Scroll Down

Investment Strategy

Nov 14, 2022

• Signs of trouble in UK real estate markets even as G-sec markets calmed down. Real estate prices declining even in US and Canada
• All asset classes rallied amid less hawkish Fed commentary
• Indian markets also rallied, though there was divergence across sectors and market caps
• Corporate results in India have been largely in line with expectations so far
• Private market activity has slowed, but this is more of a normalization post an exceptional 2021

Any global macro watcher tends to focus a fair share of attention on the U.S. But of late the focus has shifted to the UK as risks in the G-sec markets were playing out. The UK appointed a new Prime minister and a new finance minister (Chancellor of the exchequer), who rolled back most of the tax cuts announced by the previous regime and indicated austerity measures instead. This calmed the G-sec markets, but now there are signs of trouble in the real estate markets. Two of Britain’s largest asset managers have restricted withdrawals from funds managing 8.3 billion pounds ($9.28 billion) of UK property. Funds run by LGIM, M&G, Schroders, Blackrock, CBRE, and Columbia Threadneedle are now among those restricting withdrawals from property funds. After the rude bond market shock, pension funds are now trying to create liquidity in their portfolios and the illiquid property market is bearing the brunt of the same.

But falling real estate prices are not restricted to the UK alone. U.S. and Canada are also seeing rapidly declining real estate prices. Rentals are also correcting at a brisk pace, especially in the affordable housing segment of these geographies. One of Canada’s largest non-bank commercial/industrial mortgage lenders, Romspen also restricted withdrawals from its mortgage fund earlier in September.

As widely anticipated, the U.S. Fed hiked rates by another 75 bps. The commentary sounded more hawkish than anticipated as the Fed is looking to avert a wage-price spiral. Yet, almost all asset classes rallied as some of the Fedspeak suggested that there could be slower hikes going forward. Bond markets are now pricing a terminal rate of 5% in 2023 followed by a pause and lower rates in 2024.

After two-quarters of contraction, the US GDP grew in the 3rd quarter. The Atlanta Fed’s nowcast GDP model is indicating Q4 growth of a solid 3.1% currently. These estimates undergo calibration continuously as more data pours in. The street estimates continue to be below 1%. The US yield curve measure (difference between 10 yr. and 3-month yield) continues to be inverted, indicating a recession. While the indicators are a mixed bag, it is clear that Powell will not pivot just as yet, unless something breaks.

A month of green after a sea of red:
Almost all major equity markets delivered positive returns in October. Hang Seng was a glaring exception as it sold off close to 15% during the month bringing the YTD loss to ~35%. Europe equities clawed back 5%-10% to reduce overall YTD losses. The dollar is flat vs most currencies helped the overall market mood.

Source: Bloomberg, Sanctum Wealth, the data is price returns in local currency terms

Locally, Indian markets also closed the month in green. While Nifty rallied more than 5%, mid and small-cap indices underperformed. PSU banks and banks in general led the rally. Year to date PSU banks have delivered strong performance and are only overshadowed by Utilities. Many funds tend to avoid utilities and PSUs and thus have found it hard to outperform this year.

The quarterly results for the quarter that ended September 2022 have been pouring in. Currently, 33 companies in Nifty and 111 companies in Nifty 200 have declared their results. Earnings so far have been in line. Heavyweights, such as RIL, HDFC Bank, TCS, ICICI Bank and Infosys, are driving an in-line aggregate as they met analyst expectations. Financials, Autos and IT have led growth, while Metals, Oil & Gas and Cement recorded a YoY earnings decline for the quarter.

Total Revenues for the Nifty/Nifty 200 universe grew 22.7/23.5% YoY, primarily led by Financial Services, and IT. EBITDA ex-BFSI for Nifty was flat and for Nifty 200 decreased by 7.7%, marred by intense input cost pressures across industries.

Source: Bloomberg, Sanctum Wealth

Consolidated net profit for Nifty declined slightly by 1.2% and -7.6% for Nifty 200. The decline was contained mainly due to the strong performance by Financials as banks benefited from expanding NIM, higher credit growth, lower provisions and writebacks. Ex-BFSI the profitability declined significantly. NIFTY PAT ex BFSI declined by 14.8% YoY and NIFTY 200 PAT declined by 24.6%.

Sector Performance
IT – Better-than-expected quarter, despite challenging macro environment and continued supply headwinds
Banks – Growth momentum remained strong propelled by a pick-up in the corporate segment (primarily working capital loans), even as growth in retail, business banking, and the SME segments continued to remain healthy. Disbursements remained strong across segments.
Automobiles – Largely in-line performance driven by strong volume growth and favourable commodity pricing. All the companies indicated that the full benefit of softening commodity costs could be seen in the second half of this fiscal year.
Consumer – Urban and discretionary demand is holding up well but rural demand remains weak.
Oil & Gas – Mixed bag of results. Reliance Industries, the largest company in the sector, delivered in-line results.
Cement – Profitability across companies has taken a hit due to the steep rise in input costs.
Pharma – Mixed bag of results. Price erosion remained intense in the US generics segment. Further, the regulatory risk remained elevated with increased travelling by inspectors at the manufacturing sites. Currency movements positively impacted earnings.

PE funding winter?
Amid higher interest rates, high inflation, the Russia-Ukraine war and hawkish central banks global listed equity markets have seen sharp meltdowns. This risk-off sentiment is also visible in private equity deal activity across the globe. In Q3 2022 (quarter ended September 2022) the total value of PE deals in the US was down by ~20% YoY. However, one must not forget that 2021 was an aberration. Fiscal and monetary stimulus led to the highest-ever deal activity and deal value in 2021. As seen below, 2022 is more of a normalisation than a breakdown.

US PE deal activity

Source: Pitchbook
* 2022 data as of 30th Sept 2022

Similarly, we see normalisation across exits as well. With IPO markets almost shutting down, PE exits in Q3 2022 in the US declined to one-third of Q3 2021. Exits in 2022 are comparable with pre-2021. However, IPOs which had contributed one-third of PE exits in 2020 and 2021, have contributed only 1.6% of total PE exits in 2022.

While PE deal activity has been slow, PE fund raise has been strong so far this year. PE funds have already raised USD 259bn in the first three quarters of 2022 vs USD 286bn raised in 2020.

US PE fundraising activity

Source: Pitchbook
* 2022 data as of 30th Sept 2022

The situation is not vastly different in India. While the deal activity has slowed sharply in Q3 2022, down ~70% YoY and ~50% QoQ, the number of PE deals done in 2022 has already crossed 2020 and is close to 2018 and 2019. Like global private markets, 2021 was also an outstanding year for PE deals in India.

Private equity deal activity in India

Source: Venture Intelligence
* 2022 data as of 30th Sept 2022

The technology sector had seen the largest amount of funding last year. The technology sector had made up nearly half of 2021 deal value, this share fell back to about one-third last quarter, closer to the longer-term average.

In terms of PE investments by stage, late-stage and large buyout transactions saw sharp declines. With IPOs drying up, there was no pre-IPO transaction in Q3 2022. Year to date also pre-IPO transactions are behind 2021 numbers. While venture capital and growth PE transactions have declined quarter on quarter, year to date VC and growth PE deals are higher than all years except 2021.

Even as IPOs have dried up, PE exits haven’t completely stopped, in fact, the total value of exits is greater than in 2019 and 2020, so far this year.

Private equity exit activity in India

Source: Venture Intelligence

While there is no consolidated data on fundraising in India, from what we hear and see, many funds have been successfully raising funds this year and a few marquee fundraises are also being planned. This could suggest enough dry powder with PE funds to make investments at the right value.

Finally, coming to valuations unlike public markets, aggregate data on valuations is limited and hence not conclusive. However, based on conversations with various PE managers we get a sense that private market valuations are getting normalised. Additionally, PE investors are now increasingly conscious of the cash burn a business needs to do in order to scale up. A well-defined path to profitability with solid unit-level economics is now among the key factors in the investment decision-making process. These businesses would no longer attract high multiples from PE investors. However, firms with strong business models are still getting funded, albeit at reasonable valuations.

As we can see from the data shared above, private market activity has slowed down, but a large part of it is normalisation after an extraordinary 2021. Certain parts of the market are seeing higher pain, while businesses with good fundamentals, as is typically the case, are still getting funded. The resilience shown by private markets especially given the global economic environment shows the maturity of private markets over the years. While this is a market environment to navigate, we believe that high-quality managers will find ample opportunities to invest at reasonable valuations. Therefore, investors should be circumspect but not avoid the asset class.

Download Now