Before discussing alternative investment avenues for 2019, it would be important to reflect the performance of stocks and bonds in 2018. The 2 major blue-chip indices ended 2018 on a slight positive note. The small and mid-cap indices faced the blunt of rich valuations in 2018 because of the runup in 2017, hence ending in deep red.
On the fixed income side, the 10-year generic G-Sec bid yield closed within 10 bps from its opening of 7.29% for the year 2018 with peak yield touching 8.13% and the trough being a percent lower from the peak yield. In totality the previous year was not the year for double digit growth.
2019 comes with its own set of challenges and one of them is political uncertainty. Also, currently rich forward P/E builds a case for building downside protection. Though over the last 20 years the returns in such years have seen large double digit moves in either direction with a positive bias. If India Inc grows well then, the 1 year forward P/E suddenly starts to look not that expensive.
Derivatives, an alternative investment class of asset, can be a return enhancer for this year. Given the context, investors with high risk appetite and strong view point may be interested in directional calls with 5-10% of the portfolio. Investors with lesser risk appetite may build long straddle or strangle strategy. Though caution may be exercised to buy long dated F&O since volatility reduces with the measure being longer. The biggest risk element while using the above-mentioned approach would be an opposite move to the directional bet or a sideways year for the market respectively.
Commodities and in particular oilmagnets a strong correlation with global industrial activity. The peak pricing for an oil barrel crossed $160 in June 2008 which was less than 10 years away from the trough recorded over the last 50 years at close to 10% of its peak. The opportunities are immense in the commodities market provided that the entry point is reasonable. Currently crude is trading at close to $50/barrel. If this price falls to below $40/barrel, then it opens a space for opportunistic long trading. Though caution may be exercised that trading in oil would entail 2 types of exposures, viz., oil and currency.
Real estate is a very peculiar product. Every real estate project is different and hence each one can be treated as a different exposure. Over longer tenures it has been noticed that 2 properties adjoining can still produce a very different return. Real estate investments can be divided into 2 large categories which would be residential and commercial (for the general audience land, warehousing, etc. are considered outside the ambit).
From a residential real estate standpoint, the rental yield typically would be close to 2.5-3% pre-tax. A slew of infrastructure development is taking place across India. This provides an opportunity to invest in property close to such infrastructure as on completion of these infrastructure projects will provide a jump in the value of the property. A standard 5-6% appreciation of property remains in the realty market. This added with the nearby infrastructure push can see a return of 10-12% pre-tax over a 3-5 years holding period.
As for under construction residential properties, the bargaining power is strong for investors with liquidity. The real estate is having a liquidity crunch as banks, NBFCs and HFCs are currently being cautious in lending. Further with the RERA Act, moving funds from a project to another is a thing of the past. This provides buyers an opportunity to get deeper discounts (especially with small developers having limited balance sheet strength) given that the developers would be using the upfront payments as equity in the project. Subsiding the completion risk these investments would give returns close to 15% over a 3-5 years period because of the cheaper entry point.
Further, under construction residential properties will also propose a great investment opportunity for developers who don’t have holding power and need to complete projects for being RERA compliant. Non-completion of projects under RERA Act has huge financial implications in terms of interest payment on all sum received. Late stage projects with completion deadline visible in the near future may offer deep discounts in order to avoid translation of contingent liability. This wave of opportunities is still to surface largely given the cycle of developments in real estate.
Commercial real estate in India offers a lucrative cap rate. The average cap rate here in India would be between 7% and 8% as compared to global developed markets where the cap rate is 3-4%. Various IPCs have repeatedly mentioned that these high cap rates should come down resulting to huge capital value appreciations given monthly rentals to stay even. Further, as REITs are launched in the Indian markets, the compression of cap rate would be an ongoing activity until the cap rate stabilizes around 5%. A cycle of recapitalization to 5% cap rate with steady current level rentals may happen over a 5-7 year period should yield a 13-16% return. The prime risk in this asset class would be non-compression of cap rate along with large period of vacancy which can drive returns for this alternative asset class to small a single digit number.
(By Shreekant Daga, Associate Director, The Chartered Alternative Investment Analyst Association (CAIA Association)