More fund managers now avoiding high risk

The fears are understandable. There has been a steep sell-off in global stocks—MSCI World index is down 5.5% so far in CY22. Primarily, two events have dampened sentiment. First, inflation measured via the consumer price index in the US spiked to a four-decade high, rising 7.5% year-on-year in January. With that, equity investors are now bracing for as many as seven rate hikes by the US Federal Reserve in CY22. No wonder then, the biggest risk to financial market stability is monetary risk, BofA’s February survey showed.

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Second, mounting tensions between Russia and Ukraine are a big cause for worry. According to BofA findings, geopolitical risk climbed 16% month-on-month to 78%, touching the highest level since January 2020. Fund managers see geopolitical risk as the second biggest risk to financial market stability.

“Markets historically find it difficult to price geopolitical events as their outcomes are unpredictable. An invasion of Ukraine might lead central banks to hold off raising int-erest rates, but the trade-off would hardly be occurring in the most favourable of circumstances,” Alan McIntosh, chief investment strategist at England-based investment management firm Quilter Cheviot, said in a note on 15 February.

As for other tail risks to their portfolios, fund managers foresee hawkish central banks, inflation and asset bubbles as the top concerns. The Russia-Ukraine tension was the fifth most concerning event for investors, said the survey report.

“Since the outcome of any geopolitical event is difficult to predict, one would not tweak their growth estimates just based on it; however, such episodes introduce a lot of volatility in the stock market,” said Sahil Kapoor, head of products and market strategist at DSP Investment Managers. Fear gauge India NSE VIX rose 10% in the last three trading sessions.

Media reports now indicate that Russian troops have partially retreated from the Ukraine border, following which global equity indices recovered recent losses. That said, this risk may not be completely out of the market’s way.

And that’s not all for Indian investors. “For India, a potential risk is seen emerging from crude oil prices if they breach the current levels of $95-96/barrel,” said Kapoor. “While corporate earnings in Q3FY22 have largely been in line with expectations, some downgrades are likely given that raw material price inflation is being passed-on at a faster pace, which means that top-line growth has to be solid,” he added.

In a report dated 16 February, Kotak Institutional Equities pointed out that India Inc.’s Q3 earnings have only seen modest upgrades, and that, too, on the back of earnings upgrades to the upstream oil and gas sector on higher oil and gas prices. They caution that the reward-risk balance of the Indian equity market is poor, given recent negative macroeconomic and geopolitical developments and there is little comfort for the market from either valuations or earnings.

Bloomberg data shows that the MSCI India index is trading at a one-year forward price-to-earnings multiple of PE of 21 times, higher than MSCI Asia Ex-Japan’s multiple of 12 times. “As interest rates start to normalize, the extra valuation premium that the market was enjoying is getting washed off,” Kapoor explains. While the valuation gap has narrowed, India remains an expensive bet.