Equity vs debt: What’s your pick?

Little wonder then that several investors are shifting their focus to the debt market.

Equities have been in a bull phase for over four years now, with the Nifty 50 index skyrocketing 198% from its all-time low of 7,610.25 points on 23 March, 2020.

The market has been riding high on better earnings prospects, public capital expenditure, a pick-up in private capex as well, demand revival, lower interest rates, and a chance of policy continuity if the BJP-led National Democratic Alliance returns to power at the Centre.

On 30 April, the Nifty 50 registered a fresh all-time high of 22,783.35 points.

But for investors, the unrelenting bull run could mean a time to pause.

“Despite India’s robust macroeconomic indicators, the current market valuations are not cheap, as they continue to trade above long-term averages,” said S. Naren, executive director and chief investment officer at ICICI Prudential AMC.

The Nifty 50 is currently trading at a price-to-earnings multiple of 19.7 times on a one-year forward basis, compared with its 15-year average of 18.7 times, show Bloomberg data.

Given the elevated valuations, investors should exercise caution and be cognizant of potential risks, Naren said. For investors contemplating increasing their allocation to equities, he believes large-cap stocks to be better placed than midcap and smallcaps due to their comparatively attractive valuations and better margin of safety.

Bonds sitting pretty

Despite the bull run in the stock markets, and the long-term allure of equities, the near-term outlook for bonds seems more favorable, said market experts.

“As things stand, the narrative suggests moderating inflation and a possible pivot in (the third and fourth quarters of 2024) for the interest rate cycle,” said Jiten Doshi, co-founder and chief investment officer at Enam AMC, adding that equities remain a long-term hedge against inflation.

That said, Doshi also believes that bonds “are sitting pretty with most of the rate hikes already consumed in the latent value, only to benefit from easing of rates if any”.

Souvik Saha, investment strategist at DSP Mutual Fund, too, said increasing allocation to debt would be smarter at the moment, although he’s also of the view that the long-term prospects of equities remain appealing.

“Allocating to fixed income presents an appealing option as yields are currently elevated. The strategy involves investing in products with longer durations to capture these higher yields,” said Saha.

Debt funds concentrating on long-duration and medium-duration bonds offer potential for investors over the next 18-24 months, he added.

Global inclusion

Equities are already facing some competition in attracting investor attention.

“The fixed income markets have attracted record inflows from (foreign institutional investors and foreign portfolio investors) in FY 2023-24 on the back of inclusion in global fixed income indices and relatively elevated yields compared to global peers,” said Farhad Gadiwalla, head of products at UTI AMC.

India’s bonds will be included in the JPMorgan Government Bond Index-Emerging Markets (GBI-EM) in June. The weight of these bonds will gradually increase by 1% each month until reaching 10% in April 2025. With this, India will become the second-largest emerging market country in the index, following China.

According to a report last month by Sharekhan by BNP Paribas, the inclusion of India’s bonds in the JPMorgan index would ensure “foreign inflows (into debt) in the range of $25-30 billion”.

That said, bond yields might start easing from the current level due to the inclusion in the JPMorgan bond index as demand increases for government securities. The fiscal consolidation in the Union government’s interim budget for FY25 might also support the bond market.

A diversified portfolio

All said, an effective asset allocation strategy could involve a mix of multi-asset allocation funds, balanced advantage funds, and equity savings funds.

This is because these funds help in portfolio diversification and make a case for attractive risk-adjusted returns in different market conditions, said market experts.

According to Gadiwalla of UTI AMC, it may not be advisable to aggressively increase exposure to equities at this point. Instead, he believes, maintaining a diversified investment portfolio that includes bonds can help mitigate risk and capitalize on opportunities that may arise during market swings.