Markets at peak: How to manage equities?

50,000! Been a quick journey from 40,000 to 50,000 levels driven by inflows from foreign funds and domestic investors, good corporate earnings, and the reduction in Covid cases along with the vaccine rollout. The sudden jump over the last couple of months has left those investors waiting on the sidelines( to invest at lower levels), anxious and worried about where to invest now.

Market Valuations are at a high, much more than the average. The markets could move either way and for those undecided investors, here are some points to note.

Markets tend to make higher lows and drastic falls of more than 20% do not happen very often. Hence waiting for that big fall may not be useful. Each time the market reached a high, there were many who were skeptical about future performance, but the India story has driven markets higher.

SIP seems to work better than lumpsum investing. Each time the index closed at a psychological level, a SIP in an index fund tracking Sensex would have worked out much better than lumpsum returns. For example, from the market level of 25,000 to 50,000(Jan 21, 2021), the SIP CAGR is 14.40% vs lumpsum CAGR of 11.80%. From 40,000 to 50,000, SIP CAGR is 49% vs lumpsum CAGR of 19%.

The SIP returns are better because there were interim periods when markets corrected heavily. Markets are going to remain volatile and maintaining a long-term investment horizon is the only way to tackle the fluctuations.

Continue to follow the basics of financial planning. If you are not following asset allocation, put one in place. Within asset classes, diversify among a few investments. Among equities, have a mix of large-cap and mid-cap holdings. Large-caps gave the best returns in 2019 but small-caps, which had a bad performance in 2019, gave the highest returns in 2020. Each year the best performing asset class and sub-asset class changes and diversification is prudent and imperative.

Chasing the fund with near term best performance may or may not work. A SIP in the top-performing Multicap (now flexi-cap category) fund in 2014 has underperformed the Sensex and other funds in the same category. On the other hand, a new multi-cap fund launched in 2014 is the best performing fund in 2020! Hence it is important to keep a check on fund performance on an annual basis.

In summation, markets could go anywhere. At some point, the easy liquidity stance may have to change, which could lead to inflation moving up. Investors cannot control these events but can do the following for their portfolio:

Have a long-term investment horizon of at least 7-10 years. The Sensex CAGR has been more than 12%, 71% of the times on a 10-year basis and 97% of the times on a 15-year basis. (source: HDFC MF yearbook/Bloomberg)

Continue SIPs as planned.

Invest as per asset allocation and do not be skewed towards a particular asset class. Within equities, diversify among market caps.

Keep aside some funds for tactical allocation to equities, if markets correct by more than 10%.

Review fund performance on an annual basis. All funds go through performance cycles and an underperforming fund should be tracked for 12-18 months before exiting.

If you are not sure about which fund to invest into, choose dynamic asset allocation funds that allocate to debt and equity-based on quantitative parameters. When markets are low, these funds allocate more to equities and vice versa. These funds take care of asset allocation and rebalancing for investors.

Finally, believe in the India Story!