Sector show; Not just Returns but about Risk too

Making sense of the Sector Show

Most of intuitively know which sector is doing well in terms of returns. At least the sectors with the highest weightage on the Nifty like banks, IT, FMCG, oil and auto are well tracked. However, sector performance is not just about returns, but also about risk and about valuations. Which are the sectors that have given the best returns, lowest risk, and the best valuations. In this segment, we will look to address some key questions.

1. Which sectors have given the best returns over a 1 year time frame, 3 year time frame and a 5 year time frame. Being long term in nature, sectoral returns are best assessed over a 5 year term. 
   
    
2. Which sectors have the highest risk as measured by measures like Beta and standard deviation of returns. Only 1 year data is considered so that the data points are as current as possible in a rather sensitive measure.
   
    
3. How are sectors valued in terms of P/E ratio, P/BV, and dividend yield. That is the third perspective we will take on sectors. It tells if these sectors are available at attractive valuations to justify investments.

Sectoral indices offer a unique way to look at the performance of sectors through the lens of various sector indices. 

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How Sectors Fared in September on 5-year CAGR returns?

The table is ranked on 5-year CAGR returns since short term returns can often be misleading to explain the equity story.

Data Source: NSE

Here are some major takeaways.

• Realty has been the top performing sector over a 5 year period with 21.75% CAGR returns. Other solid performers that did better than the Nifty include Consumer Durables at 19.23% and Metals at 16.59%. 
  
   
• Does the story change if you look at 3 year returns? PSU banks lead the rally with 62.07% CAGR returns over 3 years. The interesting bit is that metals and realty also did very well on a 3-year basis
  
   
• What about high frequency 1-year returns? PSU Banks again led the way in the last one year followed by realty and autos. However, sectors like oil & gas have lagged while IT has surprisingly given nearly 20% returns amidst value buying. 

The big surprise package in the last 3 years has been the PSU banks, where a combination of better asset quality and improved NII and NIMs did the trick.

Evaluating Sectors on Risk Parameters

How do we measure risk. We look at risk in terms of volatility, Beta, and correlation in the last 1 year. The correlation and Beta are with reference to the Nifty index. Volatility is the extent to which the sector returns fluctuate or deviate from the median. Here are the sectors ranked on 1 year volatility or standard deviation.

Data Source: NSE

Here are the key takeaways from the risk analysis of sectors.

• In terms of 1-year volatility as measured by standard deviation, PSU banks, metals and realty have shown the highest degree of volatility. Incidentally, they are also among the return leaders, so it is returns coming at the cost of more risk.
  
   
• What are the sectors with the highest Beta in the last 1 year vis-à-vis the Nifty? Sectors with the highest Beta are PSU banks at 1.46. metals at 1.39 and IT and 1.15. On the defensive side are healthcare at 0.43, FMCG at 0.61 and Autos at 0.79. 
  
   
• Higher the correlation, higher is the performance of the index explained by the market overall. Financial services showed a very high correlation with the Nifty while healthcare, realty and FMCG have relatively low correlation levels. 

PSU banks and metals have been virtual proxies for the Nifty, so a defensive strategy may need to include the low risk names also for the sake of diversification.

What is the Valuation story of Sectoral Indices?

Let us also look at how the sectors stack up on key measures of valuation like the P/E ratio, Price to book ratio and dividend yield. That is captured in the table below.

Data Source: NSE

Here are some of the key takeaways on the valuation story.

• Consumer durables with P/E of 63.30X, Realty with P/E at 47.68X and FMCG with P/E at 42.64X are the most expensive. Realty may have concerns as the really has been much sharper than the earnings growth. PSU banks and oil trade at single-digit P/E ratios.
  
   
• P/BV is more relevant to the financials, so that is what we focus on. NBFCs are trading at P/BV of 3.2X while private banks are trading at 2.64X price to book. In comparison PSU banks are still reasonably priced at 1.20X price to book.
  
   
• What about dividend yield? Metals, IT, oil & gas, and PSU banks offer the best dividend yields as a sector, with IT seeing a spike in dividend yields in recent quarters. Realty, consumer durables and private banks have the lowest dividend yields.