Invest with caution in 2018

The year 2017 created more ‘analysts’ and ‘experts’ in equity investing than most of the years that went by. In 2018, pray that in 2019, one would still believe in equities. The year gone by saw stocks of “low” quality deliver splendid returns while “high” quality stocks underperformed.

Having seen the cycle, most seasoned investors happily stayed out of the markets. However,  some  investors, with the knowledge that what they are doing is not ‘investment’, did set aside some risk capital to make some easy money in this market by playing the greater fool theory to the tee.

After you read this, it would be useful, if you make a list of the holdings in your various demat accounts. Then, imagine that for one year, you will not be allowed to trade in these stocks. Will you wish that a few or many stocks now in your demat account be not there? This is a good way to kick the tyres and plan your stock portfolio.

If you have been an active investor in equities, this year, each day would have brought along its roller coaster thrills. Each stock would have moved anything from 5 to 25 per cent either way in a single session. At the end of the day, you count the number of winners. As you keep getting tips, you would have added more and more stocks. Finally, by now, the number of stocks you own would probably rival a mutual fund scheme.

After having done this, I request you to do one more thing. During the year, the BSE Smallcap index gave a return in excess of 50 per cent. Do the math on the portfolio you have. It is very unlikely that you would have made this return if you are in to 20 or 30-odd stocks. You would have been better off putting your money in to a mid-cap fund.

If you thought that you could easily beat a fund, think again.

I know of people who made some stupendous returns, but they did that by putting large sums in to three or four stocks which multiplied more than twice in this period. It is important to say here that they did not put ‘all’ their money in to these plays.

They have their core investments in large blue chips and this was what I term as ‘extracurricular’ activities for them. They are good analysts and also understand markets. They know the risks and can afford to lose all the money they put in to this ‘extracurricular’ activity.

One other thing that needs to be pointed out to the active investors is that  on all the short term trades the investor will have to pay taxes. If you had put it in an equity mutual fund, a one year holding would have seen you pocket all the gains. Thus, direct investing is so much more challenging.

Let us come to the more important lesson that we can take away from this bull market. Frankly, I do not know how long this exuberance will last, but surely this is not a market level from which you can expect 2018 returns to be similar to 2017.

After every steep fall or correction, we will see no interest in stocks. No one wants to buy anything as most are busy licking their wounds. These times, the mid- and the small-caps sell off big. And when the next rally comes, the rally starts with the large-cap stocks first. It is at that time, one could time the market and invest in mid-/small-cap equity funds.

Once the big caps rally, the mid- and small-caps start to run and it is better to put money in to a mutual fund structure than to chase stocks on our own.

If we have to chase stocks on our own, then I would rather place very large bets on three or four stocks rather than divide the money in to 20 or 30 meaningless allocations.

One could probably pick up three or four winners, but unlikely that anyone will pick up 20 big winners.  And if I am in a mid-cap or a small-cap mutual fund, the important thing is also about a timely exit. That needs less effort than timing the sell in each stock. Once you see the major events off and then the earnings begin to disappoint, stocks will start to fall off. And demanding valuations like what we have today, are a good time to pull off what we have.

(R. Balakrishnan is a veteran investment adviser. He is the former head of research at DSP Merrill Lynch and one of the founding team members of Crisil)