Investment strategy in a volatile market

7 Nov

Indian bourses have been setting new and new index highs every other week amidst heavy volatile trading. There are many arguments in favour of the Indian growth story. Some believe that what we are seeing here is a fundamental move where as some others swear that India is a special case compared to other emerging markets and we will keep going up. Some wisemen and analysts even predict targets for the ‘Sensitive Index‘ for not just 2008 but for 2010 and 2020 as well. The weakening dollar combined with the huge market capitalization gains have made Mukesh Ambani the richest person on earth in less than two months time. However, it may be a matter of couple of months before 9 out of 10 retail investors loose out in the market after being exposed to the high-risk game in the volatile market. Having seen and experienced three huge market falls in my investment life, I would like to advise the inexperienced retail investors to be very cautious at this point of time.

Good, bad and ugly…

There are a couple of things that are going really good in India recently. The first and foremost thing is the consistent economic growth rate of 8% and above that the country has been achieving of late. The other good thing (which resulted in the first one) is that there are couple of wise men sitting on top
who are driving the Indian economic story – P, Chidambaram and Y.B. Reddy being the prominent ones supported by other organizational leaders of SEBI etc. Strengthening rupee, low inflation rates, increase in foreign exchange reserve, turned-around PSUs, focus on futuristic infrastructure planning etc are some of the positive results of good overall leadership. The current Indian finance ministry, Reserve Bank of India and SEBI are almost always prompt in rolling out policies for positive growth and also to curb abnormalities like credit or sub-prime issues and indirect FII inflows.

However, there are couple of other things that are not really in favour of a stable economy – the first being the fact that we are having a very unpredictable political alliance at the center that can fall anytime. Many of the economical reforms, tie-ups with developed countries and global capital institutions etc are often thwarted by one or the ally. Secondly, the inability to manage (appreciate/depreciate rupee!) the rupee value at an optimum level against the US dollar has badly affected the export houses and industries like Software, textile and jewelry. Third biggest factor is that the huge FII money that is coming as foreign exchange is not really used for any long term planning. Due to the high volatility, this kind of money is not being used for developmental activities.

Some myths associated to the volatility

India is a special case and the bull run has to continue: Wrong! I personally believe that the fair value for the sensex should be around 13000-14000 at the moment as compared to the PE multiples of other stable emerging markets. The market has been fueled by the FII inflows and it can reduce anytime and India is
not really a special case.

Sensex is so high that I cannot enter now!: Wrong! Sensex is only an indicator of a small set of 30 stocks. At any point of time there are enough value stocks available in the market that you can buy.

PE valuations don’t apply any longer: Stupidity! If a few stocks are shot up because of momentum, it doesn’t mean that we are in a special situation and we can forget the valuations. If Educomp and RNRL are currently being traded at 400 or 500 times forward earnings, they are dangerously risky trading bets and not
any good for investment. Another example: Majority of IT stocks used to trade at 30 to 40 PE multiples for almost ten years now. This does not mean that, going forward Infosys is still fairly valued and be a multibagger!

Momentum trading is better than value buying in a volatile market: Wrong! Value buying is always the best mechanism to invest. Momentum trading may not be there for ever and can wipe out your money at any time.

It’s better to keep booking profits regularly to reduce risk: Wrong! If you have done your homework about your investment portfolio (See long term portfolio below) you don’t need to do this. In fact, booking profits at regular intervals will badly affect your returns. However, it is also a good option if you maintain your investment portfolio and trading portfolio altogether separated. For fun and high risk gambling you could use the trading path while the investment portfolio is probably for your retirement life.

I should book profit on my mutual funds now: No, unless you are in urgent need of money. Mutual funds are long term instruments for wealth accumulation and an ideal way to enter them is via Systematic Investment Plans (SIPs). It is not investor’s job to time the market for MF investment but your fund manager will take care of that part. So never trade a mutual fund.

A few investment tips

If you are in doubt whether you should enter the market now or not, opt for the SIP route of investment via mutual funds. Ideally SIPs should be for subscribed
for a longer investment period of say greater than two years.

Never buy your stocks in bulk: The self managed SIP route can be taken for buying even stocks. ie. You buy larger quantities when the prices go down and smaller quantities when you feel that the prices are a big high. In other words, build your portfolio over a number of months and years and not overnight. Please note that this rule is applicable only to fundamentally strong long term portfolio stocks.

Avoid playing momentum stocks. 8 out of 10 traders make losses on such trading opportunities.

If you want to play volatility then opt for some of the best exchange traded index funds. One great example for the same is Benchmark Nifty Exchange Traded
Scheme. This is a fund that invests in NIFTY stocks and is pretty much reliable in terms of low tracking error.

Don’t buy a stock due to market or analyst pressure or rumours. Do your homework before entering each and every counter.

Avoid having more than 25 or 30 percent weightage on mid and small cap stocks in your long term portfolio.

Identify sectors that have long term value and those sectors and companies that are often affected by government policies, weather, margin pressure etc. For example, textile stocks and software companies are affected big time by the rising rupee and hence they may not yield the same kind of returns as in the past. Another sector which should be almost always avoided is the airlines which are always under margin pressure.

Periodically (every three months or so) inspect your long term portfolio for any fundamental changes or external parameter influence.

Try to diversify your investment across at least four to five sectors and six to ten different stocks. Never put your bulk investment into one or two stocks alone.

Try to diversify in terms of investment instruments. One should have a good mix of Post Office deposits, equities, mutual funds, fixed/term deposits, gold and real estate in their long term portfolio. For long term, gold may be an excellent investment. Again Benchmark’s gold exchange traded fund (ETF) and DSP Merril Lynch’s World Goldfund are excellent picks for low risk investments.

My long term portfolio picks (In the order of portfolio weightage and large cap to small cap order)

Punj Lloyd
Reliance Communications
Crompton Greaves
Tata Steel
Bajaj Auto
HCL Technologies
Britannia Industries
Kesoram Industries
Bharati Shipyard
Apollo Hospitals
NIIT Technologies
Glaxo Smithkline Consumer
Ballarpur Industries
Orient Paper
City Union Bank
Hanung Toys

Note: Some of the above stocks are already fairly valued while some others should be entered during the next correction.

Disclaimer: As a retail investor I may or may not have vested interest in some of the scrips mentioned here. Readers are advised to do their homework and exercise discretion before attempting any investment.

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