As the stock markets are scaling new highs, experts are advising investors to hedge their portfolios to weather volatility in case of corrections in the markets. In fact, the mid-cap and small-cap indices witnessed some corrections in the last few days triggered after additional surveillance measures were announced by the Bombay Stock Exchange.
A momentum-driven rise in the markets is an indication to be cautious as valuations surpass the fundamentals and any negative news flow will provoke a sell-off. Mutual fund investors must ensure to invest in quality funds which have performed well across bull and bear markets and invest in schemes that are well-diversified instead of those chasing momentum bets. They should avoid investing in new fund offers (NFOs), increase allocation to debt, continue investing through systematic investment plans (SIPs) and do rebalancing of their portfolio by profit booking in equity.
Brijesh Damodaran, managing partner, BellWether Associates, says investing goals need to be based on time horizon. “If the portfolio has gained more than your expectations at the time of investing, it is recommended to rebalance now. And if one has not set the return expectation, then allocating the profits to a lower volatile asset class can be considered,” he says.
Investors must be cautious of NFOs as most of them come during a surging market. As investors are more confident in investing during these times, asset management companies feel they can capitalise on this optimism. Investors must analyse if the NFO is just cashing on a particular theme which is in vogue and the theme is sustainable in the long run.
Experts say in the current situation, it is better to invest in an ongoing fund instead of NFO unless the NFO offers an unique opportunity to invest that does not exist in current products. An existing fund which has seen bull and bear market cycles will be better placed to give higher returns in the long run. So, just diversifying by investing in too many funds and that too, in NFOs, will not help in lowering the market risk.
For a long-term investor, the impact of correction in the markets will reduce because of the cost averaging. If one has set a financial goal which is more than five years away, he should continue the SIP as any market position now will not matter much in the long run. In case the markets fall, the net asset value of the fund will also fall and investors will gain more units with the same amount of investment. So, instead of timing the market, one should invest through SIP in a disciplined manner.
However, if an investor has set an SIP with a financial goal in mind and if that is nearing, then one can redeem now. They must keep in the mind the tax impact – long-term capital gains and short-term capital gains before redeeming. Long-term capital gains accrued from selling equity-related investments after one year of holding are taxed at 10% for the amount over `1 lakh in a financial year. If sold within 12 months of purchase, short-term capital gain tax at 15% will be applicable. So, if an investor is planning to redeem units from SIP investment, he should redeem those units which are over one year.
Increase allocation to debt
Experts suggest investors should gradually move a part of the portfolio to debt to hedge against any correction in the equity markets. In fact, when the markets turn volatile, a right mix of equity and debt can build a strong portfolio and earn higher returns in the long run. Increasing the debt allocation, when the stock markets are volatile and prices driven by flush of global liquidity can help cushion the market correction. Damodaran suggests investing in ultra short-term/liquid mutual funds, and if the risk appetite is higher, consider corporate bond funds with a holding period of over two years.
As the stock prices have moved up, investors can do some profit booking by selling those funds or stocks which have not performed well. Also, this will help investors to move a part of their portfolio from asset classes which are overweight to other asset classes which are underweight in the portfolio. In a research note to clients, Credit Suisse has recommended investors to cut beta of their portfolio, especially by bringing down the exposure to mid-cap and small-cap stocks, while increasing exposure to large-cap stocks.