Morningstar Managed Portfolios: Where we see value

By Dhaval Kapadia |  02-02-22 | 
 

After hitting lows in March 2020 at the onset of the pandemic, stock markets witnessed a strong recovery largely driven by cyclical sectors, making valuations look stretched, particularly for mid and small-cap equities.

However, markets have witnessed some correction recently on concerns over faster tightening by the U.S. Fed to combat a surge in inflation amid persistent supply-chain disruptions.

Observations:

  • Market valuations seem to have priced most of the economic growth story and resultant high earnings growth projections.
  • What doesn’t seem to be priced in are the near-term risk factors like the impact of the rate reversal cycle, the potential impact of new covid-variants, high inflation, and concerns around high valuation.
  • Return expectation from bonds would be a lot more normalized over the next one year as compared to returns delivered in the last two years.
  • We are positioning portfolios to reflect forward-looking expectations.

Where we see value:

We focus on risk-adjusted returns—not just returns—and have a constructive view on our ability to navigate different market pathways going forward. In this unique economic situation, we are actively reviewing our views across asset classes and portfolio positioning.

Our valuation implied return (VIR) estimates for markets and asset classes, when compared to its long term or fair return, helps us decide whether the market/asset class is attractively priced.

  • Domestic equity

We continue to favour domestic large-cap equities over mid and small cap, where we are slightly underweight as compared to our neutral/benchmark allocation.

  • International equities

We are underweight U.S. equities as compared to our neutral or benchmark weight as U.S. equities (Tech in particular) continue to rank amongst our least favored country/region. Europe, U.K., and EM look relatively more attractive than U.S. equities, and we continue to remain overweight to these regions as compared to our benchmark allocation.

  • Debt

Based on our VIR forecasts, the medium-to-long term debt segment (5-10 years maturity) looks relatively attractive than cash and high credit quality short term debt, and we continue to remain overweight in this segment. The AA and A rated corporate bonds (3-5 years) continues to look relatively attractive over the short-term debt (G sec) segment. We continue to maintain our exposure to the credit segment as it looks attractive relative to the G-sec segment from a risk-reward perspective.

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