Diversify portfolio to guard against risk in equities, say experts

The S&P BSE Sensex closed above the 60,000-mark for the first time last Friday. The benchmark has seen a heady rise of 131 per cent from its March 23, 2020, closing low of 25,981. Factors like easy liquidity, record low interest rates, decline in Covid-19 cases, optimism about the economy’s revival, rising vaccination, and buying by both foreign portfolio (FPI) and domestic investors have fuelled this climb. Amid such conditions, retail investors should avoid falling prey to both overconfidence and fear.

Risks exist in medium term

Experts concede that the current market rally is more liquidity than fundamentals driven. Says S Naren, executive director and chief investment officer, ICICI Prudential Mutual Fund: “We are in a globally central bank-induced bull market.”

A few developments, however, offer reason for optimism that fundamentals, too, may be improving. 

Says A Balasubramanian, managing director and chief executive officer, Aditya Birla Sun Life Asset Management Company (AMC): “Sector rotation is one factor driving the market to new highs. The capital goods sector has been in the limelight for some time because investment is picking up. And real estate is reviving because inventory levels have been declining and low interest rates are driving home sales.”

Earnings of India Inc, too, have seen good growth, albeit on a low base, in the past few quarters. Most experts believe there is no immediate risk despite the US Fede­ral R­­­­­­­eserve's hawkish tone. “The actual tapering is still some time away. The $25,000 billion pumped into the system is still there and has helped elevate equity prices,” says Naren.

Over the medium term, however, he sees a risk to equities due to the rapid pace at which the market has risen, and high valuations. He expects tapering and interest rate hikes to impact the market over this timeframe. Rising inflation risk and withdrawal of ultra-easy monetary policy by global central banks could trigger a rise in bond yields, and that could cause a price and/or time correction in risk assets such as equities in the medium term, said another expert at a domestic brokerage.

Tapering, however, may not precipitate a repeat of the events of 2013, when asset prices saw sharp swings. “The unwinding is likely to be gradual rather than sudden as policy makers will take market movements into account and ensure smooth sailing,” says Balasubramanian.

Most experts remain bullish on Indian equities for the long term due to India’s structural growth prospects.

Equities for the long term  

Investors who have built equity-heavy portfolios to meet long-term goals that are 7-10 years away need not worry. They should hold on to their assets and sail through the volatility that may occur in the medium term. A study by Aditya Birla Sun Life AMC for 2001-2021 shows that the Sensex touches a new high every three-four years, and then corrects. But economic growth and rising earnings of companies ensure that the next lower and upper levels it forms (over the next three-four years) are higher than previous levels. This is why experts advise that investors should seek to benefit from this trend by investing regularly and staying invested for the long term.

Time to rebalance

While holding on to equity investments is crucial, investors shouldn't forget their strategic asset allocation in any bull or bear market. They also need to control their greed for excessive returns, fear of loss and avoid following herd mentality. “When the markets go up, investors are happy to take higher exposure to equities than their original asset allocation permits. But it is important that they rebalance,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors. Allowing equity exposure to rise will increase the risk profile of their portfolios.

Those unable to carry out rebalancing should invest in balanced advantage funds, multi-asset funds, or fund of funds, where the fund manager will carry out this task on their behalf.

Investors should also realign their sub-asset allocations. They may have become overweight on mid- and small-caps vis-a-vis large-caps, or on domestic equities versus international equities. These sub-asset allocations, too, should be restored to their original levels.

Avoid equity-only portfolio    

During a bull run, many investors tend to stick to equities only and avoid asset classes whose returns are lower. Over the past 18 months, corrections in the equity market have been short and small, leading to the belief that every correction is an occasion to buy. “But anyone who studies long-term (10-20 years) trends would find that there have been multiple occasions when equity markets have corrected sharply and remained low for long periods. Investors then find it difficult to hold on to their equity-only portfolios,” says Dhawan.   

Hence, they should diversify into international equities, fixed income and gold. Investors may take international exposure through HDFC’s recently launched HDFC Developed World Indexes Fund of Funds, which will track the MSCI World Index, adds Dhawan. This fund has exposure of about 68 per cent to the US, with the remaining to markets such as Europe, Japan and Asian Pacific. “Since the Indian market has a low correlation with developed markets, this fund can provide healthy geographical diversification,” says Navneet Munot, MD and CEO, HDFC AMC. International funds should constitute 15-20 per cent of an investor’s equity portfolio, say planners. 

Among debt funds, investors should stick to shorter duration funds as interest rates are now closer to the bottom. “The unwinding process in 2022-23 could cause interest rates to rise, so investors should stay in funds with an average duration of one-two years,” says Balasubramanian. Rising rates will improve the yields.­­­­

According to Dhawan, floating rate debt funds are a good fit for a rising rate environment. Those with a longer horizon of five-six years may opt for target maturity funds.

Investors s­hou­ld also invest in gold to the extent of 5-10 per cent, advise experts. “The yellow metal tends to do well when equities underperform. And it — alongside international equities — provides a hedge against the rupee’s tendency to depreciate a­­­­­g­­a­i­­­­n­s­t the dollar,” says Dhawan.

Importantly, investors should keep their SIPs going, whether it is in equity or debt. A classic example of why continuing with SIP is prudent is the market fall of 2020. Had anyone stopped investing during such crisis periods, they would have lost out on averaging their holdings at cheap prices. Timing the market is a tough call, experts say. Also, avoid making leveraged bets as this can cause devastating losses.   

Commercial realty a good bet

Investors booking profits in equities may also deploy the money in commercial real estate. “It is an attractive play for investors with higher spending power and long-term investment horizon,” says Anuj Puri, chairman, ANAROCK Group. Invest in a quality project at a good location, he adds. Residential real estate, he says, is currently better suited for those looking to buy for end-use.