Investment approach in volatile times

During these unprecedented times, investors, seasoned or amateurs are struggling to get their act right. There are many questions that are bothering currently with the market volatility, viz, when will the markets bottom, when will the inflation subside, when will the interest rate cycle peak and when would the war end? There are no easy answers to these and is further adding up to the market participants' dilemma. Though all these factors impact us directly, we absolutely have no control over any of them.

The only solution is to focus on the things we have control on, like sticking to one's investing philosophy, asset allocation and discipline. Diversification is an age-old strategy which works well across the market cycles as it reduces the portfolio sensitivity towards the market risks. So, while the portfolio creation is mandatory, a no or less-correlated assets would help in achieving better diversification. This helps in experiencing lower drawdowns at the portfolio level while acting as a hedge against volatility.

The asset allocation model not only involves having multiple asset classes in the portfolio but even one could look at having sub-classes within an asset. For instance, within equity asset allocation, one could have different proportions towards large, mid and small cap which at time experience non-correlated returns. This was evident during recent history when these indices differed in their behavior. In 2015, while the BSE Sensex, the large cap index has given negative returns (-5 per cent), the mid and small caps have delivered 7 per cent returns each. And in 2013, when mid & small caps have given -6 per cent & -11 per cent respectively, the large cap index has given a positive (9 per cent) return.

Of course, during secular bull and bear markets, the divergence mightn't be different as the overall asset moves in the same direction. For instance, in the last calendar year 2021, the Sensex had a return of 22 per cent while that of the mid & small cap respectively are at 39 per cent and 63 per cent. Likewise, in 2011, the returns were -25 per cent, -34 per cent and -43 per cent respectively for large, mid and small cap indices.

The last 10yr average returns stand for gold at 3 per cent, bond index at 9 per cent, Sensex at 14 per cent, mid cap index at 17 per cent and small cap index at 18 per cent. Though, the long-term returns of the equity as an asset class trumps over most other assets, the investor's experience would be less seamless due to volatility. Having said that, a multi-asset portfolio would turn much more helpful as they behave variedly across the cycles and periods. For example, in 2019, gold has delivered an annualized return of 18 per cent, the Crisil ST Bond index has returned 10 per cent and Sensex 14 per cent even as mid and small cap indices returned -3 per cent and -7 per cent.

There are no instances in the last 10 years when all the asset classes have delivered negative returns in a year which again proves asset allocation and diversification helps investors to sail across volatile periods with relative ease. Another easier and convenient way to reduce volatility in the equity markets is through staggered investments. Investors could opt for Systematic Investment Plans, popularly known as SIP which could be done over a defined period at a definitive date and at a fixed amount at each interval. This allows to average the cost of acquisition allowing one to acquire a greater number of units.

Of course, this is a convenient method for salaried class where there's a paycheck at a fixed interval but self-employed or business people could opt for a Systematic Transfer Plan, STP, where one could park the lumpsum money in a liquid or ultra-short term fund to move into equity on a regular interval of daily, weekly, monthly, etc., so that a staggered amount is exposed to the equity market even as the parked money is protected against inflation. There are a few innovations to these staggered plans where flexi-SIP/STP are on offer. In these types of plans, the investor is allowed to give a range of installment and the fund manager then decides to plow within this range depending on the market levels.

If the fund manager feels that the market is overvalued, then the amount on the lower end of the range is invested and the higher end of the range is invested if the market is considered as undervalued. This iteration would further optimise the rupee cost averaging which the staggered investments are meant to do. Though, too much of tweaks wouldn't make a huge difference in the long run. However, the proportion of allocation to each of these assets would enhance the returns for an investor and should be in line with the risk appetite.

(The author is a co-founder of "Wealocity", a wealth management firm and could be reached at [email protected])