The calendar year 2023 was a very good one for investors despite a global scare of high inflation, fresh geopolitical tensions and a 40-year-high interest rate in North America and the European Union. Equity and gold yielded better than expected returns to investors, a big surprise given all the headwinds that financial markets faced in the last 12 months.
The benchmark BSE Sensex delivered double-digit returns in 2023 after a relatively poor show in the previous year. The index was up 18.7 percent in 2023, a big improvement from a 4 percent rise in the previous year.
Equity and gold moved in tandem
It was a good year for gold investors as well. The spot gold prices were up 14.6 percent last year in US dollar terms while the yellow metal was up 15.1 percent when priced in rupee according to data from World Gold Council.
With this, the precious metal has delivered positive returns for the second consecutive year.
Spot gold prices were up 11.7 percent in the Indian market in 2022 even though prices in the international market were up by only 0.4 percent.
However, it was a tough year for bond and fixed-income investors. The bond prices in the United States declined for the second consecutive year as the US Federal Reserve raised the Fed fund rate leading to a sharp rise in the interest on treasury bonds.
The yield or interest on the benchmark 10-year US government bond was up by 51 basis points in 2023 on the back of a 170 basis point rise in the previous year. This pushed down bond prices hurting fixed income investors. There is an inverse relationship between bond prices and their yields. When yields rise bond prices decline and vice versa.
In India on the other hand bond prices rose slightly in 2023 as bond yields declined thanks to the guidance from the central bank. The yield on the 10-year government of India bond declined by around 16 basis points in the 2023 calendar year as the Reserve Bank of India refused to toe the developed countries and didn't raise its policy rate. In contrast, bond investors suffered losses in 2019 both in India as well as the United States. This was good news for domestic bond investors.
Most analysts expect the world economy and the financial markets to fare even better in the 2024 calendar year as geopolitical tensions subside and interest rates begin to decline. This could change the relative performance of different asset classes.
Time for portfolio rebalancing
A reversal in the interest rate cycle and the end of the post-pandemic boom in pent-up consumer demand could have a significant impact on various asset markets this year. Investors are advised to tweak the asset allocation in their portfolio to maximise gains from the potential rise in asset prices and minimise downside risks from potential laggards.
The asset allocation gets misaligned when different asset prices move at different speeds. This raises the weightage of assets that have outperformed and reduces the share of underperforming assets.
The investors not only need to rebalance across various assets but also within specific asset classes.
In other words, you not only have to change the mix of equity investments, gold and bonds in your portfolio but you also need to change the composition of various stocks that are part of your equity portfolio. The different industries and segments that comprise the equity market follow a cycle and in a given period some sectors do well while others underperform.
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Given this one needs to reduce the weightage of out-performers by booking profits and making incremental investments in laggards to maintain an optimum level of risk-to-reward ratio in your equity portfolio.
Here are the steps to rebalance your portfolio:
1. Start with the broad division of your financial assets or portfolio into equity, bonds and gold. A typical portfolio is one with 50 percent equity, 30 percent bonds and 20 percent gold. If you had begun 2020 with a 50:30:20 ratio, it would now be misaligned in the favour of equity, while fixed income share would have declined. Given this, it is time to book some profits in equity and move some of the money to bonds and fixed income.
2. Alternatively, maintain your exposure to equity at last year's levels and invest two-thirds (around 65 per cent) of your incremental investments in fixed income and the rest in gold and other precious metals.
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3. Bonds are also likely to outperform in 2024 as interest rates have begun to decline and could go down further which leads to a rally in bond prices. In the United States bond yields are already down nearly 100 basis points in the last three months and they could decline further extending the rally in bond prices. The trend would spread to India as well and bond prices would out-perform equities. A decline in bond yields would also translate into higher gold and silver prices benefitting investors in precious metals.
4. The biggest challenge is to rejig one’s equity portfolio. For the first time in many years, 15 out of 15 sectoral equity indices on BSE delivered double-digit returns to investors. BSE Bankex is the worst with an 11.2 percent rise in the 2023 calendar year. Besides, 12 out of these 15 sectors managed to beat the benchmark which means most investors made money last year. Such a synchronized rise across the board is rare and may not be repeated in 2024. This calls for a portfolio churn.
5. Book profits in the stocks that belong to high-flying sectors in 2023 such as real estate, capital goods and infrastructure and use the proceeds to make incremental investments in laggards such as banks, non-banking finance companies, IT and Oil & Gas. Remember, this is not a call to completely exit the sectors that out-performed in 2023 but just book partial profits. As a rule of thumb, never book more than 25 percent profits in any of your stocks that have worked in the last one year. This way you will reduce your downside risk and increase the probability of making superior returns in 2021.
(Disclaimer: This article is for information purposes only. Readers are advised to consult a certified financial advisor before investing in any of the funds or securities mentioned above.)
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist)