MF Investment Strategy For Elections

Mark Twain, one of America’s most famous literary icons, once said that ‘history doesn't repeat itself, but it does rhyme’. While the rhyme and rhythm may not be exact and the cause can be different, the effect looks to be the same with different shades. The current global situation is also rhyming 2013 all over again. The incessant fall in the currency of Turkey currently is reminiscent of what happened to pesao, the currency of Argentina in 2013. These events can spread contagion to other emerging economies. In year 2013, we saw how India become a part of ‘fragile five’ and the Indian rupee also fell along with currencies of other emerging markets. 





In the current situation too, we have been witnessing a fall in our currency, albeit with a lesser magnitude. In addition to the fall in rupee, other thing similar to the year 2013 is the government finances. We are once again going through a situation where there is widening current account deficit, rising oil prices and inflated imports, weak banking sector and bigger budget deficits. Besides, what is also similar in the case of India is we will have general elections next year just as we saw elections in the year 2014 after 2013.

The reason why general elections become important in India, not only from the political standpoint but also from the economic and stock market point of view, is because of a sudden surge in the economic activity during election time in India. Higher spending during election time on campaign, advertisement, publicity and mobilisation of voters create significant economic activity that has a multiplier effect, which ultimately causes stock market to surge. According to some estimates, during the last general elections in 2014, USD 5 billion was spent by major political parties. This was thrice the amount that was spent during the general elections of 2009. The elections to be held next year will be no different and the magnitude of spending will increase further. 

Election and Equity Market Returns 

The importance of general elections in the Indian economy goes beyond the economic activity that elections trigger. In general, the equity market prefers a strong and stable government that takes sound economic decisions and has the capability to implement it. Last thing it want is unstable government at the Centre. In case of a weak coalition government comprising of many parties and having their own vested interests coming to power, it becomes difficult to implement economic policies beneficial for the country. 

The importance of elections for equity markets can be best gauged from what happened last year in the month of December during the counting of vote on Gujarat poll. The equity market had discounted the BJP win; however, the initial results saw the ruling BJP trailing in the PM’s home turf, thereby sending shivers down investors' spine. This resulted in both the benchmark indices Sensex and Nifty nosediving 2 per cent in early trading. But later on, as the vote count swung in BJP's favour, the domestic indices recouped losses and staged a recovery. 

The global investment bank, Morgan Stanley has put a quantitative perspective to election outcome and its impact on Sensex. It sees the Sensex trading flat at around 36,000 by June 2019, if the general elections throw up a weak outcome but can go up to 44,000 if a stable government comes to power. It further gives various scenarios of election outcomes and how the market will react to them. According to the report, Sensex could hit 41,500 in case of an absolute majority, irrespective of which party wins. In a different scenario, if any of the major party wins more than 260 seats like the BJP-led NDA in 2014, it would again lead to a surge in equity markets. 

However, in case any party fails to win good number of seats and plays just a supporting role such as in 1996, the Sensex could tank to 25,000 levels. In the case of a weak majority, wherein the lead party wins around 220 seats, like the UPA in 2009, the Sensex could see limited upsurge to 35,700. 

What History Teaches Us 

To understand how the election has impacted the performance and the movement of assets under management (AUMs) of equity-dedicated mutual fund schemes, we studied the movement in the domestic equity AUMs during the last three elections held in 2004, 2009 and 2014. We studied the movement in the AUMs of the equity funds six months before the elections and six months after the elections. 

It might not be a mere coincidence that just before the elections, the market starts to rise and continues to rise even after the election. The year 2003 saw the start of one of the greatest bull run just before the election of 2004. Similarly, in the year 2008, although the market tanked, it made a ‘V’ shaped recovery the following year. Even in the year 2013, we saw that the market started to recover and then went on a dream run till January 2018 with minor hiccups in-between. 

The AUMs during these three periods increased by a huge 35% between November 2003 to October 2004. It increased from Rs 20427 crore in November 2003 to Rs 27659 crore at the end of November 2004. During the November 2008 and October 2009, the AUMs increased by a huge 76 per cent, while between November 2013 to October 2014, AUMs went up by 70%.

The graph above clearly shows how the AUMs increased before and after the election. The entire movement in the AUMs cannot be attributed to the inflows. The increase in AUMs can be also attributed to the mark-to-market gains, which means increase in the market capitalisation of companies in which investments were made.
 



Digging deep, we also tried to analyse how companies with different market caps performed before and after the elections. To analyse this, we took Sensex as representative of large-caps, BSE Mid-cap index was taken as proxy of mid-cap stocks and BSE Small-Cap index as representative of small-cap stocks. 

We found that one-year returns (six months before elections and six months after elections) have been on an average 31%, 53% and 68% for Sensex, Mid-cap and Small-cap, respectively. If we split one year into two halves of six months before elections and six months after elections, there is no clear-cut trend whether the market goes up before the elections or after the elections. However, one thing is clear that market definitely gains after the government is formed, irrespective of whether a single party attaining a majority forms a government or a coalition forms the government. The median gain remains at 31% for six months. 



These figures should be taken with a pinch of salt and there are couple of reasons for this. As in all the three earlier instances when we have entered the market, the price-to-earnings ratio of the Sensex was below its long-term average. For example, in the year 2003, six months before the elections, the PE of Sensex was 18.07, while in the year 2008, it was 12.07 and for 2013 it was again 18.16. The long-term average PE of Sensex is around 20x. The current PE is 23.6x. 

Besides, the equity market has performed strongly going into the previous general elections. One of the reasons may be the previous governments (except the current one) were coalitions (at least all that we included in our study) and the markets rallied on hopes of a stable government. However, this time around, the current government has been a stable majority government and the chances are high that a potentially less stable government may be formed, which is likely to have an adverse impact on the markets. 

What an Investor should be doing 

Given the above circumstances, investors should tread with caution. Volatility is a part and parcel of investing in equity mutual funds. However, every market condition throws up opportunities, which you should be able to encash. The current macro-environment shows that there are two themes that may play going forward. The first is to look at sectors that are going to gain from the government spending and, second, those companies that will gain due to depreciation in Indian rupee. 

Historically, we have seen government spending spikes before the state and national elections. According to an estimate by a global brokerage firm, “in the year preceding an election, on average, the Central and state governments spend an additional 0.5 per cent and 0.9 per cent of GDP, respectively, compared to non-election years.” We do not find any reason for this year to be an exception, more so after BJP could not form government in Karnataka and a narrow win in Gujarat, PM Modi’s home state. In addition to that, it has also suffered successive defeats in different bye-elections. The recent increase in minimum support prices (MSPs) of winter crops few months after the government had announced higher MSPs for kharif (summer) crops to fulfil its promise of giving farmers 50 per cent more price than their cost of production clearly shows the government’s intent. This, along with the third consecutive year of normal monsoon, is likely to boost rural incomes. 


Hence, funds having majority of their investments in companies that are serving the rural economy and draw maximum revenue from the rural sector should remain on your radar as they have the potential to beat market returns. Another major theme that is playing out now is the fall in the value of Indian rupee. It has been worst performing Asian currency year till date (YTD), falling by almost 13%. Nevertheless, it is good for companies that draw their maximum revenue in US dollar terms. Two such sectors are IT and pharmaceutical. These two sectors can help you ride over this uncertainty in a smoother way. These two sectors will also benefit from the improving demand conditions in the US, which generates maximum demand for their products. Hence, you can make a tactical allocation to these sectoral funds. 

In addition to the above two, investment in the international funds also makes sense now. In the last one year, these funds remained second best performers among all categories. The only other category that has beaten its return is IT. 

Investors who are not comfortable with investing in sectoral funds and have lower risk tolerance can go for dynamic equity funds. These funds have the liberty to invest in stocks, debts and derivatives, depending on the market conditions. They get rebalanced periodically and hence a fall in any asset class does not impact the NAV significantly. In the last one week and one-month period, these funds have performed better than many other popular categories such as ‘large cap’, ‘mid cap’ and ‘small cap’ fund. 

Conclusion 

Market conditions have changed a lot in the last four years since the last general elections. Mutual funds have now become a preferable tool of investments among retail investors. They have replaced foreign portfolio investments (FPIs) as a source of largest incremental fund flow into Indian equity markets since 2015. The Systematic Investment Plan (SIP) route has become the most preferred route of investment. SIPs have increased from Rs 3122 crore at the start of FY17 to Rs 7658 crore at the end of August 2018. 

Therefore, the stakes are high for retail investors this time. Markets are likely to remain volatile till the elections and will keep on giving opportunities to you. As an investor, you need to be prudent in your investment choices.

Dealing with volatility in the market:
 
1. Re-balancing is the way ahead If you are periodically re-balancing your portfolio, then the current temporary volatility won’t affect you. So, it is important to periodically re-balance your portfolio. In this volatility period, if you are re-balancing, you would end up buying low.

2. SIP In volatility conditions, SIP is the best option to go for as you don’t need to deal with volatility. This gives you the advantage of rupee cost averaging. During the volatility phase, for the same SIP amount, you would be buying more units. This will be more beneficial from the long term investment perspective. 

3. Financial plan to be reviewed In these volatile market scenarios, your financial plan may come to your rescue. It is wise to review your financial plan so that you will understand the purpose for which you are investing and what needs to be done next. So, if your financial goal is far off, say 10 years from now, then just stick to your financial plan and review investments periodically