The volatility playbook: Thriving when the going gets tough

Equity markets hit turbulence after recent highs. Rising volatility, caution ahead of elections, and geopolitical tensions challenge investors.

Equity markets have hit a rough patch after scaling new all-time highs last month. Volatility (measured through NSE Volatility index) has risen to a 2-year high as investors turn cautious ahead of the Lok Sabha poll results, escalating geopolitical tensions in the Middle East and unwinding of market expectations of sharp rate cuts by the US Fed. Investing is never easy, especially during the times of uncertainty as your decisions can easily be affected by hindsight bias or the fear of losses. So how can an investor navigate the shifting and volatile environment ahead?

Do not resort to panic selling

It is important to recognise that it is normal for equity markets to experience bouts of volatility. History shows that market selloffs are very difficult to predict and thus becomes challenging to time your exit and re-entry. In uncertain times, investors face significant COMO (Cost of Missing Out) by not staying invested. A simple analysis of the Nifty Index over the last 24 years, shows that by staying invested in equities, an investor would have made ~12% annualised return. Missing 10 of the best trading days, an investor’s return drops to ~8% and missing 30 of the best trading days, the investor returns would be only 4% annualised. Further, the worst days in equity markets have been followed by the best days – 9 out of the 10 best days have occurred within 2 weeks of the 10 worst days.

Investing in a well-diversified portfolio

A well-diversified portfolio built across a range of asset classes, each with varying characteristics and performance under diverse market conditions, is key to navigating an uncertain environment. An analysis across different growth-inflation regimes show that risk-adjusted returns of a diversified portfolio (i.e. allocation across equities, bonds, gold, and cash) has exceeded that of a simple 60/40 stock-bond portfolio. A diversified portfolio ensures that an investor can.

* Play upside with equities: Investors need to maintain an allocation to Equities to benefit from the upside should economic conditions remain resilient.

* Get a steady source of income through bonds: Bonds can serve as a hedge against the risk of a domestic slowdown and give a steady source of income in the portfolio.

* Use Gold as an all-weather asset: Gold has given positive returns across different growth-inflation regimes. Gold’s outperformance during stagflationary environments, when growth is slowing and inflation is rising, stands out. Further, gold allocation in the portfolio would be a good hedge against the risk of inflation staying persistent.

* Keep cash as dry powder: An allocation to cash provides a source of less correlated returns and serves as dry powder to take advantage of short-term pullback.

Mindful of the India’s long-term positive structural economy

Uncertainty around near-term events that drives short-term volatility should not distract an investor from the long-term picture, which remains positive. Indian economy is likely to make a successful transition to an upper-middle class income group within the coming two decades as a large and young population increases productivity, attracts investments, and ensures a more sustainable long-term economic growth. Further, India is well-positioned to benefit from shifts in global supply chains and reap the rewards of decade-long investments in digital infrastructure.

India’s macroeconomic backdrop sets the financial market assets up to perform well on a multi-year horizon. Equities are best positioned to benefit from a sustainable corporate profit cycle given high rate of economic growth, well-managed inflation, and strong external parameters. Fixed income would continue to offer a stable yield given investment-led growth and contained inflation. A stable inflation and currency outlook are additional support factors.

Use opportunistic allocations to boost risk adjusted returns.

Investors can buffer their foundation long-term equity and bond allocations with tactical allocations to improve overall portfolio performance. Within equities, we see value in manufacturing and infrastructure, with multi-year structural drivers in place for these sectors. We prefer a barbell approach on sectors through an overweight on domestic cyclicals, like Industrials and Consumer Discretionary along with a defensive overlay through an overweight on healthcare. Within bonds, we see attractive risk-reward in corporate bonds, especially in high quality (AAA), given cyclically high yield spreads (over government bonds) and their lower sensitivity to changes in interest rates.

Vinay Joseph is the Director, Head – Investment Products and Strategy, Standard Chartered Wealth, India.

Views are personal and do not represent the stand of this publication