Tread along carefully amid turmoil in equity

Soothsayers have been warning about equity overvaluation for over a year now. While the election of a stable government did bring about a minor rally, markets haven’t been looking rosy since.

Globally there’s the dragging trade war between the US and China, an expected slowdown in the US, near-zero interest rates as central bankers struggle against sputtering economies and inverted yield curves. India is not immune to these forces either. At the company level, the swings could not be worse. Some better-managed companies are subject to vagaries of their industry (auto) and others are creaking under the burden of unserviceable debt. So, what should the investor do?

SIP and asset allocation

At the risk of sounding clichéd, all investments and savings are not sprinting but a marathon and as such requires patience and some understanding of financial markets. There are a couple of issues to tackle - how to ride/survive the market turmoil and what should one invest in.

The first being strategy and second being the instrument. There are several strategies to dealing with market slides -- the most common one is a Systematic Investment Plan (SIP) – a hassle-free approach to long term investing. Averages the cost of purchase and is great if you don’t have time to track the markets and have a regular cash flow. It can alternatively use a ‘switch’ plan to transfer a lump sum into equities from cash/arb funds over a period.

The next one is to buy the slide or buying the dips -- which means don’t buy blindly, but in a sliding market, every time there is a dip or fall, a pre-determined amount of money is invested in the designated investment. This strategy presupposes that the markets are currently oversold or undervalued and when they bounce back, the returns will outperform the market. This requires a hands-on approach and keeping an eye on the dips.

Last but not the least, asset allocation -- the method by which one allocates monies to different asset classes and rebalances every so often to continuously buy low and sell high (or book profits) in a dispassionate manner. This largely ignores the current state of the market and generally utilizes SIP or ‘buying the slide’ or ‘buying the dips’ for the initial investment. Then conduct a periodic rebalancing.

Shares versus funds

For the second part, what should one buy and the simple answer to that is ‘depends on who you are and how much time do you have on hand’? If you are someone who can invest time and effort in studying companies and investing trading / investing concepts, then look at direct stocks. However, if you are an individual who has a regular day job or other occupation, then it is far better to invest into equities via an active Mutual Fund, a passive Index Fund / Exchange Traded Fund (ETF).

Manager selection

The difference between the three being actively managed mutual funds depend on a fund manager to outperform the market whereas Index Funds/ETFs rely on the collective intelligence of the market to provide exposure. Furthermore, while returns in excess of market returns (alpha) are the indicator of the performance of the fund manager, for passive funds it’s the tracking error or how closely do they track the underlying index.

Selecting appropriate funds, on the other hand, is not just a function of alpha or tracking error but the relative consistency of these measures across different time slices. A high-performance fund manager for a particular year may be overlooked in favour of someone with slightly lower but steady performance over the past three to five years. With uncertainty continuing over the shorter-term horizon, a broader investment into ETFs replicating the Sensex/Nifty, Next Fifty, and Midcap Indices may be preferable to a higher cost mutual fund.