Most of the time, investors are not sure how equity markets will perform or which direction the market will go. In such a scenario, investors need to follow strategies that can protect them from the downside while helping them participate in the upside of the equity markets.
At the start of 2016, many analysts predicted levels of 10,000 in Nifty and advised investors to remain invested in the market and yet, at the start of 2017, our market is languishing at 8100. Interestingly, no fund manager or analyst ever says that this is not the right time to invest even though the market is trading at overstretched valuations.
When the market was at an all-time high during January 2008, market P/E (Price/Earning) and P/B (Price/Book value) was also at an all-time high of 28.20 and 6.55. This clearly showed that the markets were in the extreme overbought zone and investors should have started exiting rather than entering the equity markets at that time. But investors were in a frenzy, thinking they would be left out from the next high.
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During the correction of 2008, investors were afraid of buying, thinking that a downside can come when P/E was 15.50 and P/B was 3.0. Again, around March 2015, market was near an all-time high with P/E and P/B at 24.06 and 3.82, respectively, and during September 2016, P/E was 24.54 and P/B was 3.4. Though the ratios were not as high as previously; still investors should have been cautious at that point. During the correction of December 2011, P/E was 17 and P/E was 2.80 but investors were not coming, thinking that the next leg of the downside would come.
Most analysts who advocate investing long-term believe in the policy of “buy right and sit tight”. Yes, Sensex has given positive returns every eight years, but why wait for so long? The general consensus for long-term investing means holding for three to five years but markets have given negative return over three and five years. Only beyond seven years, markets have given positive returns and if one had bought and sat tight, the returns might have been dismally low. Instead, we advocate investing through asset allocation strategy based on market fundamentals.
An investor can use P/E and P/B of Nifty/Sensex as a yardstick to allocate between debt and equity. If P/E is below 14 or around 15, investors should allocate 90% of funds in equity and rest in debt; for P/E at16-20, 75% should be in equity and rest in debt and with above 20-23 P/E, 25-20% of funds should be allocated in equity with the rest in debt.
However, if P/E is above 25-26, then one should invest 5-10% in equity and rest in debt. Investors should rebalance their portfolios on quarterly basis. This would help in booking profit when market is overheated and participate when market is undervalued. There are many fund houses which rebalance portfolio between debt and equity on market P/E, P/B, etc., and rebalance at regular intervals. Those investors who do not want to look at market fundamentals should think of investing in these schemes.
The writer is CMD, Tradebulls Securities