Most times investors are not sure of how the equity markets will perform, what is the direction of the market (upward trend or downward trend), what are the implications of global scenario on our equity markets, etc.
In such cases & in almost in all cases, investors need to follow some strategies that can protect them on the downside & participate in the upside of the equity markets. Years like 2008-2009, 2010-2011, & the current year with huge volatility, an investor must tread cautiously & then invest funds in the equity markets. No one can predict where the markets are headed at some points in time. Last year Budget, most experts predicted our Equity markets to be at 30-32000 level Sensex by December 2015; here we are currently between 23-24,000 levels of Sensex. Unfortunately when markets were at 25,000, everyone said invest for long term, same call was repeated when markets started going up to 30,000 levels of Sensex as well. When investors start looking at such huge volatility & negative returns in their portfolios, nothing remains long term. They start panicking & start taking short term irrational decisions on their long term portfolios. This shakes their very belief in equity as an asset class & they go back to their traditional investment vehicles like Fixed Deposits (FDs).
Very interesting comments by Mr. Uday Kotak on Equity investing
'I shall give you a view which is very different from that of the mutual fund industry. Investors will do well if they focus on fundamental valuations before rushing to the markets. ..If the analyst community is saying that the fundamentals are 14-14.5 times 2017 earnings, which comes to 6800 (NIFTY), I can understand if investors take a call between 6500 & 7000. But the same advisory community was advising investors to put money at 8500…… So where was the connection between fundamental value & putting money in equities? ………I have never heard any fund manager, at any point in time in the last 24 months, saying that this is not a good time to invest. So if the index is at 8000, they say invest for long term. If the index is at 7000, invest for long term…Where is the correlation between earnings & value? That is the discipline we need in Indian financial markets. We need to rethink the rigor required for fundamental investing'
This only indicates that when greed takes over, market participants throw caution to the winds & ignore even fundamental factors that need to be accounted for while investing like market PE/PB, etc. To illustrate this point, in January 2008, when equity markets touched 21,000 levels for the first time, market PE & PB were at an all-time high of almost 28.29 & 6.55 respectively. This clearly showed that the markets were in extreme overbought zone & investors should have started exiting rather than entering the equity markets at that time.
Similar situation was revealed when equity markets touched a new high of 30,000 in March 2015 when Market PE & PB had risen substantially to 24.06 & 3.82 respectively. Though not as high as the ones touched in January 2008, it should have still sounded alarm bells for the investors.
I have been an advocate of investing based on correlation to the market fundamentals which is taken into account through schemes which rebalance between debt & equity based on market PE, PB, Dividend Yield, etc. I have never taken either Sensex calls or stock specific calls & recommended investments only thru such strategies which has some correlation to market fundamentals.
Four effective equity investing strategies
A) Buy right sit tight
It is easier said than done & best left to specialists. As individual investors, what we may perceive as BUY RIGHT may not in the long run be a wise decision to SIT TIGHT on these investments. Also, unfortunately, our industry perception of SIT TIGHT for long term is 3-5 years investment horizon. Equity markets have posted negative returns over 3 & 5 years as well. Only beyond 7 years, equities may not have gone negative but if you have not BOUGHT RIGHT & still SAT TIGHT, your returns in this asset class would have been dismally low.
Let me share data of SENSEX returns & some stock specific returns from January 2008 till 19 Feb 2016 (which is 8 years - long enough time under the definition of SIT TIGHT):
However, if the same amount was invested in well diversified, professionally managed equity funds, result would have been totally different as demonstrated below:
Hence, as can be seen from above, BUY RIGHT & SIT TIGHT policy may not work for retail investors who do not understand equity markets well & will be well advised to go through the MF route for their investments. Active management, stock & sector selections, etc. help the investors in generating huge alpha over SENSEX returns over this long period of time.
B) Asset allocation strategy based on market fundamentals
If we consider the advice given by Mr.Uday Kotak on investing in equity markets based on fundamentals by taking into account Market PE, PB, etc. probably January 2008 was the worst time to invest in equities. That was the time when there should have been zero allocation to equity to start with. These data points & data points created by fund houses like ICICI Prudential - through their strategy of rebalancing between debt & equity based on market PB & by Motilal Oswal AMC following Motilal Oswal Value Index (MOVI) which rebalances between debt & equity based on Market PE, PB & Dividend Yield got me thinking on how I can advise my investors on correct way of investing in equity markets.
I have created a MSJ Algorithm (Mr.Vikaas Sachdeva,CEO of Edelweiss AMC gave it the name of PEACE OF MIND ALGORITHM) which gives equal weightage to both market PE & PB. This Algorithm comes with a number everyday based on which an Investor or an Advisor (for their investors) can use this Algorithm number to understand optimal allocation between debt & equity of a fund house to start with. They can, based on their comfort reallocate between debt & equity either on monthly or quarterly (I am reallocating on quarterly basis) based on the Algorithm Band which suggests this allocation. These bands for allocation based on MSJ Algorithm are as follows:
I have chosen to rebalance my clients' portfolios (based on above bands) on quarterly basis. This has given excellent results. How does this work?
At the time of investment, MSJ Algorithm will show ideal allocation between debt & equity
Let us assume that this Algorithm shows 60:40 in favor of equity on the date of actual investment
Investor/advisor does two investments viz. 60% in chosen equity scheme & 40% in liquid scheme of the same fund house
Every quarter thereafter, based on MSJ Algorithm, there will be re balancing between these two schemes on an ongoing basis
As mentioned above, same schemes which an Investor would have invested in January 2008 (one time investment without taking into account any market fundamentals like PE, PB, etc.) & stayed invested till date v/s the same Investor if he/she would have invested in the month of January 2008 thru MSJ Algorithm, results would have been as follows. Please note that in January 2008, MSJ Algorithm was 175 (higher than 160); thereby triggering 100% investment in liquid scheme to start with. Thereafter, every quarter, based on Algorithm, it would have rebalanced between debt & equity & the current value of the same is as follows:
As can be seen from above, once you combine BUY RIGHT & SIT TIGHT with correlation to market fundamentals, returns potential actually goes up 2 to 3 times v/s the investment done as a lump sum amount at one go without any correlation to market fundamentals.
Not only does the MSJ Algorithm give you huge upside over longer periods of investment horizons, it also protects you on the downside like in the current market situation. From March 2015 (when SENSEX touched a high of 30,000) till now, markets have corrected by more than 20% p.a. Same investment thru MSJ Algorithm would have given following results (protecting the downside by a huge margin + having cash in hand to deploy at every market dips). At the time of investment in March 2015, MSJ Algorithm reading was 134.90; thereby suggesting allocation of Debt: Equity of 60:40 in favor of debt to start with:
Hence, to conclude, BUY RIGHT/SIT TIGHT + MSJ Algorithm taking care of market fundamentals goes a long way for any investor to a) protect down side in falling market periods & b) generate huge alpha due to the Algorithm which is actually Buying Low & Selling High on periodic basis.
C) Investing in schemes that auto-rebalance based on market fundamentals
Third way of investing in equity is thru schemes which rebalance between debt & equity based on market PB, PE, etc. & rebalancing at regular intervals like daily/weekly/fortnightly, etc. Some of the schemes which follow these strategies are (list is not exhaustive):
ICICI Prudential Balanced Advantage Fund
Principal Smart Equity Fund
Franklin India Dynamic PE Ratio Fund of Fund (treated as debt scheme for taxation purposes)
Following 3 year rolling returns of these schemes from April 2010 will highlight effectiveness of these schemes in protecting downside & participating in upside with huge alpha generation:
D. Systematic Investment Plans
Last but not the least, SIP is also one of the ways of investing in equity over a period of time. As can be seen from above, same amount of investment of Rs.1 cr, if divided from January 2008 till date (i.e. Rs.1.02 lacs p.m.) also can create long term wealth. However, over shorter periods of time the said SIP strategy may look to be underperforming, over longer periods this can work in favor of the investors. Following table shows the same from March 2015 to March 2016 results of SIP of Rs.8.33 lacs p.m. totaling to Rs.1 crore over one year period.
Equity investing should be thru some strategy combined with fundamentals of the markets
Buy Low/Sell High is the way to invest which can be done either thru some schemes following the same or by applying Algorithms like the one of MSJ Capital (my company)
This helps in generating huge alpha over strategies like one time investment without any market correlation as there is constant profit booking at higher levels & buying at lower levels
Those interested in knowing more about MSJ Algorithm may write to me at email@example.com
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