‘Investors must set their return expectations appropriately’

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DSP Mutual Fund, in its annual note 2022 titled ‘Shooting for the moon’, highlighted that the return expectations must be set appropriately while investing in markets.

Vinit Sambre, head – equities, DSP Investment Managers and one of the authors of the note, tells Mint that they try to build portfolios that can weather any tough periods by correcting lesser than the market during sharp drawdowns. Edited excerpts:

As interest rates go up, what impact can it have on the current market valuations?

Today, many companies globally are being valued based on low rates. Low rates lead to using low discount rates in valuation models which bumps up valuations (i.e. target prices). If investors are modelling today’s low rates into perpetuity, they can justify all sorts of hyper valuations.

If and when rates rise and liquidity becomes scarce, stocks which price in very high growth in the future could be impacted more adversely. There are many assets out there which are priced very aggressively, and hence the need for some caution.

The note also mentions that DSP uses 30-40 year DCF analysis for some companies to assess valuations. What does it mean to an investor with an investment horizon of 7-10 years?

This method has no direct bearing on the investment horizon of the end investor in our funds. For investors looking at our equity funds, we would still recommend long-term horizons or based on individual goals and asset allocation. Typical DCFs offer high-growth phases of 5-7 years. On such DCFs, however, many of the new-age companies would appear extremely overvalued. So, we give companies a very long rope of 30-40 years to grow, and try to gauge if these high valuations are justifiable. In some cases, despite our very generous assumptions, we see that companies may still be overvalued.

As per the note, in the last two years, 50% of the Indian market’s return has come from multiples expansion, compared to 35% for the US and 12% for the EU. Basis this, what to factor in by investors on the return expectations going ahead?

We cannot predict future returns. The 50% multiples expansion might even expand more for all we know. When markets are running on future hope and optimism, they are simultaneously also running the risk of falling short in actual delivery. Having said that, individual stocks would offer different characteristics, and this is where alpha opportunities lie.

A graph showing similar returns from Nifty (TRI) and Crisil Composite Bond Fund indices from the peak of the 2008 till the start of 2021 is disheartening. What investment strategies can one follow to generate higher returns from equity?

The 13-year period referenced here is from the peak of the market, just before the 2008 bubble burst. It was done purposefully, to demonstrate the point that entry valuations do matter.

We have seen many market cycles in the past, and bear markets can be quite brutal. We try to build portfolios that can weather any tough periods, hopefully by correcting lesser than the market during sharp draw downs.

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