In volatile times, the right mix of equity and debt can build a strong portfolio and earn higher returns in the long run. Increasing debt allocation when the markets are volatile and prices driven by a flush of liquidity can help cushion the market correction
As the stock market benchmarks—Sensex and Nifty—have bounced back from the March lows, retail participation, especially from young investors, is growing in the equity markets. While the strong flush of global liquidity has pushed up the stock markets, investors must look at companies that have earnings visibility and are fundamentally strong.
There is a widening divergence between stock markets and the real economy. While the 30-share BSE Sensex rose 18.5% in the three months to June, the country’s gross domestic product contracted by a historic 23.9% in the June quarter from a year ago because of the Covid-19 pandemic and the lockdown that followed .
Private final consumption expenditure, the mainstay of the economy, contracted by a sharp 26.7% during the period as consumers resorted to precautionary savings because of the economic uncertainty, income and job losses.
As many retail investors are investing in stocks directly instead of investing through mutual funds, they should stick to their asset allocation strategy and rebalance their portfolio regularly in volatile stock market conditions like the one now. Investors must keep in mind that the weak macros suggest that recovery in corporate earnings will be really tough and valuations remain overheated.
While volatility is a feature in equity investing, investors must stay invested for a longer time. Those tempted to do bottom fishing must stay clear of companies that do not have a sound cash flow, earnings are poor and have weak corporate governance. Also, it is better to invest in large caps compared to mid-cap stocks as the former will be in a better position to ride the tide against volatility.
During volatility, an investor must move funds from asset classes which are overweight to other asset classes which are under-weight in the portfolio. As the stock prices have moved up now, investors can go for some profit booking. In fact, during volatility, one must sell those stocks that have not performed well and add quality stocks with medium-to long-term view.
During market volatility, stocks are often available at a discount, which is a good time to accumulate quality stocks at a discount. When the markets are volatile, investors must rebalance their portfolio regularly to manage risks in a better way. Booking profit from some of the top performing stocks and investing the money in certain stocks which are laggard now, but has the potential to rise in the future can be a good option. Experts say, going forward, investors must lower their return expectations and keep it at realistic levels.
However, before rebalancing factor in costs such as brokerage in direct stocks and penalty for foreclosing a bond. Rebalancing will also involve short-term or long-term capital gains tax. In equities an investor will have to pay short-term capital gains tax (less than a year) of 15% and long-term capital gains tax (over one year) at 10% over profits of Rs 1 lakh. In debt, the investor will pay at his marginal rate if the holding period is less than three years and at 20% with indexation if held for more than three years.
Investors must ensure proper asset allocation at all times depending on their financial goals, risk appetite and time horizon. Brijesh Damodaran, managing partner, BellWether Advisors, says an asset allocation process would help an investor to take both tactical and strategic calls in the investment portfolio. “Allocation among the assets can be predefined at the beginning of the portfolio construction and be reviewed at regular intervals of six months, or as required,” he says.
In volatile times, the right mix of equity and debt can build a strong portfolio and earn higher returns in the long-run. Increasing debt allocation when the markets are volatile and prices driven by liquidity flush can help cushion the market correction.
Financial goals play an important part in asset allocation. If an investor is nearing his goal like higher education for children or retirement, then he must shift to the safety of debt instruments, preferably investing in government bonds, or paper of state-owned companies. Damodaran suggests that the time period for equity investments should be three to five years and for anything less than this period, investments should be in fixed instruments with liquidity.