Investment Objectives & Advice

Nifty, Sensex at all time high – Part II! What should you do?

The thoughts of others were light and fleeting, of lover’s meeting or luck or fame. Mine were of trouble and mine were steady, so I was ready when trouble came.”

– A. E. Housman

Last year in December 2020 about Nifty hitting all time high, since then we have seen ~200 days of trading and in more than 60 occasions Nifty have been hitting a new high. If I was asked to write about the same topic and advise on action to be taken for your portfolio each time, I would be required to write every-week and probably twice in certain weeks. Thankfully, I have no such obligations. Though in 10 months old blog, I tried to leave you with the message that To protect your downside, you need to let go some upsideas well as To win the race, you need to run/ participate.

Imagine, if you have completely moved out of the equity market and invested in debt funds at that time. In last 10 months equity have returned ~35%, while debt investments would have accrued <5% in the same period, the difference is of 7x. In other words you would need to wait for at least 6 more years to match the portfolio value you could have achieved in equity portfolio already. Now, Obviously it is easy for me to point this out in hindsight but in no way I could have predicted the same 10 months back.

If we can not predict the future accurately, what should we be doing? As John C. Bogle said in his April 2000 speech that “When reward is at its pinnacle, risk is near at hand“. If I use that as a guideline, The recent rally should prompt us for prudent risk management. Since the number of successful rides on motor bike should not determine the need of helmet because it might take just one accident to change the life of yours and your family forever. Similarly in portfolio management, returns should not be the only factor in designing your portfolio. Alas! 99% of the general investors follow return based approach. I rarely find people being aware of the risk measurements of their portfolio. People are aware that equity is risky, debt is safe in general but I am yet to find the person with answer for “How risky is their portfolio?“. There are various ways of measuring the risk, we can always debate about the limitations of each method, though volatility (standard deviation) and max draw down continues to be the relevant and efficient way to manage risk of the portfolio.

Volatility is the measure of the dispersion of your returns, higher volatility would mean that the returns can swing a lot in either directions. In our Indian Mutual Fund landscape, Overnight funds have the volatility of ~0.2% and typically termed as least risky while the Equity small caps have the volatility ~20%+. The decision of having certain volatility in your portfolio should be based on factors like time horizon for your investments, your saving capacity and your own risk profile. I personally put myself in risk averse category so I hate having volatility of >4% in my portfolio. Before you go for the tune “high risk means high returns & low risks mean low returns”, let me flag that even with <4% volatility my portfolio has been clocking double digit returns for more than a decade. Similarly, the portfolio of my parents in retirement has <2% volatility and clocking 8.5%+ returns in current low return environment for last 5years. Therefore, be mindful of the volatility in your portfolio and ask if that is justified.

{The volatility would keep on changing as per various market conditions for different time frames and There could be high volatility clusters during any large risk off events.}

Max Draw Down measures the maximum observed loss from the peak portfolio value. Higher max draw down values mean the potential loss based on historic trend. In our Indian Mutual Fund landscape, Overnight funds have shorter history with negligible drawdowns of ~0% and Equity smallcap funds have witnessed the draw downs of 60% or more. Though the %draw down factor is less relevant to manage the risk, I personally use the term I call as drawdown delay.

Drawdown delay = Portfolio Value x Historical Draw down estimate / Monthly saving rate

for e.g. If the portfolio size is INR 6mm built by monthly savings of 20k and historical max draw down comes to be 20%, then the Drawdown delay would be 60 months as below. This basically means you have lost your 5 years worth of savings in this scenario.

(6,000,000 x 20%) / 20,000 = 60 months or 5 years

Typically when you start savings, you would have the lower drawdown delay as your savings/ principal would be small in your 1st phase of wealth cycle. As you progress in your investment journey, your monthly savings would be a smaller part of the growth in your overall portfolio and the drawdown delays would range in years. Specially people in retirement would have almost zero new savings, therefore they are advised to keep most investments in the least risky options while managing for longevity risk. In Mar 2020, during the market corrections the max drawdown for the Nifty 50 was ~38% and it was accompanied by the turbulence in the debt markets. Even in that scenario, the MDD for my parents’ portfolio was <3%. For myself, it is bit higher but still in single digit so that drawdown delay is <1yr in general.

I have not found any tool in my experience to give us these metrics for overall mutual fund portfolio. Those few tools which give the portfolio volatility, does that by providing simple weighted volatility and completely ignores the correlation impact between asset classes. Therefore, I had build it for myself in our favorite tool MS excel which can be tailor made to one’s portfolio. write to us if you are interested to check these parameters for your overall portfolio.

Now, The important part is not to just know these parameters but understand their impact to your portfolio health and align them to your risk profile. In current scenario, if the rise in market gives you the sleepless nights than below are the few remedies to improve the resilience of your portfolio.

  • You can reduce the volatility of portfolio, without reducing the exposure to the broad asset class like debt/ gold/ equity etc. by moving the portfolio from high risk products like Small/ Mid cap to Large or Multi cap scenario. Look for stocks with consistent and stable dividends with low beta
  • You can diversify the portfolio for better geographical diversification, Not all countries market will fail at the same time. In short run they might but money would move from risky locations to safer locations and global diversification would help you protect from the country specific risks
  • Light up the exposure from risky assets, for e.g. move money from pure equity funds to hybrid or Balanced advantage funds or to debt funds

Most of these remedies can be used and are used by investors in general, though problem lies in shooting blindly in hope of hitting the enemy vs making targeted changes. If you can measure the risk, you can also measure the impact of your action on the risk mitigation. let me leave you with the quote arguably attributed to Peter Drucker: “If you can’t measure it, you can not manage it.

Happy Investing!

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