13 June, 2011

Coping with Volatility

Life is never linear. There are times when elation is the dominant sentiment and at other times gloom reigns supreme. Investors get in when the markets are trending higher. There are lots of fence sitters when the markets are rising. It is when the markets have run up almost to the top that the stampede to get in, starts. But, that’s the wrong time. Again, when the markets have started sliding, investors want to sit out the slump. But they suddenly lose their nerve when markets go down the tube, on a continuous losing trend. At some point like that, a stampede starts. They just book their losses and exit out, costs be damned. They don’t look at the market at all, till there is a frenzy again. This is all too familiar right?

This is not inevitable. This will probably not happen if there is a clear time horizon and a goal for which investors are investing. Most investors are aware that the equity markets are volatile and that they tend to give returns over the long-term. If they have understood that, they would stay invested. In a situation like the present where the markets have drifted downwards and is now staying in a range, what is it that an investor can do. Let’s take a look.

1. The dumb thing to do would be to cash out equity assets at this point in time. As per the asset allocation principle, one would need to commit more money to equities, as their values would now have eroded and they would have a smaller share in the asset allocation pie. Hence, actually equity allocation needs to be bumped up. Though it may be a gut-wrenching decision to take at this point, it will prove to be a winner over time. Even if one is not doing that, one could at least wait out this slump.

2. Continue the SIPs that have been going on. We get calls to know if they should stop the SIPs at this point. On the contrary, all purchases done in this period through SIPs would help the investors get higher number of units, ultimately helping them when the markets turn again.

3. Running after Gold as it is giving exceedingly good returns now is also not advised. Gold is going up due to speculative activity. Gold ETFs worldwide are collecting huge corpuses and they are buying gold to be kept in their vaults. There is no productive use for this gold. It is just that there is a widespread expectation that Gold will trend higher, which it could. But this is speculative activity. Due to currency debasement & uncertainty in the world, Gold is a comfort investment. Keep it that way. Invest between 5-10% of your corpus in Gold and other precious metals through ETFs or other similar options, instead of direct physical investments. Physical investments have additional costs and is also subject to wealth tax. Silver had already shown what can happen when there is massive speculation – it dropped 30% in 3 days, when higher margins were imposed.

4. For those who invest in stocks, they could look at picking defensive themes like FMCG, Pharma etc. Profitability of companies are coming down. In such situations Largecap companies & others who have leadership positions in their industries, could be good bets. Such companies have better pricing power & ability to weather the storm. If investments are through MFs, schemes investing in the above mentioned areas, would be good bets.

5. For those who have a long time horizon of 3 - 5 years and beyond, Mid & small cap companies would be good picks, as their prices are beaten down and offer good valuations now. If the goals are longterm, these investments could be a good idea.

6. For Fixed income investors, FMPs are a good idea now. The underlying investments in FMPs viz. CPs and CDs are now offering over 10% returns. If a person is in Dividend option, they could get 8.6% or more returns post-tax. This is attractive and is well above what PPF offers. Best of all, this comes in an FMP with just over 1 year duration. There are Bank FDs, company FDs and bond offerings which are attractive too.

7. There is another excellent option available before retail investors. Since the interest rate cycle is more or less at the peak and is expected to taper off in about 6 months, there is potentially money to be made by investing in G-sec funds which will give very good returns when the markets turn. Even other funds holding corporate paper can similarly give good returns. One could invest in dynamically managed debt funds which a fund manager would manage and time the entry and exits of various investments, which is critical here.

8. For those wanting to put in a large sum of money in equity assets, they could break up the money and invest over time to take advantage of market fluctuations & spread their risks. In case of MF investments, investments can be done in debt funds and can be transferred to appropriate equity funds, over time.
Predicting the direction of the market is fraught with danger, which even experts are not able to do. Taking a longterm view and investing & taking advantage of the present situation, is the wise thing to do.

Article by Suresh Sadagopan ; Published in Business Standard on 12/6/2011

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