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How to build a resilient equity portfolio amid market volatility

Hari Viswanath BL Research Bureau | Updated on May 15, 2021

Select stocks of companies with good managements, robust balance sheets and reasonable valuations

The bull run since March 2020 has been unprecedented by historical standards – a bull run in the midst of the worst recession since World War 2. It resembles a rooftop party when the hotel lobby is on fire under full conviction that the fire men (central bankers and governments) have the tools (monetary and fiscal stimulus) to douse the fire and fix the mess.

It is often said that markets look to the future and this phrase has been oft-repeated to justify market movements contrary to current fundamentals. Same time last year (April/May 2020) many market observers were agog with opinions that Covid-19 would be under control in a year, setting the stage for economic recovery. Well, here we are one year later in May 2021, witnessing a deadlier second wave.

Given the uncertainties, markets have remained volatile in recent times. Have you assessed whether your portfolio is bear market proof? Bear market proofing does not mean building a portfolio will not decline in a bear market, but building one which is well positioned to withstand the phase and reap benefits, when the cycle turns favourably. Here’s what you can do.

No aggressive averaging

Painful investment stories include cases of investors buying stocks first while it is in triple digits in a bull market, averaging aggressively in double digits in a bear market and finally selling it in single digits! As correction in certain stocks increase, investors tend to increase allocation to that stock out of belief that is more attractive and overall portfolio positions may become concentrated.

When a bull market ends and bear market plays out, many stocks you thought were built to last, become history. Our own bellwether indices – Sensex and Nifty, had quite a few stocks that turned out this this way after three-digit or four-sigit share prices– JP Associates, Unitech, ADAG Group stocks, Suzlon. Yes Bank etc are examples. If that is the case with bellwether stocks, you can only expect a larger rout in mid- and small-cap stocks. Geodesic, Tulip Telecom, Educomp, Everonn, Karuturi Global, IVRCL etc. are just a few examples from a large universe of stocks that were touted as next big guns of the market in the earlier decade, but mis-fired.

A rule for each bucket

So, which stocks should you average and which ones you shouldn’t ?

Thematic/high risk bets (10-15 per cent of principal invested) - These can become potential multibaggers if the theme plays out successfully and the stock becomes a bellwether of the theme. If you had bet on electric cars as a theme in the early part of last decade and bought Tesla, it may have paid off. But this pay-off came after multiple near bankruptcy situations for Tesla. Similarly, in early stages it will not be clear who would be the ultimate winner of a theme. If you are looking to make 10-20x return on a stock, there is no reason for you to average if the stock goes to x/2 as the risks are higher when you average, given the theme/stock may not play out. Hence to manage the risk here, what investors can do is to make a one-time investment and resist the urge to average during corrections. Besides your research, if you are lucky your investment will pay off. If not, you would not have lost more.

Quality/value stocks (60-70 per cent) - Companies with best-in-class managements and corporate governance, strong balance sheets (very marginal debt or net cash in balance sheet) can be placed in this category. If any company is going to survive a bear market, it would be these companies. Companies in this category can be averaged periodically through the bear market phase like you would do in the case of a mutual fund SIP.

Cyclical stocks (20-25 per cent) tend to be most volatile to changes in macro backdrop and hence can give outsized returns or losses as this backdrop changes. Naturally in a bear market, their performance will be far worse than the broader index. If you are a long-term investor, this category of stocks you can buy or average when they are trading at levels closer to historical trough valuation levels.

Keep powder dry

While definitely at every point in time, including times of euphoria, markets offer opportunities for long-term investors, there is no case to go all out into the markets when it is trading at levels significantly above historical mean.

At a broader level, markets keep giving slam dunk opportunities to enter from time to time as, what is known as the ‘Minsky Moment’ plays out in every market cycle. Excessively speculative periods in bull markets are usually followed by a collapse. Shares fall well below fair value as the speculation involving extreme levels of leverage gets unwound when the economic expectations shift to the negative. For example, if you had missed the 2004-2007 bull market rally, you would have again got an opportunity to enter the markets at 2005 levels in 2009. Similarly, if you had missed the 2013 to 2020 rally, you would have again got an opportunity to enter the market at 2014 levels in 2020.

As per recent data, FPIs own around $575 billion in Indian equities,of which 75 per cent is concentrated in just 40 stocks. Any threats to the dollar carry trade due to inflation concerns in the US, combined with leverage taken by Indian investors as well, may trigger Minsky Moments. So, in case you have missed the 2020 rally, keep calm. You are likely get an opportunity to enter at attractive levels in the future.

(This is a free article from the BusinessLine premium Portfolio segment. For more such content, please subscribe to The Hindu BusinessLine online.)

Published on May 15, 2021

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