How a polarised market turned Ulips, equity funds out and out laggards


The headline Nifty50 index has not been an ideal representative of market conditions over the past 1-1.5 years. Even though Nifty50 has seen a marginal correction from its lifetime high recently, at the time of writing this column, the broader market (small/midcaps) and several sectors have seen a much deeper correction since the end of year 2017.

This polarisation has been quite severe, elongated and also unusual for Indian market. Only a handful of stocks pushing Nifty50 higher.

Nifty snip 13

As highlighted in the table, between the end of 2017 and that of July 2019, bulk of Nifty index returns was contributed by a handful of stocks: top 10 performers contributed 1,744 points, while the remaining 40 stocks pared it by (-) 1,157 points. If we consider the headline Sensex, the narrowness/ polarisation would be even more severe.

For the Nifty Midcap index too, there has been quite a bit of divergence in returns, with the top 10-15 stocks contributing bulk of the returns over the same period.

The broader market and several sectors have significantly underperformed.

Even though Nifty50 has returned around 6 per cent between end of December, 2017 and end of July, 2019, several sectors and the broader market have significantly underperformed during this period. Only two sectors, IT (+41%) and Banking (+14%), have outperformed Nifty over this period, while FMCG has also fared better, delivering a 4% return.

All other sectors have mostly been in the red, and several of them have registered significant losses during this period.

The broader market has seen a deeper correction over the same period, with Nifty Smallcap100 index and Nifty Midcap50 index delivering negative returns of (-) 39 per cent and (-) 21 per cent, respectively. An analysis of the companies in the Nifty50 index and Nifty Midcap50 index indicates how deep the correction and the divergence in returns has been.

Nifty snip 14

Nifty snip 15

As shown in the table, close to half of the companies in the Nifty 50 Midcap index have slipped 25 per cent during over the specified period, while 30 per cent have fallen between 0 per cent and 25 per cent. For the Nifty50 index, 36 per cent of companies have slipped up to 25 per cent, while 16% have returned between 0% to 25 per cent over the same period.

Nifty snip 16

With the correction, valuations have become more reasonable, especially in the small/midcap segment. With the deep correction seen in mall/midcap segment, the valuation premium that these stocks enjoyed over their largecap peers at the end of 2017 has come down significantly, and they are currently trading at a healthy discount. Historically, midcaps have traded at a valuation discount to their largecap counterparts. In the largecap segment (barring a few pockets where valuations are rich due to the narrow market), valuations have become more reasonable, after the correction. Although we still continue to be more positive on largecaps, some attractive bottomup opportunities have emerged in midcap segment.

Conclusion:

The narrow and polarised markets have also taken a toll on the performance of equity mutual funds and Ulips. Since Ulips and mutual funds are more diversified in nature, bulk of the largecap funds have underperformed Nifty50 over the past year or so. Also, the weightage of certain sectors (like banking & financials) has increased to almost 40 per cent in the benchmark Nifty index. Since Ulips have a regulatory restriction of 25 per cent exposure to a particular sector, and with banking sector emerging as one of the top performing sectors — this underweight exposure to the sector has also been a drag on returns given by Ulips over the past year or so.

With the narrow market phenomena, and only a handful of stocks pushing up the headline Nifty50, valuations have become quite elevated in these pockets. We feel a large part of this market polarisation maybe behind us now, and expect the narrowness to start evening out going forward. We believe India is still a stock pickers market, with potential to generate good alpha by active fund managers in the long run.

As the market matures, the alpha potential may start to narrow down, like it has happened in some of the other developed markets — but I don’t believe we are there yet. It would be prudent for investors to evaluate performance over a market cycle (both up and down market) and over the long term, rather than focusing too much on short-term performance.





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