Capital protection

Capital protection more important than returns for the next few months

Deepak Jasani | 

Deepak Jasani - HDFC Securities

The three-week lockdown to contain the COVID-19 outbreak (experience of China and Italy suggests that the risks are skewed towards longer periods of lockdowns) meant around 75 per cent of the economy would have been shut down, resulting in a direct output loss of over 4 per cent. This stress will aggravate further as the lockdown has now been extended till May 3. Additionally, a high risk that the livelihoods of the predominantly unorganised workforce will be hit and a sharp increase in corporate and banking sector stress, which are likely to further weigh on growth in FY21. 

Moody's, Fitch, ICRA and CRISIL have already cut their growth estimates for India for calendar 2020/FY21 quite sharply. Bloomberg Economics predicts 0.2 per cent global GDP decline for calendar year 2020 (CY20), as compared to over 3.5 per cent growth estimated before the Covid-19 outbreak.

Along with the growth hit and poor tax collections, we expect the fiscal deficit for FY21 (year ending March 2021) to rise by over 0.75 per cent of GDP from the 3.5 per cent target set in the budget (helped to some extent by a cut in plan expenditure).

Nifty earnings had barely started to grow till Q3FY20 and then the Covid-19 pandemic happened. Now there is a question mark on whether Nifty earnings will grow beyond single digits in FY20 and FY21. 

We have entered into an environment where normal rules of analytics will likely not apply. When everything is essentially socialised as to risk, a return versus risk evaluation is essentially meaningless since the risk side of the equation has been truncated. Globally, this may lead to severe disruption of capital markets and its constituents over the next few quarters.

The long-term fair value of most well managed companies will not change materially based on lower earnings or cash flows of a few quarters. However, in the interim, we may see values dip sharply again and again, based on over discounting of fundamental deterioration or technical reasons like large selling by foreign portfolio investors (FPIs) due to risk aversion. Hence, changing asset allocation, raising cash in the interim and redeploying later at lower levels (in same/different stocks based on fresh evaluation) may help overcome the anxiety during deep sell-offs (and its consequent impact on wealth effect). 

This is a good time when investors undertake an asset allocation review. In case they are overinvested in equities, correct it on bounces to fair allocation or even under-allocation. In case they are severely underinvested in equities, start a systematic investment plan (SIP) in mutual fund schemes or in exchange traded fund (ETF) basket or in direct stocks for a period of 8-14 months.

In debt, move most investments into Bank fixed deposit (limit of Rs 5 lakh in most Banks with more in some well managed Banks), public provident fund (PPF), employee provident fund (EPF), NPS (Gsec), FD with blue-chip AAA (non-finance) companies, Debt Mutual fund (only overnight, liquid or Gilt funds), Post office instruments, Tax-free bonds of PSUs. Defaults/downgrade in ratings could create a minor shakeout in the debt markets (which RBI will try to prevent). Take steps to protect your debt investments.

Also, the ultimate winners out of this turmoil may not be the same as those in your current portfolio. Capital protection more important than returns for the ensuing few months.