Direct exposure to equities is fraught with risks for unseasoned investors

Begin investing directly in a very small portion of your portfolio and see if you have the flair for it

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7 min read Last Updated : Dec 27 2020 | 7:20 PM IST

Retail participation in direct equities has risen at a rapid pace this year. This is evident from the rise in the number of new demat accounts that were opened—a record 6.8 million between April and October. Non-institutional participation in the cash segment of the market, which serves as a proxy for retail participation, has also gone up between March and November, from an average of around Rs 22,500 crore to Rs 35,000 crore.

Those choosing the direct investment route, however, need to bear in mind that beating professional fund managers or even the leading benchmark indices over the long term, is not an easy feat to pull off.

Key factors investors need to keep an eye on

Earnings revival: After a gap of many years, corporate earnings estimates for the next financial year are being revised upward. “Corporate earnings are looking up due to better cost control, and revenue upsides in sectors like information technology and pharma. In banking, the level of stressed assets on account of Covid may turn out to be half of what was initially feared,” says Rahul Singh, chief investment officer-equities, Tata Mutual Fund.

However, optimism about the recovery in corporate earnings and the economy has, to a good extent, already got factored into valuations. “What can take the markets further up from current levels is corporate earnings outperforming these already heightened expectations,” says Vinit Sambre, head of equities, DSP Mutual Fund. He says he is a little cautious about this materialising and would prefer to see more data points in this regard.

Private capex revival: Private capital expenditure, which has lagged behind for the past 8-10 years, may revive. “Factors like lower interest rates and the government’s push to revive manufacturing through the Production Linked Incentive (PLI) scheme could lead to the much-awaited revival in the investment cycle,” says Singh.

Liquidity flows: Over the past year, liquidity has become a dominant factor that has driven valuations in the Indian markets up. The continuity of liquidity flows will be a major determinant of what happens in the markets. Currently, most central bankers and governments in the developed world are intent on following loose fiscal and monetary policies till their economies stabilise. If the dollar continues to weaken, flows into emerging market equities, including India, may continue.

But fund managers say it is hard to predict how long liquidity flows will continue. They could reduce or reverse if the loose fiscal and monetary policies produce runway inflation in the developed markets. Money flows can also change direction suddenly due to news flow.

Vaccine: As more people get vaccinated, Covid-related uncertainties could wane, and the appetite to invest in riskier asset classes, like emerging market equities, could rise.

But the markets took a battering last week on news that a new, more infectious, strain of the virus has been found in the United Kingdom. It has already led to fresh lockdowns there. If the spread of the virus accelerates once again, leading to more lock downs, it would cause a setback to both the economy and the markets.

Rise in crude price: If the global recovery, especially in the developed markets like the US and Europe, gains strength in the wake of the arrival of the Covid vaccine, then crude prices could begin to rise again. “Once it crosses $60 a barrel, that is typically when India begins to underperform other emerging markets,” says Singh. Till that happens, however, India remains in a sweet spot.

Valuations have run up: Valuations are not inexpensive anymore. “But compared to other emerging markets, India is still at around a 40-45 per cent premium only. This has been the average level over the past 10 years. While valuations are up, they have not turned euphoric yet,” says Singh. He adds that the risk-free rate—the 10-year bond yield—has come down. “When the cost of equity comes down, it provides support to valuations,” says Singh.

Downsides of direct investing

Direct investors need to be wary that at present they are able to devote time to equity investing. But once things normalise, and they begin travelling to office once again, they may not have as much time and energy left to devote to direct equity investing.

Today, international diversification has become important if you want to build a portfolio that is not hostage to the vagaries of the domestic market. But investing internationally is not cost-effective unless you have a very large portfolio size. Besides brokerage fee, which may be low, investors will also have to spend on remitting money overseas through the liberalised remittance scheme (LRS) route, and this could involve paying considerable charges to banks.

Retail investors may also lack the funds required for proper diversification. You need to build a portfolio of at least 20-25 stocks to be adequately diversified.

What should direct investors do?

Run a trial: If you want to invest directly in equities, do so for only a small part of the portfolio initially. Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisers suggests investing only five per cent of your total equity portfolio in direct equities initially. “Investors should then measure their performance against that of equity funds and indices, and then decide whether they have the ability to invest on their own. When comparing performance, compared the performance of your direct equity portfolio to that of equity mutual funds, and not to debt funds or even hybrid funds,” he says.

Avoid pro-cyclical behaviour: Investor behaviour tends to change, depending on the part of the cycle the markets are in. As past bull markets have demonstrated, investors become bolder and display a propensity to take higher risks as stock prices move up. At the top end of the market cycle, they also tend to chase poor-quality assets. “Retail investors need to understand that risks actually rise as prices move up. They also need to become more cautious about the quality of the business they invest in at the upper-end the market cycle. Diluting the quality of stocks held can lead to serious losses,” says Sambre.

Keep the winners: One reason why retail investors find it hard to beat both professional fund managers and the indices is their tendency to sell the winners early and hold on to their losers. "Retail investors are comfortable selling something they have made profits on. But the company behind a stock that is going up maybe getting stronger on fundamental parameters and may be worth hanging on to," says Dhawan.

Diversify: Retail investors also need to focus on being properly diversified. "They need to be diversified on both sectors and stocks," says Dhawan.

If you do decide to follow the direct investing route, follow the systematic investment approach even in stocks. Do not invest a lump sum amount. Invest gradually so as to average out your cost of purchase of shares. The SIP approach will also mean that you will have some funds available to take advantage of market corrections.

Table: Current valuations are higher than long-term averages