By Vinay Ahuja, Senior Managing Partner, IIFL Investment Managers
A conflation of numerous factors that include stock specific fundamentals, macro-economic scenario and investor behaviour impact stock market movements and contribute to the cyclicality in markets. These movements offer investors opportunities to initiate investments or realise long-term gains. Investors looking to build long-term portfolios that can weather the storm of volatility need to be aware of various opportunities in the market and capitalise upon them in a structured and disciplined manner.
Create an investment policy statement (IPS)
An IPS is the bedrock of sound investment decision making. A well-articulated IPS becomes the narrative that defines how investment-related responsibilities are managed. Our primary goal as an investor is to allocate our financial assets in such a way that they remain secure and provide us with returns that adequately cover our long-term goals and aspirations. For this, it is imperative that the IPS addresses and takes into account an individual's return requirements and risk-taking ability. These requirements are dynamic in nature and change in response to a change in an individual's life circumstance.
Investment options in an upward trending market
In an upward trending market, stock prices usually move up at a faster clip and can often trade at valuations which are not justified by their fundamentals. However, an upward trending market also gives investors a great opportunity to generate returns and reap the benefits of investing in stocks that they might have purchased at a lower valuation. In such a market scenario, there are usually three questions that investors ruminate over:
Should I increase my allocation to equities
What stock should I pick up for the portfolio in an increasing pricing and valuation scenario
The right time for profit booking
To answer this, we must first step back and review the IPS. That should help in answering questions one and three. If basis the IPS the portfolio allocation to equities has exceeded the proportion initially agreed upon then it might be time to book some profits.
On the other hand, if portfolio allocation to equities has still not reached the desired proportion then the investor can start increasing exposure to equities. However, this needs to be done in a careful and staggered manner by selecting companies that hold good long-term value despite the current higher prices.
Investment options in a downward trending market
It is widely believed that stock market corrections are always steeper than rallies. What this basically means is that the momentum at which stock prices fall is generally higher than the momentum at which they rise. This also means that downward trending markets give investors little time to judiciously react to the change in prices. This often leads to frenzied activity and investment errors. However, a falling market can present a great opportunity for investors to add quality companies to their portfolios at reasonable valuations. The only virtue that you need to have in a falling market is "patience". In the short term, investments made in falling markets might yield negative returns. Investors should be patient with their investments and understand that the true value of their investments will be realised over the long term.
Investment options in a sideways market
Navigating consolidating or non-trending markets can be fairly tricky for the average investor. How do you make an investment decision when you are unsure of the future direction of the market? In such markets, investors need to adopt caution and exercise patience.
Once again the IPS comes to our rescue. Since an IPS clearly articulates the allocation to various asset classes, it is a very handy guide for making investment decisions. If allocation to equities needs to increase, then an investor can look to invest in diversified funds which help him gain exposure to various sectors, thereby positioning him to take advantage of the next rally. On the other hand, if allocation to equities is at the desired level then an investor can explore other asset classes at the time.
While being cognisant of the market scenario is important, investors must keep in mind two things when making investment decisions:
- Have a well-articulated IPS that is capable of meeting your goals while adhering to risk constraints
- Do not let short-term market movements derail your long-term investment journey
Be smart about your investments and seek the right guidance from a trusted advisor.