The Hindu Business Line : Return ticket

Is the wildly gyrating stock market giving you sleepless nights? Are you tempted to tune into one of the business channels on TV every few minutes to check whether you have suffered new blows to your net worth? Well, as the cliché goes — No pain, no gain. An ability to handle risk to your capital is crucial if you wish to partake of the eye-popping returns that stock markets can offer. But it is possible for you to be a long-term investor in stocks, without the frayed nerves and chewed nails that most people associate with equity investing. Here are a few strategies that enable you to “de-risk” your stock portfolio, by reducing the impact of day-to-day swings in stock prices on your wealth.

Allocate right

How much your portfolio suffers during a market downturn is directly proportional to how much of your wealth is locked into stocks as an asset class. If Rs 8 lakh out of your Rs 10 lakh nest-egg is in stocks, you are bound to have anxious moments when markets take a free fall. Constructing your portfolio to a specific asset allocation plan, with exposure to various investment options such as stocks, bonds, property and gold, can reduce your portfolio’s vulnerability to ups and downs in a single asset class like stocks.

Decide your allocation to stock markets based on two factors — time horizon and ability to risk capital. It may not be prudent to put money you’d require over the next 3-5 years in stocks, as this wouldn’t leave time for prices to recover from a lengthy corrective phase. A simple way to evaluate your risk appetite is to gauge your loss-taking ability. Think you cannot digest an erosion of more than Rs 1 lakh in your net worth? In that case, assuming that the stock markets will plunge 50 per cent in the worst-case scenario, you shouldn’t be investing more than Rs 2 lakh in stocks.

It also helps to decide how much you will allocate to specific types of stocks or sectors. Saravanan, an active stock market investor, owns several blue-chips but also likes to punt on low-priced stocks. He says one approach that works for him is setting aside a specific limit of, say, Rs 20,000 out of his entire portfolio for such ‘trading’ positions. As individual risk appetites vary, you can set a specific limit (say 10 per cent) on your investment in trading and momentum stocks. This will safeguard you against staking too much on momentum stocks that could melt down quickly during a market collapse.

Risk diversification

Mutual fund managers typically do not hold more than 10 per cent in a single stock and more than 25 per cent in a single sector; applying the same principles may help you diversify risk. Working to a specific asset allocation plan will require monitoring your portfolio at regular intervals and booking profits on holdings that have exceeded their limit. This will help you cash in profits in a disciplined way, without emotions entering the picture.

MFs contain losses better than stocks: Want to invest in the stock markets and yet have the time to take your eye off the ball? If you are a first-time investor, you can build a portfolio of four-five diversified equity funds instead of scores of stocks. If you already have a portfolio of stocks, consider selling the more volatile ones and sweeping the money into equity funds. As each equity-fund typically holds anywhere between 30 and 70 stocks across 6-12 sectors, you will acquire a more diversified exposure to the markets than you would with individual stocks and thereby reduce your risk. The NAV of equity funds too will take a hit during market declines. But with a fund, you are less likely to have 40-50 per cent of your investment shaved off, a possibility when your individual stock picks go awry.

Ashwath, who began investing in stocks just a couple of years ago, says he lost heavily in the recent market meltdown even though he stuck to only the well-known names. Even index stocks such as DLF and NTPC have had 30 per cent shaved off their value, he laments; he had huge sums invested in these. The corrective phase between January 10 and February 12 saw the Nifty losing 17 per cent in value; but there were individual stocks that lost as much as 40-50 per cent.

Diversified equity funds lost just 16 per cent of their collective NAV during this meltdown, with even the worst performing fund containing its decline to 21 per cent. Though the bull markets of the past four years have led many of us to believe that making money on stocks is a piece of cake, the rally in stocks is likely to turn much more selective as the global environment turns more uncertain. Large and unpredictable swings in stock prices are also making it very necessary for stock investors to time their investments right. Taking the equity fund route to investing allows you to leave the stock selection and the timing to a qualified professional.

Core portfolio MFs

Diversified equity funds (rather than thematic funds) with a good track record over five years — such as Magnum Contra Fund, DSP ML Equity Fund, Birla Sun Life Frontline Equity Fund — may be good choices for the core portfolio. Investing in index funds and exchange traded funds (which passively mirror indices such as the Nifty, Sensex and Junior Nifty) is also a low-risk option.

Explore structured products: Taking the fund route may be less risky than betting on stocks, but equity fund NAVs too can take a plunge when markets fall. Are there any products that allow one to take some exposure to stocks without risking one’s capital? There are, but such products typically allow you to only “participate” in and not ‘match’ stock market returns. You may have to sacrifice some of the return potential in order to protect your capital. A host of products from fund houses and portfolio managers have evolved over the past few years that help you earn stock market linked returns, sans any big risk to your capital.

Mutual fund houses offer capital protection funds that are usually 3- or 5-year closed-end products. These combine investments in debt and equity, with the debt portion designed so that you are assured return of capital at maturity; the equity portion will grow in line with the markets till maturity. The positive aspect of such funds is that they are sure to protect capital; but on the flip side, they may offer ‘debt-plus’ kind of returns rather than actual equity market returns, as only a portion of your money is ploughed into stocks.

For big-ticket investors who have Rs 5 lakh or Rs 10 lakh to spare, there are a slew of structured products offered by portfolio management services. Equity-linked debentures, which have been quite popular over the past year, promise either to return your capital or to deliver returns that match the Nifty, Sensex or any other specified index at the end of a fixed period. These products are typically ‘all or nothing’ products where you may make no returns if stocks deliver negative returns over the period of the scheme. Dynamic allocation products switch actively between debt and equity, based on a predefined formula, to assure capital protection and equity market linked returns on maturity. More complex variants also use a combination of stocks and derivatives to protect the portfolio value against any erosion in the event of a market fall.

De-risking checklist

Cash in on profits and re-balance your portfolio to ‘steady state’ once a year.

Invest not more than 10 per cent of portfolio in one stock.

If you hold high-risk or momentum stocks, cap them to 10-15 per cent of your portfolio.

Set a 20-25 per cent returns target for your stock portfolio and book profits when this is exceeded.

Go for diversified equity funds rather than thematic funds or direct equity, which is more volatile.

Invest a portion of your portfolio in structured products, balanced mutual funds or hedged products, to safeguard some portion of your capital.

More Stories on : Stock Markets | Investments | Insight

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Return ticket