Rebalance portfolio, avoid overexposure or complete exit from equities

Book profits in mid- and small-cap segments, allocate money to fixed income and gold

The Indian stock markets have been on a high with the Sensex recently climbing Mount 70K in intraday trade. Market experts say the momentum is likely to continue.

“Downward-trending global interest rates, moderating global growth and stable domestic growth have created a Goldilocks situation for India. There is still scope for a 5-10 per cent upside over the next few quarters, barring some unexpected and sharp downturn in the global economy,” says Mihir Vora, chief investment officer, TRUST Mutual Fund.

The rising market, however, poses a dilemma for investors on whether to continue buying, reduce equity holding, or exit equities altogether. According to experts, one should avoid extreme steps and stick to one’s core asset allocation.

Avoid overexposure to stocks

The prevailing exuberance may trigger within you a fear of missing out (FOMO). However, avoid excessive exposure to stocks or equity mutual funds. “In a bull market, many buy just about anything. Pay heed to valuations and fundamentals instead of getting carried away,” says Santosh Joseph, chief executive officer and founder, Germinate Investor Services and Refolio Investments. Equity allocation should remain in line with the original asset allocation.

At the other extreme, some investors may want to exit stocks and equity mutual funds altogether. By doing so, you risk missing out on potential gains if the markets rise further. “Equity allocation should remain an important component in meeting one’s long-term wealth creation objective,” says Asit Bhandarkar, senior fund manager-equity, JM Financial Asset Management.

Limit small- and mid-cap exposure

Investors should avoid over-allocating to small- and mid-cap stocks, despite their recent strong performance. “Valuations of mid-caps and small-caps are at highs and the margin of safety has reduced. Over-concentration of the portfolio in a few stocks or sectors and use of leverage to enhance returns are clearly the biggest risks to be avoided,” says Vora.

Allocate more money to large-cap stocks and mutual funds. “We see greater merit in allocating to large caps, given their stability, strength and reasonable valuations,” says Bhandarkar. Use a mix of passively managed index funds and smart-beta funds focusing on large-caps.

2018: Why over-allocation to mid and smallcaps is risky

              Category average returns (%) Category 2018 2019 2020 2021 2022 YTD Large-Cap Fund -1.5 11.7 13.9 25.8 2.0 19.2 Mid-Cap Fund -11.3 3.5 24.0 44.4 2.8 33.0 Small-Cap Fund -16.9 -0.7 31.0 62.5 1.3 37.6              

Returns are of regular plans

           

Source: NGEN markets

         

Avoid penny stocks

In bull markets, many investors trade in penny stocks. This is fraught with danger. “Going from mid- to small-caps, small- to micro-caps just because the stock has not moved relative to others is a poor reason to buy. Currently, there are many stocks where the free float is very limited, and these are moving at hyper-speed. Don’t get caught in ‘pump-and-dump’ operations,” says Vora.

Closely examine your portfolio’s asset allocation to identify deviations. If you do not have an asset allocation, create one that aligns with your financial goals and risk profile.

“Having an asset allocation is crucial as it contributes to building a stable portfolio and mitigating the risk of overconcentration in any single asset or investment,” says Joseph.

If you are underinvested in equities, stagger your investments in equity or equity mutual funds (using systematic investment plans in the latter). If your equity allocation has risen, rebalance. “After a significant bull run, the equity weight in a portfolio may exceed the desired level due to market dynamics. This could be an ideal time for investors to rebalance their portfolios by reallocating funds to other asset classes,” says Alekh Yadav, head of investment products, Sanctum Wealth.

Diversify portfolio

Diversification is a key element of portfolio construction. “Investors must diversify across different asset classes, sectors, and instruments. They should consider their risk tolerance, return objectives, investment horizon, and liquidity needs to decide the extent of allocation to different asset classes," says Yadav.

The current market conditions warrant a higher allocation to debt.

“With equity valuations rising and fixed-income rates at elevated levels, fixed-income investments have become relatively more appealing. One can consider making an incremental allocation to fixed income,” says Vora.

He adds that globally, there are signs of dollar depreciation, which is potentially positive for gold and emerging markets. He suggests that investors should consider a small diversification into gold.