Riding Financial Turmoil

The global financial landscape has changed dramatically over the last couple of weeks. Lehman Brothers has filed for bankruptcy. Merrill Lynch has been bought over by Bank of America. The US Federal Reserve agreed to provide AIG, once the largest insurer in the world, a bridge loan of $85 billion and take an 80 per cent stake in the ailing company to stave off a bankruptcy that would have thrown global financial markets into deeper crisis. There is a strong possibility of some more financial institutions falling victim to the global crisis.

No wonder, the recent developments are being termed as once-in-a-century type of crisis. Needless to say, the aftermath of these events left investors shell-shocked the world over. The US government’s quick and decisive action to preserve financial system and sustain its overall economy had its immediate impact on the global markets. Though there have been concerns about putting significant amount of taxpayer’s dollars on line in the US, the government justified the ‘unprecedented action’ as absolutely necessary to fix the current economic situation. The government felt that a further stress on the financial system could cause massive job losses, erode housing values and dry up loans for housing as well as education.

Thankfully, the exposure of Indian entities to sub-prime crisis is limited. No doubt, the current crisis would mean lower FII participation for some time. Indian investors, however, have been trying to gauge the impact of these events on their investments. While equity investors are worried about the plunging stock markets and its impact on the valuation of their portfolio, many mutual fund investors are worried about the status of their investments too. A mutual fund investor is exposed to different types of risk while investing in them. For example, for an equity fund investor, the risks are mainly related to the market movements, i.e. ups and downs. As a result of these market movements, NAVs of equity funds also go up and down. Besides, for those who invest in thematic, sector or a mid-cap/ small-cap fund, the volatility risks can be much higher compared to diversified funds. On the other hand, for debt fund investors, there are risks like impact on the NAVs due to changes in interest rates and credit as well as liquidity risks. MF investors also have to face performance-related risks, i.e. the fund may underperform the benchmark as well as its peer group. That’s why tracking one’s portfolio is an important aspect of mutual fund investing.

All in all, most of the risks associated with mutual fund investments can be tackled by adopting a long-term approach and by giving utmost importance to selecting the right funds, both in terms of the risk profile as well as potential to perform. As we all know, volatility in the market is a natural phenomenon. However, the extent of volatility and the period may vary depending on the factors responsible for it. [PAGE BREAK]

That’s why a long-term investor needs to have an asset allocation strategy in place. Remember, a successful asset allocation strategy requires a commitment to keep a designated percentage of assets invested in their respective classes, regardless of the current performance of those classes. Inevitably, some asset classes and subclasses perform better than others over the short-term. Even diversified funds can lose ground in a falling market, and it’ seasy to be tempted to sell all your equity funds and move to the safe havens of debt and debt-related funds for good. Then, there are those investors who feel that they can move back into equity funds when the market starts recovering. The problem is nobody knows when that day will be. And if you miss getting back in at the right time, you can lose a huge portion of your profits.