There is no doubt that market valuations have risen considerably over the past few quarters, both in frontline indices like the Sensex or Nifty, and also in the midcap / small cap indices. Retail investors are worried whether the valuations would sustain at current levels. A vast section of the retail community is reluctant to invest at this juncture, fearing a correction or possible reversal in trend.
Entering at the peak
Since December last year, Nifty has given an absolute return of 26%. Two potent risks exist at this point of time. One, the markets have peaked and would decline hereon, and secondly, the markets might correct a little, and then enter into a sideways territory for an extended period of time before the next rally. For example, the Nifty reached a high of 8,901 on February 1, 2015, the decline thereafter caused the Nifty to take exactly two years to regain this level. Now, an investor who entered at or near the February 1, 2015 level did not witness any returns for two years. He actually experienced mark-to-market losses during this period.
Importance of investors’ efforts
In the midst of such a strong bull market optimism is both exaggerated and unrealistic. Downsides are ignored without serious consideration. Putting in time and effort in the study of potential investments should be the investor’s primary focus, before consideration of valuations and market levels. This is even more crucial at higher valuations. The investor should undertake proper due diligence before buying equities or equity mutual funds.
Review asset allocation
Another aspect that the investor should consider is changes in asset allocation. Asset allocation is primarily based on the risk appetite of the investor and his goals. Investors, however, are unable to understand or evaluate their risk appetite appropriately, and tend to be influenced by market conditions and opinions. As a result, he takes on either more or less risk during bull or bear runs than what is suited to his profile. Even if the investor does get the allocation right before investing, he should review it every six months to assess whether there are any adverse changes.
SIP or staggered investing
If the investor decides to invest at higher levels even after considering the factors mentioned above, he should consider the SIP option, or stagger the investments over a period of time. As a result, even if the market goes into a downturn, the investor will be able to average the cost of his investments.
Be careful of IPOs, penny stocks
During a bull market a large number of IPOs hit the market vying for the investors’ funds. Investors should be careful not get influenced by a few successful IPOs or grey market premiums, and assume that all IPOs would perform similarly. Investors invariably lose money in the last IPOs at the fag end of the bull run. Investors should also desist from investing in penny stocks that come to life at the mature stage of a bull run, showing volume and price rise based on inflated expectations of a quick turnaround. In most of these cases, smart investors exit at higher prices, and the retail investors are stuck with the penny stocks if they do not exit fast.
Risks in small & mid-cap stocks
Investors with exposure to mid-cap stocks should understand that these generally rise/fall faster than large-cap stocks. In 2008, Nifty declined by approximately 55%, whereas the Nifty Free Float Midcap 100 fell by 70%. Between November 2010 and December 2011, Nifty fell by 25%, whereas Midcap 100 fell by 38%. Even the recovery from the lows of December 2011 to previous highs took almost a year longer for the Midcap 100 Index, as compared to Nifty. Hence, the investor should be more cautious about his holdings in mid-cap stocks, and should partially book profits in stocks that have performed well during the rally. Bull runs throw up opportunities to study stocks that have performed well in a short period of time. Retail investors should make the most of this chance. Who knows, the next correction may give an opportunity to acquire them at better entry levels.
The author Deepak Jasani is head, Retail Research, HDFC Securities