| Investing in Volatile markets |
Neelesh Surana, Head - Equity
Published in Indian Express newspaper, September 2011 |
| Writing an article on volatile markets could not have come at a more relevant time given the sequence of rather violent movements witnessed over the last few weeks in the global markets. It has been two full years of bottoming out for global markets, yet there is little certainty where the world is heading economically. There are more questions than answers with regards to global issues related to the European contagion, US economy, etc. It does appear that, the excesses of the past cycle were so enormous that the ongoing consolidation phase could |
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take a long time to heal. While the world has always been full of uncertainty, it is at the time of maximum pessimissim that the confusion among investors is high. It is difficult even for the experts, leave alone an average investors, to do a prognosis of how the excesses of unhealthy balance sheets in a developed world on one hand and healthy corporate balance sheets will pan out.
While no investment strategy would guarantee absolute positive returns across all timeframes, rationally managing wealth helps face the volatility in a much better way. It is worth remembering the basics of long-term investment, especially in difficult markets. Let me break the subsequent article into three parts [a] how to deal with investments in general [b] those related to equity mutual fund investments and [c] dealing with direct equity investments. |
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| I. Volatility and Invesments – Asset allocation is crucial
Volatility and Invesments – Asset allocation is crucial |
| Define investment goals and asset allocation : |
| The first step is to define one’s investment goals in terms of financial requirements, risk tolerance and time horizon. The same is to be followed by carefully crafting an asset allocation plan which should be used as the basic building block to achieve the financial goals. It is important to stress-test the asset allocation so as to achieve the broadly the desired results under various assumptions. The risk adjusted returns of a well-crafted portfolio across diversified asset classes would weather volatility in a much better fashion than an impulse oriented investment. The following points are important with respect to asset allocation: |
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| Diversification : |
Asset allocation help achieve diversification which reduces leads to an optimal return with lower volatility. Approapriate diversification should be considered across all asset class i.e. [a] Fixed income; [b] Equities; [c] Real-estate and [d] Precious metal/others. Also, with equities the best way is to participate through mutual funds. Diversification with equity mutual fund should be across different fund families which have differentiated stocks – this could vary across scheme mandates across fund houses, international funds, etc.
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| Importance of liquidity : |
Individual needs vary so do the reaction of people to same market volatility. A well culled out asset allocation helps reduce anxieties, as well as helps provide the required ammunition in form of cash to take advantage of any particular situation.
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| Take care of minor details: |
Investments made should be in sync with the income requirement. For e.g., we do get frequent queries regarding when to partly redeem mutual funds to meet one’s regular income requirement. In this context, it is important that when investments in equity mutual fund should be made the timeframe should be made with a timeframe of a minimum two to three years. Also, those who in need of regular income should opt for the ‘dividend’ option rather than timing redemptions as most well managed equity mutual funds do give regular dividends.
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| II. Equities Mutual Funds and volatility - SIP is a much better route |
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Market declines at times can be unsettling. However, it is important to realize that market declines are natural. Many a times the no action is required when markets declines, i.e. simply doing nothing provided it is a well thought out allocation with planned diversification within equity mutual funds. The best way, to participate for in equities is through the Systematic Investment Route (SIP). SIP is a process which helps invest a pre-determined amount at regular intervals into mutual funds.
The advantage of SIP are: |
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| SIP is process driven, and not an emotional/impulse decision : |
The single biggest advantage is that SIP helps control the urge to constantly time the markets as the investment is through an automatic process driven route.
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| SIP averages the cost, and works best in a falling market : |
By buying at different levels, SIP ensures that investment would have occurred at different NAVs thereby averaging out the cost. Infact, SIP works best in a falling market. The idea behind SIP is that by investing the same amount each month over a period of time you do not have to worry about the right time or wrong time to invest.
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| SIP could help link income to savings: |
SIP improves savings habit as it can be linked to one’s regular source of income, for example salary.
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| III. Volatility and Investment in equities directly - Be a contrarian |
Market declines at times can be unsettling. However, it is important to realize that market decliThe overreaction hypothesis: People overreact to unexpected and dramatic events. The overreaction hypothesis states that investors react irrationally to events by placing too much weight on current events. In other words, investors get emotional, biased and thus overreact by being either over-optimistic or over-pessimistic. Investors get too optimistic about stocks (or markets) when the near-term prospects are good (driven by greed) and vice-versa i.e. investors get too pessimistic about stocks (or market) when the near-term prospects are bleak (driven by fear). Although the overreaction takes stock prices abnormally high or low, in the short term they adjust to the investments intrinsic worth in the long term. Benjamin Graham aptly said, “In the short run, the market is a voting machine, but in the long-run it is a weighing machine”.nes are natural. Many a times the no action is required when markets declines, i.e. simply doing nothing provided it is a well thought out allocation with planned diversification within equity mutual funds. The best way, to participate for in equities is through the Systematic Investment Route (SIP). SIP is a process which helps invest a pre-determined amount at regular intervals into mutual funds. The advantage of SIP are:
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| Volatility a boon to contrarian investors: |
For those who understand investment directly in equities, volatility is a boon. A contrarian, equity investor has huge advantage when markets are volatile. With his eye firmly, fixed on fundamentals, he would scout for opportunities by identifying the extent of overreaction at moments of peak optimistic and pessimistic. This however requires two attributes [a] a correct assessment of the intrinsic value of business; and [b] a firm belief that stocks prices would trace the value over time.
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| Let me end with an interesting quote from Shakespeare which while not intended for the equity markets fits aptly for a contrarian investor, “There is tide in affairs of men which, taken at the flood leads on to fortune”. |
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