With valuation reaching such historical highs, a 10–20% correction triggered by domestic or global geopolitical events cannot be ruled out.
Buoyed by steady buying by domestic and offshore investors, the Indian equity market is setting new highs despite a few disappointments on the macro-economic and corporate earnings front. One of the major contributors to this vertical trajectory has been the small investors from Tier II and Tier III cities, who have finally warmed up to the equity cult through systematic investment plans (SIPs). Gushed with liquidity, major indices like SENSEX, NIFTY 50, BSE Midcap and BSE SmallCap are trading at PE multiples of over 22, 24, 31 and 60, respectively. With valuation reaching such historical highs, a 10–20 percent correction triggered by domestic or global geopolitical event (s) cannot be ruled out.
As a large number of retail investors are yet to experience any major market corrections, here are some dos and donts for managing equity investments in the current market scenario.
Don’t invest for the short-term: Mutual funds usually attract most of its first-time investors during bull markets. Buoyed by the exceptional returns generated during the bull phase, many first-time investors invest lumpsum amounts with high expectations for quick returns. However, every bull run is followed by a bearish phase. With the entire equity market in the expensive zone now, even a 10–20 percent market correction, followed by an interim bearish phase, may keep your investments in red for a considerable time to come. Thus, invest in equity funds only when you can afford a time horizon of three years or more. As the bull and bear phases largely coincide with the changes in the stages of an economic cycle, stay invested in your funds for over seven years to make the most from an entire economic cycle.
Don’t compromise your liquidity: Bull market phases like the current one often tempt many to channel their entire surplus into equity funds. As equity market can change its direction for worse for ‘n’ number of macroeconomic or geopolitical factors, any unforeseen financial emergency during that period may force you to either redeem your mutual fund investments at a loss or take expensive loans from banks. So, invest your monthly surpluses only after making sufficient allocations for your emergency fund and various short-term goals. As market corrections may create attractive buying opportunities in the equity segment, create a market crash fund consisting of short-term debt funds to exploit such buying opportunities.
Invest through SIPs: Although many are expecting a steep correction due to the high valuation of equity markets, corrections usually take place when it is least expected. That is the unpredictability of the equity markets. Thus, those staying away from the markets may end up missing the bus if the market continues its current upward trajectory and corporate earnings improve to catch up with market expectations. Therefore, instead of timing your investments, route your mutual fund investments through SIPs. By ensuring regular investments on pre-determined dates over a period of time, SIPs eliminate the need for actively tracking the market and enable cost averaging by buying you more units during market corrections.
Don’t overexpose yourself to sectoral or segment funds: Bull markets have this amazing trait of bringing fresh retail investors to the market. One or two sectors start registering phenomenal returns, which then makes retail investors to blindly follow them. Two such recent examples would be high investor inflows witnessed in mid-cap and banking funds due to high annualised returns of about 30 percent and 40 percent, respectively over the last one year. However, overexposing yourself to a few sectors or segments comes with significant risk. As fund managers of sectoral/thematic funds cannot invest in sectors beyond their investment mandate, they are forced to remain in those sectors or themes even if prospects remain bleak for the foreseeable future. Even mid-cap and small cap funds become riskier assets during bull markets as mid-cap and small cap companies decline the most during steep corrections and bear phases. Thus, first build a core portfolio consisting of large cap and multi-cap funds and then use sectoral, thematic and mid-cap funds as tactical investments for boosting your overall returns.
Don’t panic in case of a steep correction: Many first-time investors, especially those having invested lumpsum during the bull phases, redeem their investments during subsequent market corrections. Similarly, those investing through SIPs tend to stop them fearing further losses. While the former may lead to unnecessary booking of losses, the latter can jeopardize your financial goals. Instead of letting fear cloud your investment decision-making, treat market corrections as opportunities for creating long term wealth. Therefore, try to top up your existing investments during corrections with lumpsum investments in a staggered manner. This will help in reducing your investment cost and achieve your financial goals sooner.(The writer is Head of Mutual Funds at Paisabazaar.com)