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Equity is the Best Bet

As a long-term asset, equity is still the best option as it tends to bounce back harder & registers net gains

In the past 10 months, only one asset class has held value in convincing fashion. That's precious metals. Gold and to a certain extent, silver are counter-cyclicals - they usually do well during recessions. Hence, while other assets have slid back towards 2006 levels, these two metals have continued to do relatively better.

Among other assets, performance has been a question of judging the degree of losses. Most commodities have lost 50 per cent or more from their respective mid-2008 peaks. Real estate prices have eased 20-30 per cent while stock prices of real estate companies have dropped 90 per cent. If we trust the stockmarket's reputation as a leading indicator, real estate prices should fall further to mirror the drastic erosion in developer-market-capitalisations.

Other businesses have been hit to various degrees. Banks have been hit by high rates and rising NPAs. Auto-makers and other consumer-driven sectors have been hit by soft demand. The least damaged contingent seems to be FMCGs but even those stocks have lost ground.

An unusual situation prevails with respect to debt instruments. Defaults have risen across most classes of debt and are expected to rise further as recessive conditions get worse. However, the RBI has started cutting rates in the last quarter and this should result in yields dropping across all debt classes. T-Bill yields have already eased from their highs and they may drop further.

There may be a lag but in theory, those rate cuts will eventually feed through the system and make debt portfolios worth holding again. But debt fund managers will need to be quite selective about what they pick and about timing. Investors in debt funds will also need to be very selective about the funds they invest in.

The rupee has fallen to historic lows. This is largely due to continuous and massive redemptions of FIIs and hedge funds exiting Indian assets. To a certain extent, this has helped IT and ITES stocks hold value but the problem with those sectors is the essential weakness of the global economy. So far, the newly-established currency futures contract on the NSE has seen almost one-way movement with the rupee sliding from 45 to below 50 on large volumes. This is liable to change if the FIIs ease off on the selling. The rupee could also strengthen if the US economy goes deeper into recession.

Against this gloomy backdrop, let's debate two questions: 1) Do investments in gold or silver seem worthwhile? 2) What other asset classes are worth investing in?

My take on gold and silver is that they are passive investments but they are likely to hold value through the recession. If conditions become even more catastrophic, they will be good hedges. Silver is unwieldy used because it has to be held in bulk. Gold can be bought and held in ETFs like the Benchmark Gold EES or UTI's Gold ETF. Or, futures contracts can be rolled-over though this may turn out expensive in the long term.

Financial planners suggest that between 5-15 per cent of a given individual's portfolio could be in precious metals. Calendar 2009 and fiscal 2009-10 could be a time when the asset allocation share of gold /silver should be at the higher end of the range. One problem is that precious metals will probably lose value once the business cycle turns. So an investor will probably have to sell off a significant part of those holdings and time those sales right in order to correct their weightage.

Among other classes, the historic record suggests that equity is probably the safest asset class during a recession. This is because it tends to bounce back hardest and it tends to eventually register net gains. The upside on other asset classes is usually more limited and the downside on most asset classes is equally significant.

However, equity is a long-term asset. It's quite possible that debt will recover earlier, especially given the trend towards rate cuts. In that case, debt funds could be a reasonable investment in the context of the next 6 months.

The clinching argument in favour of equity (and equity-related funds) is really the potential upside. A retraction of 50 per cent in the major market index means 100 per cent gains as and when equity prices recover to early 2008 levels. No other asset promises that sort of near-guaranteed returns.