Unnerved by volatility? Trim mid, small and sector fund exposure

Foreign institutional investor outflows from India in October exceeded Rs 1 lakh crore, a level not seen even during Covid.

The Indian equity market has seen considerable volatility recently, with the Sensex down by 7.2 per cent over the past month. New investors, who joined post-Covid, need to exercise caution and avoid impulsive decisions.

 

High FII outflows

 

Several factors have contributed to the Indian market’s downturn. Valuations are high, while last quarter’s earnings fell short of expectations. Concerns over the escalation of the Israel-Iran conflict have unsettled investors. Foreign institutional investor (FII) outflows from India in October exceeded Rs 1 lakh crore, a level not seen even during Covid.

 

Get accustomed to volatility

 

From a historical perspective, this bout of volatility is not large. “Over the past 45 years, there have been only four years when the market has corrected less than 10 per cent. A 10-20 per cent correction in a year is the norm,” says Arun Kumar, head of research, Fundsindia.com.

 

 

Volatility is an intrinsic part of equity investing. “Investors need to get accustomed to volatility, bouts of which will keep happening periodically. What they have witnessed in the recent past – the markets moving up in a unidirectional manner – was in fact the anomaly,” says Arnav Pandya, founder, Moneyeduschool. He advises retail investors not to panic or withdraw from equities, but stay the course until they meet their investment goals.

 

“Investors with a long-term horizon and quality funds should not let this correction affect them,” says Pankaj Shrestha, head of investment services, PL Capital - Prabhudas Lilladher.

 

Kumar adds that those finding the current correction alarming may consider reducing their equity allocation.

 

Stick to your asset allocation

 

Maintain an allocation aligned with your risk appetite and investment horizon. “Most investors are likely to be overweight on equities. They should shift some money from equity to debt to rebalance their portfolios,” says Pandya.

 

Pandya recommends adding debt mutual funds to ensure portfolio stability and capitalise on potential rate cuts. Shrestha notes that with the United States already cutting rates and India likely to follow, debt funds could offer good returns.

 

Realign market cap exposure

 

Most investors would also be overweight on mid, and smallcap funds. During downturns, these categories typically decline more sharply than largecaps.

 

Kumar suggests limiting exposure to mid, and smallcap funds to 25 per cent of the equity portfolio, or 30 per cent in aggregate (including mid and smallcap holdings in flexi and multicap funds). “If you are heavily exposed to mid and smallcaps, shift a part of it to largecaps,” says Pandya.

 

Shrestha, too, favours largecap funds currently. “The largecap category has run up much less than mid and smallcaps, so we believe it is likely to do better in the near future,” he says.

 

Sector and thematic funds

 

Sector and thematic funds require precise timing for entry and exit. “But most investors tend to invest in them when they have already run up,” says Kumar.

 

Sector funds can experience extended downturns. Unlike diversified funds, a buy-and-hold strategy often fails with these funds. Shrestha believes such funds are unsuitable for new investors.

 

Pandya concurs: “Unless you are an informed investor, exposure to the sector and thematic funds should not exceed 10 per cent of your equity portfolio.” Pare your exposure if it is higher.

 

Shrestha suggests investing through systematic investment plans (SIPs), which can help investors benefit from volatility, and doing a top-up when the fall is steep.

 

                                                 

How to gain from a major market correction

 

- For a correction up to 20 per cent, rebalance if equity allocation deviates by 5 percentage points from the target

 

- For a drop beyond 20 per cent, raise equity exposure above the original allocation (if you have the risk tolerance)

 

- If your debt exposure is Rs 30 lakh, determine how much you’re willing to shift to equity (assume Rs 20 lakh)

 

- Once the correction exceeds 20 per cent, shift 20 per cent of the designated amount (i.e., 4 lakh)

 

- Shift 30 per cent when the market drop exceeds 30 per cent; 40 per cent once the fall crosses 40 per cent, and the remainder after a 50 per cent fall

 

- Though major corrections appear intimidating, they present the best opportunities in hindsight