Rebalance your portfolio, ensure a mix of cyclical and defensive stocks, and keep away from speculative stocks
Considering the performance of the equity market in 2020, investors could be more optimistic for the coming year. Despite one of the worst pandemics in more than a century, globally the stock markets are rising. Factors such as Covid-19 vaccine development and plans for vaccine administration to people, economic recovery, amplified fiscal and monetary policy, etc., bring a positive and cheerful ambience as we enter into 2021. Let us discuss in detail what investors should do to usher in good returns in 2021.
Almost all the businesses are making attempts to adjust to the new normal and get back on track. If one looks at the consolidated balance sheets of large, medium and small size companies, the damages owing to lockdown is minimal and recovery is steady so far. Recovery is better than expected in several segments including manufacturing apart from the services segment. So, investors can expect a fast recovery and profitability could improve in the forthcoming quarters.
Rebalance your portfolio
Rebalancing your portfolio at this juncture is essential because asset classes do not move in the same direction or at the same pace. The past few months have been a perfect example of this differential growth. For instance, if your portfolio consists predominantly of equity shares and owing to a bull run, the portfolio weight tends to be skewed towards equity. As investors have no control over volatility, but they do have control over the risk in a portfolio through prudent asset allocation. Empirical evidence and back testing studies have proved that investors who regularly rebalance their portfolios and maintain a predetermined or desired asset allocation tend to do better than investors who go with the flow and keep their portfolios static.
Focus on the following
Among the various asset classes, equity outperforms and investors should shift a significant part of their investment in equity either directly or through other investment vehicles. As the economy recovers from a recessionary period, it is expected that cyclical stocks with potential value will outperform growth stocks which are attached with high valuation. Investor should keep an eye on sectors such as banking, discretionary consumer products, energy and industrial goods.
They should be owning shares in companies in these sectors in 2021. The IT sector has a lot of tailwinds going forward as the global economy begins to recover and that will keep the margins improved while going forward. Post Covid-19 and the vaccine, one could expect more consumption and spending towards luxury goods and experiences across the globe, including India. One could also consider segments such as cement, housing materials suppliers, industrial and capital goods as good buys. There are a significant number of pharmaceutical companies which export medicines in sufficiently large quantities and these are also expected to do well.
Keep adequate defensive sector
Along with expectations of high returns on equity in the year 2021, there are some risks also that investors need to keep in mind. Investors should also have adequate exposure to defensive stocks in their portfolio. The major advantage of allocating a sizable portion of your portfolio to such shares is that these have relatively low business risk and not excessive financial risk. Defensive stocks’ rate of return is not expected to decline during the overall market decline or it may decline less than that of the overall market. For instance, consumer staples such as food and beverages, pharmaceuticals, public utilities, etc., with superior earnings growth and consistency in performance come under defensive stocks. Further, there are certain industries that typically make for attractive investments over the course of the business cycle.
Stay away from speculative stocks
A speculative company is one whose assets involve great risk and also have a possibility of greater gain. So, a speculative stock possesses a high probability of low or negative rates of return and a low probability of normal or high rates of return. Specifically, a speculative stock is one that is over-priced, leading to a high probability that during future time period when the market adjusts the share price to its true value, it will experience either low or possibly negative rate of returns. Thus, investors should stay away from such speculative shares.
The year that went by is a memorable and exciting year for the entire investor community as market indices were on a roller coaster ride, from extreme pessimism to extreme euphoria. However, through proper asset allocation which should broadly be aligned with financial goals, time horizon and risk appetite of the investor, he is most likely to weather such shifts smoothly.
The writer is a professor of finance & accounting, IIM Tiruchirappalli