As the new-year hails upon us and we all look forward to 2019 with great expectations, Nalin Kumar, Head of Investment Banking, IDBI Capitals Markets & Securities Ltd. shares with us his thoughts on what the investment scenarios will be in the coming year.
As we look forward towards 2019 “It was the best of times, it was the worst of times” resonates from Charles Dickens, A tale of two cities. Indeed the world is face with opportunities and challenges like perhaps never before in this last decade.
The interlink-ages and dependencies of trade and capital flows in the global economy make decisions in one part of the world reverberate in other parts. The USA China trade war can quickly spiral into a currency and capital war with consequences for the rest of the world. While the US has been the largest export market for a globally efficient Chinese manufacturing power house the surplus from these exports have often been reinvested in US Bonds. Surpluses from one economy have been reinvested in balance sheet of the other enabling the US to consume goods and services at lower cost and finance this deficit. In a rising interest rate environment it is in Chinas interest to sell under-performing US Bonds, consequences of which can be damaging to the US economy. In any case, China has been fast attempting to reinvent itself as a domestic consumption economy, and may well succeed given its large population and government success in working with the levers of the economy. So, will Mr. Trump’s hard-ball tactics work? Or, will China pull a rabbit out? Who will blink first?
Most of the developed world has been running on high octane via bloated central bank balance sheets and low interest rates driven by quantitative easing for more than a decade (Japan with since 1990s, Europe since 2000s and USA since 2008). As central banks threaten to withdraw the punch bowl the markets get into taper tantrums. Reversal of low interest rates and trimming of the balance sheets are a certainty, however, timing and pace of change will play a major role in determining the market direction. What will be the outcome?
The Oil dependent Middle-Eastern economies continue to remain potential flash points as regimes attempt to balance budgets in potentially declining oil price scenario. But US sanctions on Iran and production cuts by OPEC countries threaten large oil importing economies including India and China. Level of Oil prices in 2019 will be a major determinant of winners and losers. In the longer run, however, solar energy and electric vehicles will tilt the equation against current oil producing beneficiaries.
Add to this mix rogue regimes like North Korea and investors are left wondering where the next bullet is coming from and yet the markets have continued to climb the walls of worry… but will they?
In the globalized world creation and preservation of wealth requires either exceptional understanding of the forces that drive inter-linked global markets or a generous dose of luck. If creating wealth takes ingenuity, hard work and perspiration preserving wealth may make creating wealth seem like child’s play. The ultra wealthy tend to recognize that being good at one does not guarantee success in the other and consequently increasingly rely on wealth managers and family offices to create bespoke strategies. The choices are varied and at times bewildering even for the smartest. Consequent to the vagaries of tax-regimes the skill set for truly managing and generating wealth on wealth available only with a small set who command a premium. They are the ones who are truly a godsend for the jet set who have arrived and recognize that the most precious and non-recoverable resource is TIME… TIME to enjoy the various privileges and pleasures available only to the Ultra Wealthy! And, here are some secrets of Ultra wealthy to create wealth via investments.
- Look At Every Investment As A Business
Think of everything as a business or investment. Assets acquired should ideally be income earning and supported by a well-structured debt funding to reduce post tax cost of ownership. Even high-profile purchases, such as yachts and aircraft, can have tax efficient lease structures and can be chartered out during the downtime to help recoup the cost. Homes, artwork, jewelry, wine, and even automobiles are bought with knowledge of resale and/or investment value. Pure consumption expenses are never supported by heavy liabilities as these ultimately destroy value. Investments are made into businesses that not only are proven money makers, but it is generally something the owner enjoys or is passionate about.
- Cost Average Index Investments
Stock market indexes world over have been huge wealth creators over the long term. Almost every super wealthy person owns investments that reflect the major indexes, as low cost ETFs, portfolios of the major components of the indexes, mutual funds, and even futures. While there are periods of negative returns in the indexes, they generally do not last long. The wealthy manage these periods by using cost averaging when investing in stock indexes. This requires consistent purchases of the investment over time regardless of the market price of the investment. It enables you to take advantage of the down periods by purchasing more shares at the lower price.
- Long Bias
In general and on an average, the ultra-wealthy are long stocks and the indexes. The reason for this is the fact that the stock market has an inherent upward bias. No other financial market can claim to have the same characteristic.
- Diversify With Real Estate
Real estate is a mainstay in nearly every ultra-wealthy person’s portfolio. The real estate can be commercial, residential or even raw land but it all falls under the same umbrella. Taking your stock market profits to reinvest in real estate is a powerful way to mimic the investing tactics of the super-rich. Depending on your situation the real estate is best used as a tax hedge, cash flow generation, and/or pure speculation on price appreciation.
Asset Classes for investments in 2019
Real Estate is a good long term hedge against inflation, yet real estate world over has been driven up multi-fold in the last decade following low borrowing costs, but as several economies attempt to use regulatory forces to cool prices and as the rate cycle turns this less easy to liquidate asset class is likely to see lower inflows.
Gold once considered the best hedge against inflation has underperformed; however, its time in the sun may be soon approaching. Between 5 and 10% in a portfolio in Gold would not hurt but for the lack of income generating potential. However, recent innovations in the form of gold bonds provides for 2% yield which makes the case more compelling.
The good old Bank Deposits offer safe, consistent returns in times of high uncertainty but high taxation reduces the post tax return to sub inflation levels relegating the asset class to only limited periods where holding cash equivalents is the best strategy.
Currently Government securities are available at yields of 7.5%, and if inflation remains subdued and the new RBI Governor delivers on rate cuts this asset should figure in portfolios. For those willing to take higher credit risk the world of corporate bonds and high-yield bonds provide a 200 bps pick-up. With the mandate for large corporate to source 25% of incremental borrowings from capital markets this segment should be well-supplied. Investors with a greater than 3 year horizon will also see their post tax returns efficient to ensure that this segment receives a meaningful allocation for fixed income portfolios. The risk is from credit quality as the recent volatility in non banking and housing finance companies has highlighted. Caution is the buzzword as one moves down the credit curve in search of increasingly higher yields.
Being an investor in the US market is challenging. With US Fed on a rate hike path and balance sheet trimming direction bonds are clearly not attractive. Further, USA Bonds and the yield inversion is pointing to a potential recession in 2019/2020. So, neither may stocks or bonds work. So where do investors hide? Herein lies the advantage of the emerging markets. Beaten down emerging stock and currency markets may offer value and could potentially see an avalanche of hot money flows.
Wealthy investors also have the option to make venture investments into disruptive technologies and businesses. The world is changing at a rapid rate. Some of the world’s most valuable companies did not even exist two decades ago. Entrepreneurs are slicing and dicing market segments and offering huge value to customers via new business models leveraging on networking and connectivity as well as increasing utilization rates of assets across the world thus extracting value from existing assets.
Wealthy investors are also able to invest with smart money in hedge fund and Private equity structures which promise to achieve alpha several points ahead of classical debt and equity options. In addition structured products which can offer interesting plays in volatile markets such as these will be in vogue. Capital protected and with leveraged upside, could an investor be asking for me?
Collectibles and art will continue to be asset classes of interest to the investor with the eye for the asset.
Commodities – soft as well as hard – will continue to be impacted by global demand as well as a volatile dollar but offering the opportunity to win big in case of a China rebound. Crypto which looked to rocket at escape velocity in 2017 is struggling following regulatory clampdowns in multiple countries but the underlying blockchain technology offers excellent potential for in future years.
In challenging times and when outlook for outperformance of high return asset classes is not visible diversification and appropriate asset allocation is key to portfolio health. While time in the market is more important than timing the market, avoiding the declines/holding cash during declines can increase the portfolio returns 2x to 3x as compared to just riding the cycles.
The India story has structurally strong demographic drivers for the consumption theme which is likely to be the mainstay for the country supported by potentially pro-rural policies by the government in an election year. In addition export oriented auto, pharma and tech industries are likely to remain supported while the rupee readjusts to its long term equilibrium levels. The best investments are likely to be chosen from financial services firms including traditional private and retail banks, government banks emerging from npa crisis and nimble private nbfcs offering newer business models.
The author is a senior investment banker for families and HNIs assisting them with strategies to create wealth in their core business and non-core diversifications as well as generating returns on their diversified investments. Views expressed are his own.