01 Dec, 2021

Be wary of investing in equities at heightened valuations

According to a study, market returns are highest when the trailing PE ratio is below 16

The benchmark Nifty has corrected around 7% since its peak on 18 October. However, valuations in the stock market continue to be stretched. According to a study by QED Capital, investing in equities at heightened valuations has historically led to many years of low returns. Although history does not always repeat itself exactly, historical trends provide a guide to how future returns can look like.

QED Capital Advisors LLP carried out an analysis of monthly rolling returns for 3 and 5 periods from January 2010 till October 2021. Rolling returns is a concept that looks at returns derived if you invest and withdraw at different points of time. According to the study, market returns are highest when the trailing PE ratio is below 16. At such times, the historical 3- and 5-year returns have been 16% CAGR (compound annual growth rate). On the other hand, when the PE ratio is north of 24, 3- and 5-year returns get compressed to 7% CAGR. The PE ratio is roughly 26 at present. Equity returns improve when investors hold for longer periods, ideally 7-10 years. However, for many rst-time investors, a poor returns spell of 3-5 years can shake their faith in equities.

“The solution is if you want to deploy lump sums now then you should park your money in a conservative balanced fund. Later if markets correct, you can move to equity. And if you are doing SIPs (Systematic Investment Plans) then there is no need to change anything,” said Anish Teli, Founder, QED Capital Advisors LLP. Some Hybrid funds rebalanceequity and debt internally, saving investors from incurring tax and exit load that they would incur if they switch between mutual funds. Short term capital gains tax can vary from 15% to slab rate, depending on the type of the fund. Balanced Advantage Funds (BAFs), which rely on countercyclical models, have pulled back their equity exposure. For instance, ICICI Balanced Advantage Fund and DSP Balanced Advantage Fund had an unhedged equity exposure of 30-31% of their portfolios in October.