The recent correction in stock market gives investors a good opportunity to re-assess their expectations from their investment portfolios and also their tolerance to risk. When markets are in a bull run, investors are rarely aware of the risk they are exposing themselves to. But it becomes all too apparent in a crash! Being an optimist and believer of market cycles, helps maintain that it is never too late to correct ones mistakes.

Excessive volatility in portfolio values may be attributed to many factors:

1. Problem: Concentration          Antidote : Diversification
If your stock portfolio has a small number of securities, then undue change in value of any of them, will excessively impact the total market value of your portfolio. If you don’t want this to happen to your portfolio, diversify your holdings across more stocks. Too many will again make it impossible to track and study, and there is also a good likelihood of below market performance of the portfolio due to excessive diversification. Ten to Fifteen should be alright.

2. Problem: Equity oriented portfolio          Antidote : Diversification
Check the asset allocation profile of your portfolio. Does it have too much equity, if not only equity? Equity as we are all aware, is among the most volatile asset classes available. At any point in time, one must be prepared to accept a 20% fall in the market values. By having a balance between equity and bonds in your portfolio, the overall risk of the portfolio can be brought down. If your portfolio size allows it, have a mix of bonds, real estate and equity.

3. Problem: Mid cap exposure          Antidote: Diversification!
Shares of mid cap companies tend to be more volatile than large cap companies. This is because of the shallow market for such stocks. Small quantities of selling or buying can swing the prices a lot. Further, small companies, because of their size, are more vulnerable to economic downtrends than large companies. Hence their prices could fall at the sound of someone sneezing! Investors in mid cap stocks should be prepared to keep them for the long haul for them to become multi baggers. (Also read - Mutual Funds: Your best personal Portfolio Manager)

No stomach for this sort of behavior?  Have more of large cap stocks or large cap funds.

4. Problem: High single sector exposure     Antidote : Diversification!!
Having too many companies in the same industry sector (for example cement, IT etc) renders your portfolio sensitive to their fortunes. If you do not like your portfolio to be held to ransom by policy makers here or for that matter, in some foreign land avoid concentration in any one sector.

5. Problem: High Beta         Antidote : Diversification!!!
Beta is a statistic, which indicates the sensitivity of a share price relative to the broad market movements. A high beta for the stock indicates that the share price moves in proportions greater than the index movement. If this aggression is not your intention, include low beta stocks or low standard deviation stocks/ funds. (These data are commonly available in many business newspapers).

6. Problem: No money to buy at lower prices 
    Antidote : Diversification!!!
Investors often wish that they had more money in their pocket to buy their favorite stocks when they are bottoming out, and as a result they are saddled with stocks, which they have bought at a high price. The waiting period for them to profit from their holding elongates after a fall. The best way to solve such a problem is to diversify investments across time. Whether it is stocks or equity funds you are buying, a discipline of buying them in small quantities (in relation to the portfolio) but at regular intervals will ensure that you are able to buy your favorites during a fall, too. As a result you are able to average your purchase price and remove the risk of investing all your money at a peak.

It is by no means a coincidence that all antidotes are Diversification! Diversification in all manners serves to mitigate risk. The diversification may be by asset class, capitalization, time or sector. (Beware: According to the Capital Asset Pricing Model, excessive diversification will bring down returns!) Conversely, super returns can be had only by taking undue risk or by taking a higher risk than what exists in the market as a whole. Ultimately, matching portfolio design to your expectations of upside and downside holds the key to a good sleep!

- Srikanth Bhagavat

The author is Managing Director, Hexagon Capital Advisors Pvt. Ltd. He can be reached at bhagavat@hexagononline.com.

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