Risk management in portfolio management is seen as a key framework only when the market indicies are going south or when there is a gloomy scenario.
Risk management in portfolio management is seen as a key framework only when the market indicies are going south or when there is a gloomy scenario. This has been noticed since time immemorial and it is said: “In times of war prepare for peace and in times of peace be prepared for war”. When represented in investment management terms, it means that when the markets are euphoric, do consider asset allocation and liquidity needs and when the markets are less buoyant, consider the evolving green shoots and revisit asset allocation.
Lessons from February 2018
What has the equity market movements of February 2018 thrown light at? History repeats and you as an investor is condemned to repeat the same mistakes. (If not all the investors, majority of them definitely). And why do we refuse to learn from history? Is it the greed for more or the fear of missing out ( FOMO)? Or is it a combination of both? Building up a portfolio from scratch and then nurturing the growth, the distribution of the proceeds for meeting the goals is a simple process. But what kills the whole framework is the detour we, as an investor, take on account of greed and FOMO. So in investing, the EQ (emotional quotient) should be more than the IQ (intelligent quotient) to be a success.
Risk management in portfolio
How can you as an investor set up the risk management framework in the portfolio? Even before you invest, do consider a scenario of what will be your action if the equity indices or the asset class in which you have invested witnesses a downward movement in prices exceeding 20%? Will you stay put? Or will you exit? Or will you buy more? Or will you buy in tranches? There is no right answer to the above situation. It depends purely on your investing strategy and the time horizon and the liquidity needs. So the first and the most important rule is to know yourself—your EQ—to be more specific. Are you prone to stress or pain at times of volatility? During 2007-2017, an investment in a large-cap mutual fund scheme delivered a return close to 14.5% (a growth of more than 4.3 times), but then on eight different occasions, the portfolio went south, in excess of 12% and on one occasion close to 40%. Can you bear this volatility over a decade of investing?
Build investing strategies
Today, the Indian markets have historical data based on which scenario building can be carried out. And this scenario building can help and complement you in developing strategies. The other important point is to have the asset allocation in place. Do not allocate funds for short-term liquidity in volatile asset class. Ask those investors who invested in equities between November 2017 to January 2018 the funds which were required at a notice of 0-3 months. Majority of them, on redemption, had to take a loss in capital. Whatever the circumstances, do not let greed guide the decision of asset allocation. At the same time, even fear should not guide the decision making in asset allocation. Look at the time horizon, liquidity needs and company fundamentals closely before investing in volatile times. Another risk factor to consider is the liquidity available for exit. Many a time, on account of circuit breakers in the stock, an investor is unable to exit at the price he wants. In such instances, he can exit only when the circuit break restrictions are removed, or he has to be extremely lucky that the order has got executed. Risk is a critical part which drives the portfolio building and management process. Never ever should one compromise on this part.
The writer is founder and managing partner, BellWether Advisors LLP