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No portfolio can be safe from market corrections – even the top performing manager will see portfolio value decline during any major market correction – and hence, investors are well-served to focus on alpha generation i.e., outperformance over market returns, in both rising markets as well as falling markets.
How to ensure my portfolio is safe from any correction in markets? What are the top sectors to own given markets that have hit all-time highs? I am waiting for a correction to enter the markets, when will that correction come? Should I liquidate my holdings and take a cash call given that Nifty has already crossed 17,000?
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Over the last few weeks in our interactions with investors and channel partners, we have faced these and many such questions along similar lines which invariably pivot on predicting the market movements or taking top-down macro bets in the near term.
To begin with, no portfolio can be safe from market corrections – even the top-performing manager will see portfolio value decline during any major market correction – and hence, investors are well-served to focus on alpha generation i.e., outperformance over market returns, in both rising markets as well as falling markets.
Our fundamental, long-held belief has been that in the short term the direction of equity markets is impossible to predict, hardly any different than a coin flip which has a 50-50 chance of landing a heads or tails. Hence, taking entry/exit calls or cash calls in order to time the market and avoid market corrections is a rather futile exercise. Thus, from a prudent risk management perspective, it is crucial to stay fully invested at all times with a bottom-up approach to investing in great businesses at attractive valuations.
Let us take the example of the recent market crash of 2020. Even if one had a crystal ball to foresee the damage Covid would inflict, it would have been impossible to predict the market implication of such an event. An investor who would have taken a cash call fearing the worst when the market crashed in March 2020 would have been left high and dry in a month or two.
For a winning portfolio, it is best to maintain a balanced portfolio with an aim to ensure that performance is a function of stock selection capabilities of the team rather than being driven by non-stock-specific macro factors such as market timing, sector, currency, or other such factor exposures. A well-diversified portfolio based on the bottom-up stock selection that is balanced across cyclical and non-cyclical ensures that alpha does not get easily overwhelmed by non-stock-specific risk factors over any reasonable medium to long time period.
It is not that top-down bets such as sector rotation are always wrong - It’s just that they are right as often as they are wrong.
Our analysis suggests that in the last decade sector leadership has changed every year. In fact, not only the top-performing sector but barring an exception or two, even the second and third best-performing sectors have changed through successive years.
Similarly, we also find that no factor (momentum/volatility/fundamental or quality/sentiment) has consistently outperformed the Nifty index every year. The key lesson is that it is impossible to time the market and deploy top-down tools like sector rotation to sustainably generate alpha. It is only through a balanced portfolio approach and staying invested at all times, can one expect the portfolio to outperform through various sub-segments of the market cycle. This underlying philosophy allows us to decouple our investment decisions from market levels and free up the team’s bandwidth to focus on businesses rather than worry about the macro.
In conclusion, a robust stock selection criterion coupled with a balanced portfolio construction approach should be the basis of investment decisions. Predicting the macro is an impossible task and is a source of random risks rather than alpha. To paraphrase, Peter Lynch, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
The author, Ramesh Mantri, is Director (Investments) at White Oak Capital. The views expressed are personal
(Edited by : Anshul)
First Published: Sept 17, 2021 4:17 PM IST