investment strategies: Market-neutral strategy might click in 2022 as bulls and bears engage in a tug-of-war

As 2021 involves an finish, it instantly dawned on me that regardless of fears of the pandemic globally and India itself seeing a horrible second wave in Could-June 2021, this has turned out to be a robust and comparatively easy 12 months for fairness markets (~+25 per cent) — an surroundings not seen since 2017. The truth that it got here after 2020 — which noticed one of many quickest and deepest declines within the equities market adopted by an equally quick and steep rise and, lastly, closing the 12 months up 15 per cent — is in itself outstanding, particularly within the backdrop of Covid-related fears and information that retains pouring in. So, 2021 wraps up the most effective two-year interval for Indian fairness markets for the reason that 2012-2014 interval, one thing I’m not certain most of us haven’t seen given the overdose of distraction from information round Covid, politics, tech disruption and geopolitical points, amongst others.

The important thing logical question that arises from this statement is, what subsequent? After a couple of years of super-normal debt market returns (2015-2018), and now top-of-the-line two-year interval in a very long time for fairness markets (2020-2021), it’s time to perceive what lies in retailer for us and the way can one get probably the most risk-adjusted returns whereas dealing with the market circumstances in the absolute best approach — which in excessive likelihood is not going to be simple.

The explanations for it not being a straightforward investing surroundings in 2022 are as follows:

1. Indian fairness markets are buying and selling at excessive multiples on an absolute foundation, whereas being at one of the crucial prolonged relative multiples when put next with Asia ex-Japan and rising markets. On account of this motive, most international banks downgraded Indian equities just lately.
2. Earnings development restoration and sustainability, whereas having proven early encouraging indicators, are nonetheless not easy and devoid of volatility. One wonders if the pattern of actuality massively underperforming expectations on the earnings entrance, that has been seen over the previous a few years in India, will lastly be damaged.
3. On the similar time, sure long-term cycles from quant and technical facet for each fairness indices in addition to demographics level to a secular bull market presently underway, and top-of-the-line durations for Indian fairness markets probably forward of us over the following few years. The capex cycle lastly appears to be turning round, which additionally provides additional consolation on this view.

So, this implies there are excessive probabilities of a tug-of-war between bulls and bears and sector rotation in addition to excessive inventory dispersion with some performing strongly whereas others performing poorly, and most issues not being extremely correlated by way of efficiency or inventory strikes. Therefore, the easiest way one can reap the benefits of such a market surroundings may not be from a directional technique, like lengthy equities, however market-neutral and long-short methods, as these would have the ability to reap the benefits of the excessive intra-sector and inter-sector dispersion of returns, particularly when correlation throughout shares and sectors is low (curiously, throughout the globe and never simply in India).


What are fairness market-neutral methods?

These methods try to use relative performances in inventory costs by being lengthy and brief with an equal quantity in varied shares.
We clarify this utilizing a situation. Primarily based on a rating from a quant perspective, let’s choose 5 shares from the BSE 100 that we expect will rise and 5 shares which may not do properly over a sure interval. Then assuming we’ve Rs 100 as property below administration (AUM), a market-neutral method would require us to separate the quantity among the many 5 shares on the lengthy and brief facet by way of inventory futures. Now, that is attainable to do in an AIF fund because the Securities and Trade Board of India (SEBI) permits 200 per cent gross exposures of the AUM within the futures market. Given the method, the online publicity to the fairness markets involves zero, as we’re equal on each the lengthy and brief facet — i.e., +100 and -100. This technique has low market threat, whereas taking part in the relative efficiency between the bunch of shares that one has gone lengthy and the shares on which one has gone brief.

As the online exposures to the underlying fairness market is zero, it will not matter a lot what the precise fairness market does. This market-neutral technique eliminates massive tail threat and isn’t correlated to fairness or debt markets.

The target behind such methods is absolute returns relatively than directional returns. It makes an attempt to supply constant annual returns with comparatively low threat on account of eliminating systematic threat by having zero internet exposures to the market, and takes benefit of excessive volatility or excessive dispersion out there.

Therefore, such methods can really be an all-weather buddy and could possibly be probably the most fascinating for the 12 months forward.

(Rishi Kohli, Managing Director & CIO, Quant Methods, Avendus Capital Public Markets Alternate Methods. Views are his personal.)