Equity as an asset class is among the most rewarding but also highly volatile. How you handle this volatility can decide the course of your equity portfolio. The Sensex hit a high of 61,475 (January 17, 2022) and a low of 54,383 on February 24. Then, in March it fell further to 52,261 (March 8) only to rise to about 58,891 on March 31. The fluctuations in just the first three months of the calendar year show that responding to volatility in the appropriate manner is extremely important for equity investors. Here is a guide for investors on ways to deal with market volatility.
Follow A Disciplined Approach
When the Sensex crashed to a low of 29,468.49 points in March 2020, a drop of almost 9,442.46 points or 24 per cent within a month, people who had adequate cash flows saw an opportunity to enter the market. But it’s not possible to take advantage of every market crash or high. During the same crash, people who waited in the wings for the market to fall further would have lost out. Similarly, those who booked their profits later in the year, when the markets were at nearly 40,000, would have lost out on the later rally. At present, the BSE Sensex is hovering around 60,000 points.
“Equity markets will go up and down, it’s their inherent nature. So, we should not unnecessarily hurt our investments by rapidly buying and selling them,” says A.K. Narayan, CEO and founder of AK Narayan Associates, a financial advisory and financial products distributor.
Timing the market is not worthwhile. “Investors who try to time the market in the near term miss out on the massive bounce-back rallies that often follow these sharp reversals. However, these events are known only in hindsight, and thus it is most prudent to stay invested at all times,” says Prateek Pant, chief business officer, WhiteOak Capital Management, an investment management and advisory firm.
For individual investors, the best strategy is to invest regularly to average out the ups and downs in the market. “We recommend that people who were waiting on the sidelines and now want to take advantage of the low prices of equities, should do so via the SIP (systematic investment plan) route rather than going for a lump sum option. Stagger it and move towards your desired asset allocation goal,” says Sorbh Gupta, fund manager, equity, Quantum Mutual Fund.
Differentiate Between News And Noise
As an investor in equity markets, you should learn to sift out the unwanted information and retain only what’s needed. When the news of the Russia-Ukraine war broke out, many investors panicked and started selling heavily. Though the markets were seized with another bout of volatility, individual companies suffered little on account of the war and, therefore, their fundamentals remained unhurt.
“In the short term, a company’s stock price may be down despite it being fundamentally strong, but not necessarily in the long run. Multiple other factors could affect the stock price or market cap, including sentiment, industry outlook, management quality, promoter or corporate actions, and these might or might not have near-term impacts,” says Vasanth Kamath, founder and CEO, Smallcase, an online investment platform. A company’s stock price will always catch up to its fundamentals regardless of the overall news. “A long-term investor should choose to invest according to a company’s fundamentals rather than the news around it,” says Narayan.
Your investment horizon also determines whether a particular piece of news is relevant. “For example, if you have a three-year investment horizon, the present war event is ‘noise’ but if you have a three-month horizon, you would be tempted to react to it,” says Shrey Loonker, associate director and fund manager, PMS, Motilal Oswal Asset Management. See if the event impacts the business model of the company structurally or is it just a short-term bump.
Volatility Is Short Term, But Investing is Long Term
The likelihood of equities performing better is higher when you stay invested for the long term. In the short term, markets’ knee-jerk reactions can erode your wealth. For instance, the market fell sharply during the 2008 financial crisis and also when the Coronavirus hit India in 2020, but it bounced back to new highs gradually after both these events.
If you look only at the short-term numbers, they will likely disappoint you. However, long-term performance will surprise you. The broader market indices Nifty 100 and S&P BSE 100 have, respectively, delivered merely 0.75 per cent and 1.23 per cent compounded annual growth rate (CAGR) in the last three months. However, in the last five years, they have given 14.98 per cent and 15.08 per cent, respectively.
“In equities, you are technically buying a part of a business so that you can get the benefits when the business grows and generates profits. Thus, investing in equities has to be a long-term process and not short-term,” says Rushabh Desai, founder of Rupee With Rushabh Investment Services.
Turn Volatility In Your Favour
Volatility can also offer an opportunity to mature investors to rebalance and average the cost of investments. In a market sell-off, you may find several stocks or mutual fund net asset values (NAVs) available at a discount.
You could use the opportunity to stock up on potential performers. This can also help you average out the cost and reap better returns.
Let’s take an example. You invest Rs 1,000 in a mutual fund with an NAV of Rs 11. You will be allotted 90.90 units. You do nothing with your investments and at the end of the year, the NAV moves up to Rs 13. You will get a return of 18.18 per cent.
However, if the NAV fell to Rs 9 at one point during the year and you invested another Rs 1,000, you would get another 111.11 units. Now you have an investment of Rs 2,000 in around 202.01 units. If the NAV reaches Rs 13 at the end of the year, your returns would be 31.30 per cent.
Stick To Asset Allocation
Regardless of the market levels, your investments need to be in sync with your asset allocation plan because they have been formulated after taking into account factors such as volatility, inflation, risk appetite, time horizon, and others.
For example, typically, gold and debt instruments act as a hedge against volatility in the portfolio. When equity markets are down, these assets shield the overall portfolio from shocks and provide stability. “You have to keep a balance between equity, debt and other asset class investments. You shouldn’t be biased towards equity because it gives the highest returns. Even if debt instruments offer lower returns, you should allocate some portion of your investment to debt for capital protection. Otherwise, you will take on undue risk, and your capital could get eroded during market crashes,” says Narayan.
During market volatility, look at rebalancing your portfolio to stick to the required asset allocation. For instance, if the value of equity falls during a drawdown, invest more in this asset class. “Discipline towards asset allocation will always benefit in the long term. During market drawdowns, as the equity allocation would fall in the short term, the discipline to maintain the asset allocation will mean investing more in equity to achieve the pre-decided levels. It works in the opposite direction too. Asset allocation makes you automatically act rationally,” says Loonker.
Diversification is key to asset allocation. Don’t have a narrow focus on equities; spread your investment risks across asset classes. “Diversification should be done within equity also; between large-, mid- and small-caps. Put money according to your asset allocation goals,” adds Narayan.
The best way to reap the benefits of equity investments is to have a holistic view of the nature of the market, your own expectations and investment behavior and financial goals. Once these pieces are aligned and placed in the proper positions, you will not be bothered by market volatility and your portfolio will be well-positioned to take advantage of the opportunities while remaining safe.