Equity Market Volatility & Asset Allocation

Equity investors have always been taught that time in the market and not timing the market will help in generating superior return. This is basically derived from the underlying fact that arriving at the right valuation for equity is next to impossible and investors are bound to miss an investment opportunity if one waits for the right price indefinitely. 

Fundamentals of Equity Investment

The broad risks involved in equity investments are price risk and business risk. When one looks at investing in a new company, the business risk is high because of future uncertainties. However, the price one pays will be relatively low. So, the price risk is less. However, when one is investing in a profit-making company, business risk is much lower, but the price one pays is higher. Understanding and assessing the price and business risk is important to understand equity investing and generating wealth consistently.

By building a portfolio of various established companies, the business risk stands substantially reduced. Price risk in such a case will be based on the equity market level. As mentioned, there is no easy way to access price risk. One way to average out the price risk is to invest over a period. Since investors are generally impatient, they tend to flood the market with large investments in the hope of maximising gains, as a result of which valuation remains elevated for a long period of time. On the other hand, when corporate earning disappoints or fails to meet expectations, investors are quick to cash out as well.

Massive Liquidity and Market Volatility

Owing to various challenges like the global financial crisis and the pandemic, economies across the world have resorted to quantitative easing and accommodative monetary policy which has distorted the real economic situation thanks to the ample liquidity in the economy. This liquidity flooding has delinked equity valuation from fundamental factors like earnings and dividend.

So, it is very likely that we may see huge swings in equity valuation depending upon market liquidity. As an investor, the return from equities largely depends upon the level of valuation a market gives. Since liquidity has started playing a major role in driving valuation, it will also stand to impact the return on investment as well. Ideally, a prudent investor would strive to buy at fair value but this is no easy task as the market valuation tends to swing between over and under valuation.

Market Volatility and Investment Opportunity

Each rally and correction are an opportunity to prune the asset weight in a portfolio. During the undervaluation phase, investors should allocate more to an asset class and vice versa. For example, the S and P BSE Sensex has crossed 60,000 level four times within the past 12 months. As a means to capitalise on such market swings, many schemes have been launched wherein the fund manager has the flexibility to increase and decrease equity allocation. One such popular category is dynamic asset allocation or balanced advantage fund category which invests in equity, debt and derivatives.

There are funds like those of multi-assets as well which can invest in gold or silver and real estate, apart from equity and debt. Some of these funds use their own models as well to deploy their investment. Given their superior risk-adjusted return, the corpus of such schemes has been steadily rising. As of August 2022, the balanced advantage category has a corpus of around ₹1.87 lakh crore. Two other categories – asset allocator and multi-asset funds – together have a corpus of around ₹43,000 crore. The superior risk-adjusted return over a five-year period of dynamically managed funds when compared to other categories like Large-Cap and flexi-cap is clearly visible in the table given below.

The writer is Director, Value One Up Distribution Pvt Ltd ■ Email : vbvalinvest@gmail.com ■ Website: www.valueoneuponline.com