Stock-market experts are cautioning that investments in the market in 2007-08 will not return as much as they did in the past few years. Meanwhile, interest rates are rising. For investors, the two things mean it is time to review their asset allocation, the proportion of their investment that goes into equity, debt, real estate, bullion and other such.
Analysts expect the Sensex, the 30-stock benchmark index of the Bombay Stock Exchange, to return 15-20% in 2007-08, far below the 40%-plus it has returned every year since 2003. Rising interest rates will erode the profitability of some companies and also narrow the gap between risk-filled investments in equity, and safer ones in bonds, especially government paper.
The gap is simply the difference between returns on equity, say 40%, and the risk-free rate of return (returns on the safest debt instruments available). If the risk-free rate is 5%, then the difference is 35%. However, with experts expecting the Sensex to return 15%, and with the benchmark yield on 10-year government bonds hovering at 8%, the difference is a mere 7%, which will not be enough to convince many risk-averse investors to opt for equity. “It is time for one to reduce the exposure to equity and increase that to debt. The return from equity is expected to be considerably low compared with previous years. Meanwhile, interest rates are going up and that makes debt instruments more attractive,” said S. Sundararajan, a Mumbai-based financial planner.
Financial planners have traditionally recommended that an investor’s exposure to stocks should be 100 minus his age, with a 5% adjustment for market conditions. Thus, in a bull market, a 25-year-old would invest 100 less 25 plus 5, or 80% in equities. And in a bear market, a 50 year old would invest 100 less 50 less five or 45% in equities (the classification usually includes equity mutual funds).
Planners believe fixed maturity plans (FMPs) of mutual funds are ideal investments in the current market conditions. FMPs are mutual fund schemes that invest their entire corpus in financial instruments that mature on a pre-mentioned day.
“Many FMPs have started delivering returns of around 10-15%, which mature between 12 to 15 months, with benefits of indexation,” said Sundararajan. The indexation benefit allows investors to factor out the effect of inflation on investments and pay tax on the actual profit. It will also relieve investors from the pressures of having to predict the market.