By Prateek Pant
Over the last few months, we have faced numerous questions from our clients– most of them pivoting around predicting near term market movements – (1) Should I liquidate my holdings given that markets are at all time highs? (2) How should I rebalance my portfolio given the ‘imminent’ tightening by global central banks? (3) The rupee is depreciating, should I rotate my portfolio into pharma and IT; and finally (4) I have been on the sidelines since the beginning of this year waiting for a correction to enter the markets, but….
Whenever we have encountered such questions, we remind ourselves that similar doubts and debates had resurfaced at every point in time – even when Nifty first breached 6,500 in March 2014 or when the Nifty breached 10,000 for the first time in July 2017 or, for that matter at every other level, which was considered “historic” or “all-time highs.” And we have continuously reminded ourselves that it is impossible to predict the direction of the equity markets in the short term, hardly any different than a coin flip that has a 50-50 chance of landing heads or tails. Hence, taking entry/exit calls or cash calls to time the market and avoid market corrections is a rather futile exercise.
Take the example of the recent market crash of 2020. An investor who would have taken a cash call fearing the worst when the market crashed in March 2020 would have been left high and dry in a month or two. Investors who try to time the market in the near term miss out on the massive bounceback rallies, often following these sharp reversals. However, these events are known only in hindsight, and thus it is most prudent to stay invested at all times.
It is also important to not get swayed by top-down macro factors (rupee, possibility of rate hikes, election result outcomes) while investing. Our analysis suggests that investing based on such macro hunches is a zero-sum game; it is not that such top-down bets are always wrong; it’s just that they are right as often as they are wrong.
One approach instead is to maintain a balanced portfolio at all times to ensure that performance is a function of stock selection capabilities of the team rather than being driven by non-stock specific macro factors such as market timing, sector, currency, or other such factor exposures. A well-diversified portfolio based on bottom-up stock selection that is balanced across cyclicals and non-cyclicals ensures that alpha does not get easily overwhelmed by non-stock specific risk factors over any reasonable medium to long time period.
Ultimately, it is only through a balanced portfolio approach and staying invested at all times, can one expect the portfolio to outperform through various sub-segments of the market cycle. For a high-performing fund manager, the goal is always to be among the top percentile. In a relatively more inefficient market like India, where alpha generation potential is high because of a very well-diversified mid/small-cap segment, it is counter-intuitive to follow any investment strategy which is based on predicting top-down/macro factors or timing the market.
The market gains in the past year may have made investing in equities look so easy, especially for the younger investors who entered the market during the lockdown phase. On the other hand, someone who entered the market between 2010-11 would have found the going tough over the subsequent year or so. Ultimately, it is all about having a time-tested philosophy and a well-honed process to back it, such that performance reflects skill and not luck factor. Because, as we all know that skill can be replicated while luck over time is a zero-sum game.
(Prateek Pant, Chief Business Officer, White Oak Capital Management. Views expressed are the author’s own.)