Looking to beat volatile stock markets, here’s how to build a turbulence proof portfolio
September 25, 2020 2:39 PM
Equity markets have always been volatile; in fact, volatility is in the inherent nature of equity investing. If it’s not volatile it’s not equity investing.
Stocks around the world scaled a record high as expectations of more monetary stimulus also lifted demand for risky assets.
By Sachin Shah
Equity markets have always been volatile; in fact, volatility is in the inherent nature of equity investing. If it’s not volatile it’s not equity investing. So, one cannot avoid or run away from volatility. The only option is to make good use of that inherent volatility and therefore, as they say, “Make Volatility Your Friend”. Volatility is like a wild animal that gets crazier at times. It’s risky and at times it can also be fatal. In that sense, to tame this beast, it’s very important to first understand the facts and reasons behind volatility. One of the key explanations behind volatility has been the human emotion of “Greed & Fear”. It’s very important for investors to avoid being swayed by these emotions, particularly as part of herd mentality.
During some major local and global events (recent examples being election results, demonetisation, COVID-19) both negative & positive, markets tend to overshoot. One of the key reasons for markets going overboard is because of the leveraged positions (investors investing on borrowed / loans) that get created in the markets. Leveraged positions are like a double-edged sword; they would give extra returns if the bet goes right, but at the same time they could wipe out the entire capital with some volatility in the market. Effectively, with slightest of the volatility the portfolios that have been created on borrowed funds tend to have significant losses and therefore those investors tend to panic and are in a hurry (or forced) to sell their investments at lower prices, irrespective of the intrinsic value of the asset.
So, for investors the first golden rule is to Invest with only their Own Money & Not with Borrowed Money (No margin funding).
Now, the second step of figuring out when to invest will also help investors maximise their returns. As they say, “Be Greedy when others are Fearful and be Fearful when others are Greedy”. Effectively, BUY when everyone is selling, and the markets are going down and SELL when there is euphoria in the markets and the markets are rising rapidly. Of course, this is easier said than done; therefore, there are a few strategies that investors could adopt and follow them in a disciplined fashion.
Volatility is Your Friend if You Dollar-Cost-Average – In Indian parlance this is commonly known as SIP (Systematic Investment Plan), where one invests at regular intervals (say on a monthly, fortnightly or weekly basis) a fixed sum of money in a particular asset. This helps investors to average the purchase price of their assets as and when they are down. And one of the key ingredients to get good returns is the right Purchase Price.
The other important tool investors can use is asset allocation model & rebalancing of that asset allocation at regular intervals. It is very important for investors to have the right allocation across asset classes – Debt / Equity / Real Estate / Precious Metals, among others, depending upon their age and risk profile. Now, once the allocations are made to the respective asset classes, these allocation percentages tend to deviate over a period of time as the prices of various asset classes start moving in different directions example being: if equities start moving up sharply, their allocation percentage in the overall portfolio would by default increase in that particular phase. It is during times like these that the investor needs to revisit the asset allocation and reset the portfolio to original allocations by selling the additional weight percentage of equity and reinvesting the same in the other asset classes where allocations have reduced. During the downturn of equity markets, an exact opposite action will help buying more into equities when the chips are available at competitive valuations and therefore, ensure a good Purchase Price.
One of the other strategies that can be adopted by some savvy investors is Covered Call Options. In this strategy the investors get to underwrite the calls of higher strike prices for the assets that are already owned by them. In the case of asset prices not moving up rapidly, the investor will earn premium, an extra income on his/her investments, and if the prices do move up rapidly, they will have to sell their assets at the higher strike prices, effectively ensuring regular profit booking to happen at higher levels.
(Sachin Shah is a Fund Manager at Emkay Investment Managers Limited. The views expressed are the author’s own. Please consult your investment advisor before investing.)