The year 2014 turned out to be stellar for Pakistani equities as the KSE-100 index surged by 27.2%. It also meant that the average return for the index over the last three years stood at a phenomenal 41.7%.
Despite headlines being dominated by political infighting and violent insurgencies, the index continued to rally on the back of foreign buying and improved sentiment. This sentiment was driven by a number of factors including the rapid build-up of foreign exchange reserves, a significant decline in inflation and the country’s successful re-entry into the global debt markets which saw it raise $3 billion from international creditors.
With macroeconomic stability becoming increasingly evident on the basis of declining yields and a stable currency, the KSE-100 jumped by 8.09% in the last quarter of the calendar year 2014 (CY14). According to Bloomberg, the KSE-100 was the third best market globally in CY14 and for the third consecutive year remained among the top 10 markets of the world.
Investors who chose to take equity risk through mutual funds managed to do even better than the broader market, as the top 10 funds outperformed the KSE-100. The top ranked funds started to outpace the index in the last quarter as the collapse in oil prices started to weigh on energy stocks which constitute almost 25% of the index. Market exposures were ramped up in October as the smart money switched out of oil and gas and into more lucrative options.
This sector rotation continued well into November as average market exposure grew from 86% to 90%. Asset managers who were able to trim their traditionally heavy oil and gas exposure at the right time benefitted the most as the sector generated a dismal return of -19% for the year. In contrast, the best performing sectors during the year were autos (+137%), pharmaceuticals (+84%), cements (+65%), chemicals (+34%), electricity (+32%) and banks (+29%).
An attribution analysis of some of the best performing funds shows a significant variance in the top 10 holdings. Some funds focused their exposure on cornered stocks with low volumes and high liquidity risk, relying instead on market volatility and sentiment to generate returns. Other funds focused on strong fundamentals and concentrated their holdings in value stocks. Acquiring positions in small and mid-caps came back into vogue as sideboard items outperformed blue chip stocks by a wide margin. Equity funds that were able to make high conviction calls and maintain their exposure through December were the top performers in 1HFY15.
The table shows the top 10 holdings of the best five equity funds at year end. For discerning investors, it is important to assess the investment strategy of their mutual fund and recogniSe that heavy exposure to illiquid and volatile stocks may provide short term returns but prove costly to exit. Thus, while returns are important, the quality of returns and inherent risk of investment is an equally important parameter that should be considered. This should help investors mitigate losses in their portfolios when markets are in turmoil as they can be confident that their investments are in fundamentally sound companies which can survive and recover from negative events.
Though it is tempting for investors to realise gains and exit the market after an excellent three years, 2015 promises to be another profitable year for equities. Inflation is expected to remain muted, while privatisation flows and low oil prices should buttress concerns over the external account.
With foreign exchange reserves climbing in excess of $15 billion and the Pakistani rupee showing resilience against the US Dollar, the central bank can take an aggressive stance on easing the monetary policy. Lower interest rates and a more stable political environment would allow the market to continue re-rating to higher multiples. Mutual fund investors should look towards asset managers who base their strategy on high quality fundamental research. This will directly translate into high quality and sustainable returns which can provide investors with a hedge in a volatile market.
Published in The Express Tribune, January 13th, 2015.
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