Sectors to look forward to equity investments in 2021

In this article, Mohit Ralhan, Managing Partner & CIO, TIW Private Equity talks about the sectors to look forward to equity investments in 2021.

It is a well-known fact that economies go through various business cycles. A typical business cycle has four phases, starting with early recovery, followed by a period of economic growth and then, a period of slowing growth, and finally, a contraction or degrowth. The cycle then gets repeated time and again. An interesting point to note is that different sectors within the economy also go through the same business cycle but at different points in time. Therefore, an investor, who can identify a sector-specific business cycle, can employ an immensely profitable investment strategy based on sector rotation. It works better than a broad diversification across all sectors of the economy. Several academic papers have examined the performance of sector rotation strategies for American & European markets and have established its efficacy in both, bull and bear markets.

For example, if one looks at the chart of Nifty Metal and Nifty FMCG indices from 2016, one will notice that Nifty Metal has outperformed Nifty FMCG between 2016 and 2018 but severely underperformed in 2019 as well as during the first quarter of 2020. A sector rotation strategy would have worked quite well if an investor possesses the skill to identify specific economy cycles.

Typically, in the early phase of macroeconomic recovery, financials, real estate, industrials, and materials perform better in comparison. During the accelerated growth phase, consumer discretionary, energy/utilities, and telecommunications perform better. Although the above is not cast in stone and market-specific factors also come into play, but an investor can attach higher probabilities of the indicative sectors outperforming during the specific economic cycles. Currently, the economy is going through an early recovery phase and one can track financials, real estate, industrials, and materials. Also, given the expected rise in inflation, consumers and materials can be a good sector to invest in.

In addition, there are certain market-specific factors that are giving rise to specific themes, which are typically based on events and policy decisions by the government. These are relatively long-term bets and do not get impacted by shorter-term economic cycles. The push to Atmanirbhar Bharat has the potential to make a few of India’s mid-cap speciality chemical companies become large. This sector has given excellent returns over the last few years but still, even the leading companies are relatively small in terms of their market capitalisation. The progress of India in the manufacturing segment will be keenly watched and may come up with a recurring theme to identify investments in their early stage. The push towards electric mobility and anti-pollution measures impacting the auto industry is another such theme. It is expected to change the industry structure, giving rise to new leaders and investment opportunities.

Overall, the Indian economy is at an inflection point. This is one of the most crucial decades for India and it is expected to emerge as the third-largest economy by the end of this decade. It will give several investment opportunities to build and preserve wealth.