Will it help to pause your SIP in a volatile market?

The last calendar year was undoubtedly volatile for equity markets. The benchmark BSE Sensex reached up to almost 39,000 in August 2018 before correcting all the way to around 33,500 in October 2018. The latter wasn’t even the lowest point for the year which came about early in the year in March 2018 at around 32,500. And over the last three months, the Sensex has moved in a very narrow range of about 1,000-1,500 points. But what now—at above 36,000 at 17 times forward price-to-earnings (PE) ratio is the Sensex still richly valued? Some argue that retail investors’ money coming in via mutual funds has held up stock prices beyond its fundamental value. 

If you look beyond the benchmark indices, a similar story of high valuation plays out in the BSE Mid Cap index. The BSE Small Cap index, however, is currently trading at a valuation lower than its long-term average (see graph), thanks to deep correction in small-cap stocks in the second half of 2018. But does high valuation in many segments of the market mean that one should stay away from buying equity?

This kind of volatility can be baffling. If you have money getting channelled through a mutual fund systematic investment plan (SIP) into the equity market, before you rush to make any changes, keep in mind the following factors.

Benefit of falling prices

Given domestic and global uncertainties, the risk of correction can’t be denied. But there is no way to tell whether it will happen for sure and when.

Investing via an SIP means a fixed amount is allocated to a scheme and you get units against that at the current price or net asset value (NAV). If markets rally, the NAV will likely move up too and you will get fewer units for each subsequent SIP instalment. The reverse happens when the market corrects; you get more units for the same amount. When you accumulate units in a correction phase, what you are doing is buying more while prices are down. 

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One can argue that not everything will go up in a rally, but for long-term investors, the periods when markets are trending lower are just as important to help enhance returns over the next few years. “If there is no volatility in equity, it will be like a fixed deposit. Most investors expect equity to give linear returns but that doesn’t happen," said Melvin Joseph, Sebi-registered investment adviser and founder, Finvin Financial Planners.

Hence, don’t fear a correction even if it comes. And if the markets don’t correct, your investments are continuing anyway. Its best then to stick with your SIP through the ups and the downs in a market cycle.

Upsetting asset allocation

No one asset always performs well. During high inflationary periods, when interest rates are high, physical assets like gold become a good store of value and investors also find comfort in real estate. When the opposite happens and corporate earnings grow, equities are in favour.

The dilemma in this cycle has been the relative strength in equity inflows despite low growth in corporate earnings. Steady inflows meant that valuations in some pockets of the market continued to stretch beyond reasonable expectation. The correction in the second half of 2018 has provided some relief. According to Gopal Agrawal, senior fund manager and head of macro strategy, DSP Investment Managers Pvt. Ltd, “The downside in the market seems to be limited at current valuation. However, for any meaningful upside, we need a revival in the investment cycle."

What should you do in this situation? Exit now because there are some stocks which are expensive or invest more because the market momentum may recover from this level?

If you follow a structured asset allocation, this question is easier to answer. You must buy or sell equity to maintain your asset allocation. Nisreen Mamaji, certified financial planner and CEO, Moneyworks Financial Advisor, said, “Asset allocation is a function of asset cycles and along with that an individual’s age, risk profile and other specific requirements. Most clients are looking for steady returns above what fixed deposits give, not some spectacular return by risking capital. Asset allocation too needs to follow this principle rather than change with the market."

Goals matter

Ask yourself the question, why am I investing? If you have defined financial goals, you should continue your investments in line with those goals regardless of what happens in the market.

An SIP over 7-10 years goes through several cycles of market ups and downs. Even if you start at the peak of the market, staying the course will mean you come within your range of expected return. For example, a monthly SIP in the Sensex (TRI) started at the peak of the market in January 2008 would have completed 10 years now and the annualised return at the end of 2018 would be 12%. Had this 10-year SIP been started in January 2003, at the lower end of the market cycle, your return in ten years would be higher at 14% annualised. While this seems to suggest that there is merit in waiting for the cycle to turn, the turn can only be seen clearly in hindsight. Also, if you leave your money in the bank, there is an opportunity cost of missing out on returns, which doesn’t get captured in this return narrative.

“I don’t recommend equity if the goal is within five years; ideally seven years. There could be good and bad years in this period. Closer to the goal, one can rebalance into debt funds for safety of the corpus," said Joseph.

Hence, if you are using equities to create long-term wealth, it’s important to stay the course and work towards your goals. If the goal is to maximise return, you need to be more discerning about where and when you invest. Investing at levels closer to the market peak might mean that you will have to remain invested in the market for longer than expected to earn the return you want.

Uncertainty to stay

There are many variables which remain uncertain for now; economic growth in key economies like Europe and US, the US Federal Reserve action, crude price and domestic fiscal deficit overshoot and general election outcome, among other things. These uncertainties make it harder for fund managers to commit an amount immediately to fresh stock ideas.

“Valuations have corrected but there are many variables which can add to uncertainty. For now, we prefer buying consumption-oriented companies where earnings visibility is high rather than cyclical companies which can get affected by macro-economic changes," said Agrawal.

This also means that there isn’t enough comfort to rule out a further correction. However, most experts and fund managers also concede that there are many buying opportunities in the market, and once uncertainties settle, it may be easier to commit more decisively to a broader range of stocks.