Shanthi Venkataraman
Are you stuck in an investing rut? After all, although you have a sizeable portfolio of stocks, you have just seen a good 40-70 per cent of your portfolio value eroded over the last six months. Your financial advisor tells you to stay invested, but admits that there could still be some downside, God forbid. He also tells you not to expect a sharp recovery anytime soon. Think long term, he says. You start thinking of cashing out on equities, putting your money in debt and returning to the markets when stocks recover. But he warns that you might miss out on the rally, when it happens.
Fret not. To be sure, investing in the stock markets during tough times is certainly not easy. But you can re-jig your portfolio such that it contains declines better, even as it retains the potential to beat the 8-10 per cent you earn from debt. Here are a few “defensive” moves you can make to meet your goals.
Hold cash: If you see a further downside in the offing, the easiest strategy to follow would be to cut positions across your equity holdings and hold cash to the extent of about 10-15 per cent of your equity portfolio. This not only reduces the extent of losses, but provides you with liquidity to invest when stocks are at rock-bottom prices.
Stick to large-caps: Quality mid-cap stocks deliver higher returns than their large-cap counterparts over the long term. However, holding large positions in mid-cap and small-cap stocks (those with a market capitalisation of less than Rs 4,500 crore) exposes your portfolio to further downside risks. In uncertain times, investors back stocks of companies that are either in mature businesses, have stronger financial muscle, larger market share or any other strong competitive advantages. Large-cap stocks typically do not fall as much as their mid-cap counterparts. At any rate, large-caps usually are the first to recover when market conditions start improving. While you can continue to hold a couple of mid-caps for your grandchild’s portfolio (read stocks that are sure-fire large-caps of tomorrow), switching over to large-caps is a prudent measure in a volatile market.
Buy defensives: Defensive stocks or sectors refer to those stocks which have a low association with the economic cycle. Healthcare and education sectors, for instance, are unaffected by the uneconomic cycle. In the recent market correction, FMCG and technology stocks have fared better than the rest of the market.
One reason is that these companies are expected to cope better in a higher interest rate scenario, given their cash-rich balance-sheet and low capital-intensive nature of their businesses.
One can also look at “low beta” stocks. Beta measures the sensitivity of a stock to market returns. If a stock has a beta of 0.8 vis-À-vis the Sensex, then for every 10 per cent appreciation of the Sensex, the stock rises 8 per cent. Similarly, if the market falls 10 per cent, the stock declines only by 8 per cent. Choosing low beta stocks can, therefore, help in limiting the downside of the portfolio, although it caps the upside as well.
Diversify: You have heard of this strategy often enough. But there are different ways of doing it. For instance, you need not invest in every sector, especially if you do not understand its dynamics. There is also no point in buying into sectors that have serious earnings concerns, simply for the sake of diversification.
Instead, you can limit your buys to about five-six sectors, but spread your holdings over several stocks. Limit your exposure to, say, about five per cent in each stock. Book profits when the value of your holdings in a particular sector or stock exceeds your target limit.
Achieving this fine level of diversification is no doubt difficult, which is what makes mutual funds a good option at these times.
Switch to mutual funds: If your portfolio is in shambles, maybe its time to call for professional help. Mutual funds bring professional expertise and are able to provide diversification at a cost efficient manner.
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But think of it this way. It is quite likely that the average diversified mutual fund does fare better than the average retail investor both on the upside and on the downside.
If you are still not convinced, consider a passive ETF (exchange traded fund), which removes selection errors and offers diversification. This way, you only earn or lose as much as the Sensex or Nifty.
You can also use mutual funds to diversify into international markets or to invest in real estate or gold (courtesy ETFs).
Use prudent investing strategies: When and how you invest matters as much as stock selection. Bad timing of investment in the best of stocks can be a losing proposition. If you are investing in mutual funds, consider phasing your purchases through systematic investment plans.
If you are investing in stocks directly, consider accumulating a stock by buying it in small lots.
If you decide to invest Rs 10,000 in stock A, currently quoting at Rs 100, begin by buying 50 stocks for Rs 5,000. If the stock then falls to Rs 80, you can buy a further 60 stocks with the balance Rs 5,000. This way you reduce your acquisition cost to Rs 90.
Fix a target return and book profits once the target is achieved, retaining the capital alone.
Do not be afraid of selling at a loss. Instead of waiting for the stock to recoup its losses, try switching to another stock with greater promise.
All the above measures may drag your portfolio returns in a steadily rising market. But they do help you make the best of a volatile market.
The Businessline dt. 13 7 2008
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