Mutual funds best option to counter market volatility

Jim Cramer once famously said that every once in a while, the market does something so stupid it takes your breath away. Volatility could be comprehended as a norm rather than an exception.

This occurs due to some news pertaining to the macro-economic factors like inflation/deflation, economic growth/contraction, political uncertainty/turmoil, regulatory/ legislator changes, sector-specific news, etc. or micro factors pertaining to a particular company, its management, its board, product, etc. These factors create an immediate euphoria/fear resulting into a particular stock’s up/down movement.

The other important but periodic in nature is during the announcement of results. The analysts and market participants arrive at certain expectations on a company’s financial performance based upon the sector, peer and overall economic activity.

The scrip responds to the actuals by gains and falls respectively depending upon the outperformance and underperformance. And sometimes, the stock might outperform irrespective of its past quarter performance purely from the guidance the management provides for the next quarter and beyond. Also, the change in the macros could add to the valuations to be either premium or discount.

The current volatility is mostly attributed to these changes taking place in the macros while some persistent issues in some sectors, aggravated by the changing macro environment.

This phenomenon was earlier restricted to the top stocks in the Indian equity market but with investor awareness and analysts tracking; augmenting the volatility entire spectrum of the stock capitalisations (cap).

This in a way is a good sign, though investors have to be more active and vigilant to respond both reactively and proactively creating more pressure. Further, due to the integration of the global financial system and the presence of foreign investors in the domestic bourses, the stock market is prone to volatility even for reasons beyond the domestic and micro concerns.

The current plight of Foreign Institutional Investors (FIIs) for the past few quarters is due to the increasing interest rates in the US and has impacted the overall flows across the Emerging Market (Ems). So, in such an environment, how could investors not only protect themselves from the unpredictability but also play it to their advantage?

To be immune to these fluctuations is almost not possible but one could contain the loss by using some risk mitigation tools. First, one needs to pick the right stock in terms of valuations and the possible growth prospects.

And if one is a long-term investor, the intermittent spike/ crash shouldn’t really bother and if possible could use the intermediate bottoms to further increase the exposures. But, if one is a short-term player, one has to have clear set targets for profit booking and stop-loss while the other way to reduce risk is to hedge with F&O strategy.

Investors should also be wary of an event/news based rally or drops in a stock and shouldn’t be catching a falling knife. Hence, avoid exposures when there is a sudden fall due to such an event and wait for the storm to settle to make exposures in those stocks.

Initiate new positions or consolidate existing ones in an oversold high-quality stock if the fall is more generic and not scrip-specific. Also, during such times, identify the stocks cheaper in valuations with better fundamentals.

Possibly, the best way to counter stock fluctuations is to build a portfolio. Of course, when opting for stocks, it’s ideal to have the least correlated ones that would generate higher returns (high-alpha) and higher deviation (low-beta). One research puts that 80 per cent of the portfolio value comes from the top five stocks in a typical portfolio of 30-50 stocks.

The other way is to build a MF portfolio that reflects the needs and matches the risk appetite so that these fluctuations are less pronounced and also act as a hedge.

Even here, the investor could use the profit booking strategies and re-enter through a systematic transfer plan (STP) to retain the passive nature while using the top-up switches for an active participation. (The author is co-founder of “Wealocity”, a wealth management firm and could be reached at [email protected])