“Should I simply cash out on my equity portfolio and switch to safe, debt investments?” Surprisingly, that question, and not “What should I buy?” seems to be topmost on investor minds, after the 36 per cent plunge in the BSE Sensex over the past six months.
Even investors who have doggedly held on to their stocks (or equity funds) through the entire meltdown from 21000 to the current 13400 levels, are now beginning to lose their stomach for risk and wonder if they should exit before they lose more value.
In the short term, they can. Taking a call on where the BSE Sensex can go from here is difficult, even for seasoned investors; too many times have even big names in the global investment business got that call wrong.
From a fundamental perspective, the collapse in the Sensex PE multiple, from 29 times trailing earnings in January to about 16 times now, ensures that rosy growth projections are no longer factored into Indian stock prices.
Current market valuations factor in only about 16 per cent earnings growth for the market over the next five years, down from 30 per cent in January. If slower earnings growth is a concern now, the slowdown is not likely to last forever.
Even economists who are cautious on the Indian economy now are not disputing its growth potential for the long term. They are only worried about a ‘cyclical’ slowdown, which may last for a year or slightly more. Even conservative forecasts for Sensex company earnings estimate growth at 15 per cent.
But this isn’t any guarantee that the stock market will not decline any further in the short term. The magnitude of the 2008 crash definitely proves that sentiment and perception play as much of a role in deciding how much investors are willing to pay for stocks, as growth expectations.
The picture on liquidity flows, the key determinant of how the stock market may behave in the short term, is still far from rosy.
In light of the above, how should individual investors decide whether to sell now? That would depend on two factors — when you need the money and the quality of stocks or equity funds you own.
Need your money in a year? Switch
Investors who need to encash their portfolio within the next year (to meet a financial goal), should probably consider a gradual exit from stocks and a switch into safer debt options such as fixed maturity plans. For such investors, debt investments promise fixed returns and an exit at assured prices one year hence. If they stay invested in stocks, they bear a further risk of downside.
In any case, given the magnitude of cuts taken by individual stocks in the past six months, one year will not be a sufficient time window to recoup a material portion of these losses. Investors deciding to exit their portfolio should do so in tranches, so that they don’t fail to take advantage of any intermittent recovery in the market.
Long term investor? Hold on tight
If you have invested in stocks with a 3-5 year perspective, this would be a particularly bad time to exit your equity portfolio.
By remaining invested in equities right from 21000 to 13450 levels, you’ve already lived through one of the worst-case situations in equity investing — a 30-70 per cent erosion in capital values.
By exiting now, you would be depriving yourself of the rewards for this fortitude! With market and stock valuations way below stratospheric levels, the fall has increased the odds of a reasonable return on your equity investments, over a 3-5 year holding period.
However, your return expectations would need to be moderate, at 15 per cent annualised, instead of 30-40 per cent that you have been used to over the past four years. This would still be much better than debt returns.
Timing can backfire
A rational approach now would be to try and forget the “buy” price (or NAV) at which you entered each stock or equity fund. That is irrelevant now. The call that you have to make at this time is whether you can find equity investments, at current levels, that will beat debt returns of 8-9 per cent over the next three years. That doesn’t seem to be in much doubt.
If you redeem your stock portfolios at today’s prices, a switch into debt investments such as fixed maturity plans can earn you a 9-10 per cent return over the next one year. But you would face a re-investment risk at the end of the year.
Experience shows that Indian stocks have the potential to gain 12-15 per cent even in a week’s time, if in a recovery phase.
Last week’s market bounce certainly brought fresh evidence of how swiftly even large-cap stocks tend to move in the Indian market.
Attempting to time your entry into the market (if you plan to re-enter the stock market when “things are better”) may lead to high transaction costs and poor decisions.
Timing moves, especially when you have several decisions to make, have the potential to backfire.
What if you buy a range of stocks only to discover that it was a short-lived rally driven by “short-covering”? A recovery in the Indian stock market now is largely a function of when global institutional investors will peg up their ‘
Switch to safer bets
Having said this, given the very real earnings concerns surrounding Indian companies at this juncture, there will be some stocks and sectors in your portfolio that are not worth holding on to, even at this juncture.
With the investment environment uncertain, small and mid-cap stocks (with select exceptions) seem certain to trail blue-chips in the event of a market recovery.
Selling some of those small-caps, even at some sacrifice, and deploying that sum in large-caps from the Sensex or Nifty baskets may ensure that your portfolio doesn’t miss out on any recovery phase.
The time also appears ripe to exit your “low-conviction” trading buys and replace them with stocks that have a stronger claim to fundamentals.
If stock selection seems fraught with risk, switch to good diversified equity funds; they will be certain to capitalise on a market upmove.
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