Five tips to de-risk your portfolio in volatile market

The post-COVID rally in the stock market is going from strength to strength. The Indian market climbed a new high on Wednesday. The combined market capitalisation of all BSE listed companies touched around Rs 20 lakh crore on Wednesday while the Sensex closed at a new lifetime high of 58,723.

Most market analysts and large institutional investors expect the rally to continue given that the world’s major central banks are in no hurry to withdraw the easy monetary policy.

Also Read: Equity Investments: 5 common mistakes to avoid

While scaling new heights, markets have also become volatile and highly sensitive to news flows. Investors now put in money and withdraw their capital at the blink of an eye, leading to sharp rise and fall in share price.

At the other extreme, the once red-hot AU Small Finance Bank corrected by 13 percent in a day as news broke about sudden exits of many senior management personnel from the company. 

Similarly, small and mid-cap stocks had begun to decline suddenly beginning August after 18 months of strong show.

Also Read: Top 10 Equity Mutual Funds with best returns in the last 6 months

Investors need to protect their portfolio from these sudden and sharp moves in the share price if they want to make money from equity on a consistent basis. Otherwise, years of gains may vanish in a matter of days. Here are five thumb rules to diversify your equity portfolio and protect it from unpredictable moves in the market.

1.       Invest at least a third of your money in institutional stocks. If you are risk averse or nearing the age of 50, then invest at least 50 percent of your money in institutional stocks.These are stocks in which institutional investors like insurance companies, mutual funds and pension funds invest. They are long-term investors and stay invested in a company for years and even decades.

These stocks are also liquid with high trading volume that makes exit easier in the case of an untoward event or emergency. Additionally, most of these stocks belong to the F&O category and as such don’t have circuit filters, which means they can be bought and sold at any level of price change during the day.

Also Read: Top 10 Sectoral Funds with over 95% returns in last one year

While the definition of institutional stocks may vary slightly from analyst to analyst, generally top 200 to 250 stocks in terms of market capitalisation are believed to belong to the institutional universe. In the current market, it means any company with a market capitalisation of Rs 15,000 crore or more. Keep increasing this threshold in the proportion of the rise in the Sensex.   

2.       Never invest more than 30 percent of your money in a single sector. At any point in time, stocks from one or two sectors are rally leaders and give exceptional returns. After a few months the sector rotation occurs and leaders become laggards and vice versa. For example, the first seven months of 2021 belonged to metals and IT stocks but now metal stocks have hit a plateau and FMCG, telecom and oil & gas stocks are rally leaders. The sector rotation however, happens suddenly and it becomes difficult for investors to time it. Given this, it is important for investors not to over invest or completely exit a sector.

Also Read:  5 ways to profit from current low interest rate environment

3.       At least 20 percent of your portfolio should always be invested in low-risk and defensive sectors such as FMCG and IT. FMCG and IT stocks such as Hindustan Unilever, Nestle, Asian Paints, ITC, TCS, Infosys and Wipro among others tend to do well when the overall market is weak.

Additionally, most of these defensive stocks are among the top dividend payers which means a steady annual dividend income for you which is most likely to be tax-free.

Also Read: 6 ways to earn more on your savings & investments amid falling interest rates

4.       Choose a stock that has not run-up too much from its pre-pandemic levels. The stock valuations are now at an all-time high. While BSE Sensex is currently trading at a price to earnings multiple of 31X -- nearly 20 percent higher than its pre-pandemic valuation – a P/E multiple of 50X or higher is now very common. While valuation has lost some of its importance in the era of abundant liquidity, rich valuation raises the earnings expectation from the company. And if the company fails to deliver it could translate into a sharp correction in the stock price.

Rich valuation also means that investors are now aggressively looking for value stocks and many of them with good fundamentals such as government-owned companies or PSUs have now begun to do well.

Also Read: 10 PSU value stocks giving higher dividend yields than bank FDs

So invest at least 10-15 percent of your portfolio in good companies that are still trading at share price closer to their level in January and February 2020.

5.       Review your portfolio every month. The market has become very dynamic and a company or the economic fundamentals can change in a quarter or every month. That’s why it is important for you to review the selection of stocks and their weightage in the portfolio at the end of every month. If a stock has run-up too soon and too fast, book some profits in that counter and allocate some of it in good stocks that have been languishing for some time. Remember, ‘buy it and hold it for years’ strategy is now dead as stock prices now sharply go in either direction, greatly raising investor’s opportunity cost.

Happy Investing! 

(Advice: This article is for information purpose only. Readers are advised to consult a certified financial advisor before making investment in any of the funds or securities mentioned above.)

(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).

Also Read: 10 tips to buy stocks without taking undue risks

Look up our YouTube Channel