Tax breaks for corporate bonds and a hunt for better returns as interest rates declined, leading to higher allocations for fixed-income assets in mutual funds, are expected to continue in 2016, pushing down equity allocations further as interest rates rise and corporate earnings slow. Rising inflation expectations could reverse this trend.
Equity made up 60% of mutual fund industry assets in 2009, falling steadily to 10% in 2014.
“Fixed-income assets will be more popular in 2016,” Candor Asset Management Chief Executive Ravi Abeysuriya said, adding that he didn’t think the 10% industry allocation for equity changed in 2015. His firm launched a Rs500 million mutual fund in November 2015 with 100% exposure to fixed-income assets. Tax breaks on corporate bond issues and investments, and heavy government spending in a low interest rate environment saw a boom in demand for new corporate bonds and government securities in 2014. The mutual fund industry doubled its assets to Rs126 billion in 2014 on the back of this surge.
That year, mutual fund fixed-income assets more than doubled in value, outpacing equity assets growth, which only grew by half its size. The mutual fund asset build up in 2014 was driven by the creation of new mutual funds exclusively focusing on fixed-income assets and existing funds increasing their allocations to this asset class. That year, 10 new mutual funds were launched, taking the total to 63 with just one new management firm joining 13 others in the industry.
Fixed income dominance over equities in mutual fund asset allocations will continue in 2016 for two reasons. One, interest rates are expected to rise next year, increasing the appeal for corporate bonds and government securities. Second, sentiments are low on equity prospects on muted earnings expectations. Corporate earnings in the September 2015 quarter fell 6.2% from a year ago and 12-month cumulative earnings grew just 2%. Some analysts suggest investors should hold cash rather than trade in the stock exchange.
One factor that will come into play in 2016, which could see an increase in equity allocations, is inflation.
“We expect inflation to rise in 2015 as global food prices increase and the rupee depreciates,” Frontier Research Vice President Travis Gomez said. In theory, equity is viewed as an inflation hedge as opposed to fixed-income assets, which could see real returns diminish when inflation rises.
“Interest in equities will pick up as recent price drops of certain stocks have made valuations more attractive. Overall, we are quite favourable towards select stocks in the banking and finance segment; the drop in share prices after the budget could be a market overreaction,” Gomez said.
Capable fund managers will find value in equities by focusing on fundamentals, and will begin to exploit low valuations to increase their exposure to well-governed companies that have clear growth prospects.
“Fixed-income assets are everyone’s favourite now, but looking at the long term, more equity has to come in, and low prices now are a god-send,” Abeysuriya said. The Rs500 million Candor Opportunities Fund managed by his firm will follow the same strategy. “The fund will mainly be in the fixed-income space, cherry picking real value stocks, but we are in no real hurry,” he said.