies continued to fare better, but the bellwether index has been flat, or mildly negative. Nevertheless, there's a lot to cheer about. Sectoral performance has been encouraging. Auto and private banks, for example, have outperformed.

During the financial slowdown in 2013, mid-caps had taken a hit, but in recent times have been faring a shade better than large-caps. As a result, many mid-cap companies across sectors, such as pharmaceutical and infrastructure, have fared quite well. In fact, the whole mid-cap basket looks relatively more expensive on the valuation spectrum compared to large-caps. On relative valuation, large-caps also present an opportunity. Some large-caps were sold by foreign investors. Now, as their prices have come off considerably, they are turning attractive.

At present, mid-caps are trading at a PE of 19.2 times, while large caps are trading at 16.9 times. The valuation difference between large- and mid-caps has currently increased to 14 per cent, the highest in the past 12 months.

The overall economy is looking good on the back of planned public sector investments. Additional boost could be provided by the implementation of the 7th Pay Commission. The consumption sector led by discretionary goods could see some traction, though they will largely reflect an earnings increase. As the Centre contemplates an increase in investments through the public sector, cyclical and infrastructure firms are looking good based on valuations for 2016.  

Investors should look at defensive equity investing with products in the balanced advantage and dynamic asset allocation category. These funds invest in equities when markets are cheap and book profits when they are rising, thus limiting risk and aiming to provide good long-term returns.

If your investment horizon is more than 3-5 years, pure equity funds with large-cap bias should be your choice. Keep investing systematically as volatility due to geographical, economical and geo-political events cannot be ruled out. Happy investing!

Nimesh Shah is MD and CEO, ICICI Prudential AMC