In the last couple of days, the stock market has lost about 12% of the value and has fallen from 21,000 to 18,361. The volatility witnessed in the recent past is more due to a growing awareness of risk in the global markets.
Apart from India, markets in other regions have also witnessed similar falls. Besides global factors, there are technical factors such as unwinding of positions by speculators and the triggering of margin calls, leading to a cascading effect, especially on stocks with lower liquidity. This kind of volatility would create a lot of confusion in everyone’s mind, including long-term investors. Can this confusion be logically addressed, especially keeping in mind where the valuations stand as of today? The trailing price earning multiple (P/E) of the Sensex has fallen from a high of 28.5 times to about 23.5 times, which is available at a 17% discount from the recent past. Trailing price-to-earnings is calculated by taking the current stock price and dividing it by the trailing earnings per share for the past 12 months.
However, the fundamentals of the markets would not have changed that much. The markets are trading at a P/E multiple of 17 times with respect to March 2009 earnings, which shows the fair valuation of the market.
What should an investor do in a scenario like this?
Though the advice would be investor-specific, depending on his profile , assuming 50% equity and 50% debt profile of an investor, we take various situations to explain the adjustment:
A new investor who has to build up his portfolio:
Should treat this as an opportunity to enter the market with at least 50% of the equity allocation (25% of the total portfolio) and the balance 50% (25% of the total portfolio) could be added in a staggered manner over the next six months.
An investor who started a portfolio six months back and the person’s equity allocation has fallen to 40%:
Should buy 10% of the total portfolio at the moment to rebalance/reallocate the portfolio.
An investor who is overexposed to equities about a month back, is now closer to 50% equity at the moment:
Should do nothing.
An investor who after the stock market crash is about 60% exposed to equities against a profile of 50%:
Should try to reduce the allocation to equities in tranches, over the next six months, either through a systematic withdrawal plan or if fresh liquidity comes in, it should go towards debt.
The key for an investor in the long run is asset allocation and one should stick to the plan. There are three things, which impact any asset class—momentum, liquidity and fundamentals. In the short term, momentum and liquidity play a major role, while in the long run, it is the fundamentals and fundamentals only that are of the essence. Clearly, long-term investors should not be worried about market volatility, infact they have the advantage of time where they could make the most of the volatility offered by markets. This is a tough time for most of the investors to react, hence one should be guided by asset allocation rather than anxiety or fear.
(Himanshu Kohli is founder partner of Client Associates, a Gurgaon-based private wealth management company.)