Posted on 7/29/2022 10:58:00 AM

Investing in Turbulent Times
The Russia-Ukraine conflict and the sharp spiral it has set off in oil and other industrial commodities reinforces one big learning for investors. It is that in the financial markets, one can never foresee or adequately prepare for turbulence that may lie ahead. In the equity outlook essays written at the beginning of 2022, some commentators had dissected the impact of US Federal Reserve rate hikes on expensive stock valuations. Others had talked of pullouts from emerging market stocks and bonds as US treasury yields rose. Some stock pickers talked of business disruptions wrought by Covid on consumer psychology and behaviour and how this could spark a change in the sector leadership in the markets.

But investors who had their eyes trained and portfolios prepped for all these events have had a curveball coming at them from an entirely unexpected source – the Russian invasion of Ukraine. With this event, market commentators have veered from discussing which sectors would lead the post-pandemic recovery, to what one should do in an apocalyptic scenario. The supply shock that has sent oil and metal prices shooting through the roof, has reignited stagflation worries, with investors now wondering whether they must reposition their portfolios from other assets to gold, and from users of commodities to commodity producers and miners.

All this may prompt ordinary investors to wonder if a drastic change to their asset allocation, SIP or fund selection strategy is needed. Here, we try and address the top-of-mind queries.

It’s very difficult to keep up SIPs in equity funds when my older investments are in the red. Can I stop and resume when returns are better?

No, you should keep investing. Your SIP investments generate the best long-term returns when your instalments are invested in falling markets. That’s when stock prices and valuations turn reasonable. If the market rises steadily after you start your SIP, you will actually be averaging your costs upwards and reducing your eventual portfolio returns. Think of shares in a company as being similar to your favourite brand of clothing or shoes. When the price of your favourite label falls and is available at a deep discount, would you stop buying it or buy more of it?

In equities, the lower your entry valuation, the higher your long-term portfolio returns. If you stop your SIPs now and think of resuming when the returns look better, you will be missing out on great opportunities to buy good companies at a discount. It is also difficult to know when the market will bottom out and start moving the other way.
I’m also hearing about ‘opportunistic’ SIPs. Can I increase my SIP amount now?

Yes, only if this won’t change your overall asset allocation. At the beginning of your investment journey, if you had a good advisor, you would have mapped out an asset allocation plan that suits your goals, investment horizon and risk appetite. The asset allocation plan decides how much money (overall or in each goal-based portfolio) must go into equities, debt, gold, real estate and so on. If you did this exercise and planned your SIPs or investments basis this, you shouldn’t be tinkering with it because of changed market conditions. There may be times when investment opportunities in equities and bonds coincide. If you neglect one to invest exclusively in the other, you can not only miss out on returns but also throw the risk profile of your portfolio out of gear.

The Russia-Ukraine war has sent prices of some commodities like crude oil and nickel shooting up. Shouldn’t I be capitalising on that by buying commodities/commodity stocks and reduce my other equity bets? After all, higher raw material prices can tank company earnings?

There are two reasons why you shouldn’t give in to such knee-jerk impulses. One, the problem with reacting to such events after they happen is that the news is often already priced in. Global asset markets tend to react quickly to disruptive events. By the time you make a decision to reallocate from your pre-decided assets to newer ones like commodities, prices would have already reacted, leading to lower potential for upside. Two, while events like a geopolitical conflict seem apocalyptic while you are living through them, they can prove to be short-lived with everyone going back to business as usual after the event. Do you remember the face-off between Iran and the US in May-June 2019 where the former was blamed for attacking Iraq and the US threatened a retaliatory strike? Do you remember stand-off between India and China in the North-East in May 2020? Well, these events set off war speculation and roiled markets too, but proved short-lived. As we write this, we don’t yet know if the Russia-Ukraine war will escalate or not.

As a lay investor, it would be better to let professional fund managers managing your money position your mutual fund portfolios for it. If you’re taking the mutual fund route, and have invested in a fund with a skilled manager and a good long-term record, you can be sure that he or she is tracking these events and preparing for them so that it doesn’t hurt your portfolio returns.

Gold is said to be a safe haven at times like this and has performed very well, recently. Should I be shifting some money from other assets/funds into gold ETFs?

Gold performs the role of a portfolio hedge when global calamities strike. ETFs present a good route to own gold in India because they are very liquid and faithfully mirror market prices than other physical forms of gold. They’re also easier to liquidate and buy into when needed. When equities or other financial assets go through turmoil, gold tends to display no correlation with them and may gain in value. Given that the very purpose of owning gold is to insure your portfolio against unforeseen events, it becomes necessary to own an allocation to this asset at all times. Buying gold after a risk has materialised is like rushing to buy an insurance cover after an illness or accident! That’s the time when you may end up paying a very high price for the insurance cover.

So what you’re saying is that one shouldn’t make drastic shifts between assets and must stick to a predecided plan.

Yes, for a smooth investing journey, it is always good to own multiple assets in your portfolio which have different risk-reward characteristics. Equities can create potential wealth in the long run, but they can go through long phases of poor returns followed by sudden bursts of high returns. Fixed income investments can generate steady returns, but those returns can be high or low based on interest rate cycles. Gold can insure your portfolio against volatility in other assets, but returns from it can be poor for extended periods. Therefore, it is best for investors to adopt a multi-asset approach to their portfolio at all times.

I am convinced about the benefits of having measured allocations to all assets. But if I’d like to make tactical changes to my allocation between equities, debt and gold, how should I do it?

Use valuations as your guide. If you want to make such tactical allocation changes correctly, you should closely track macro events, monitor stock and bond valuations and be aware of historic valuation levels at which equities or bonds may peak or bottom. As the factors influencing valuations keep changing, you’ll need to apply some qualitative judgement to the model too. Do remember that making tactical changes to your allocations will mean liquidating some assets and adding to others. This will have both short term and long-term capital gains (tax) implications that you will need to factor in.

Author-Aarati Krishnan
(As published in IPRU Insights)

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