Weathering the storm: Strategies for managing risks amid market turbulence

Market volatility is inevitable; staying focused on long-term goals is key to navigating it successfully

The recent stock market volatility can be attributed to global market risks and elevated valuations in specific sectors. Factors include the Bank of Japan's rate hike and weaker US job data, leading to a global sell-off. "The Indian market has not experienced a significant correction since March 2023, making it more sensitive to negative news due to high valuations," says Neelesh Surana, chief investment officer (CIO), Mirae Asset Investment Managers (India). So what should retail investors in mutual funds (MFs) and stocks do or undo in such a time as this? 

Mistakes MF investors make

During bull markets, investors often make portfolio mistakes, such as favouring overlapping thematic, sectoral, or momentum-based schemes and neglecting safer, conservative investments that cushion downturns.

 

On excessive allocation to mid- and small-cap funds, Kavitha Menon, SEBI Registered Investment Advisor and ARIA Board member, says, "Investors tend to select funds based on their latest performance with little attention to risk and volatility. This recency bias is a behavioural pattern that we see in all bull markets. Feeding into these funds are large inflows coming via sips flows, mostly channelled via platforms and 'do it yourself' investors."  

A surge in sector-focused (new fund offer) NFOs -- like infrastructure, autos, and manufacturing -- has captured most MF inflows, driven by investor interest in novelty and recent performance, and distributors finding them lucrative. This is another mistake.

As of July 31, 2024, 38 per cent of equity mutual fund net flows went into sectoral/thematic funds and 12 per cent into small-cap funds. Investors favoured sectoral themes with recent high returns. "Investors should remember that "winners rotate." Today’s top market segment might not perform well in the future, and no style excels every year. While economic theory assumes rationality, emotions often drive us to focus on recent performance, neglecting valuations and asset allocation. Now is a good time to review and rebalance portfolios based on valuations, goals, and time horizons," says Manuj Jain, chartered financial analyst (CFA), co-head of product strategy, WhiteOak Capital AMC.

Market volatility

Is this volatility expected to continue? Predicting short-term volatility is tough. The Indian market may react to negative news despite a limited correction since March 2023. However, stable fundamentals and strong retail flow suggest no major sustained drawdown. "For instance, in the June quarter, retail direct flows, including SIPs, hit a record $19 billion. This suggests that despite ongoing volatility, strong retail investment may offer stability," says Surana. 

So how should investors deal with this phase of high volatility? Certain sectoral or thematic strategies have delivered high returns due to anticipated earnings growth, but recent performance shouldn't dictate future return expectations. "Given the high starting valuations, investors should be prepared to tolerate higher volatility if and when a trigger occurs. Investors may also consider directing fresh investments into other parts of the market that are still available at relatively reasonable valuations and have underperformed recently despite reasonable earnings growth in the past few years," says Jain. 

"Given India's strong growth drivers, we're positive on equities. With valuations reasonable but not cheap, we advise a disciplined, balanced approach through staggered SIP investments, focusing on the long term," says Surana. In a bull market, it's easy to overlook risk. "The best strategy is to have a solid plan, diversify, and rebalance regularly,"  Menon advises.

Mistakes new stock investors make 

Many new investors underestimate the risks of high valuations, especially in small and mid-cap stocks. They chase momentum without considering whether their investments outperform the Nifty 50 or broader indices.

"Overexposure to these volatile segments, driven by short-term gains, can lead to significant losses during market corrections. Many also try to time the market, buying speculative stocks without understanding their intrinsic value or long-term potential," warns Tarun Birani, founder, TBNG Capital Advisors.

Driven by FOMO, investors buy at unreasonable valuations, causing low-quality stocks to become overpriced. "Even during corrections, these stocks are quickly bought up, further inflating prices," notes Vikram Kasat, head advisory, PL-Capital, Prabhudas Lilladher.

The stock market may seem easy to those who have only seen an upcycle. "However, equities are cyclical, and downturns are inevitable. Be cautious and thoroughly research any company before investing. Evaluate management quality, business strength, and valuation. Markets fluctuate; they are not unidirectional," advises Nishit Master, Portfolio Manager at Axis Securities PMS.

Dealing with this phase of high volatility

Investors should focus on fundamentals, ensuring diversified portfolios are weighted toward quality stocks. "Monitor if your equity holdings are outperforming broader indices like the Nifty 50. Don't ignore valuation concerns, especially in mid and small-caps. Avoid impulsive reactions to market swings; instead, maintain a long-term perspective and regularly review your investments to align with your financial goals," says Birani.

"Prioritise a long-term approach, investing in high-quality companies at reasonable valuations. This reduces the need to fear market volatility," adds Master. 

Investor opportunities

Should investors buy more equities during this correction? "It's wise to hold some cash and allocate funds gradually," says Kasat.

"With a horizon beyond three years, consider increasing equity allocation," says Master. Prioritize quality investments in companies with strong fundamentals. "Focus on aligning additional investments with your long-term strategy, not just short-term dips," adds Birani.

Discipline and patience are crucial

Experts advise against timing volatile equity markets. Discipline and patience are crucial for successful investing. "Equities require a three- to five-year horizon, which can lead to superior returns," says Master.

Focus on asset allocation, diversification, and investing in quality stocks. Monitor economic indicators and policy changes for context. "Staying committed to long-term goals helps navigate market volatility," says Birani.

Tips for Market Volatility

• Diversify: Spread investments across assets, sectors, and regions to reduce risk
• Invest in Quality: Choose companies with strong fundamentals and management for long-term value
• Stay Informed: Understand market dynamics and focus on long-term goals
• Leverage Volatility: Buy quality stocks at lower prices during market swings
• Keep Cash: Maintain cash to seize opportunities during drops. Avoid perfect timing and adjust as needed