What should retail investors do now, if they have completely missed out on this bull market? ? Nothing?, said a fund manager with a leading mutual fund when we posed this question to him. Though that answer may have us gnashing our teeth a bit, it is actually not a bad one, under the circum- stances.
Lured back to IPOs?
However, evidence from various segments of the equity market today suggest that some sections of retail investors aren`t heeding this advice. For one, from the way the retail response to initial public offers (IPOs) has shot up, retail investors seem to be succumbing to the lure of listing gains once again.
After a series of IPOs that scrounged for retail money, recent ones such as Microsec Financial (retail portion subscribed 11 times), Eros International Media (26 times) and Career Point Infosystems (32 times) met with runaway retail response. This is vaguely reminiscent of the frenzied market of 2007, when IPO allotments were seen as prizes to be secured and every IPO was thought to be a sure-fire listing bet.
Yet, experience tells us that chasing IPOs may be the most risky way to play a bull market that has already run on for some time. While the Sensex has almost made it back to its January 2008 highs, nearly 40% of the 2007 IPO stocks are still in the red for their original investors, with some even trading at less than half their offer price. The reason for this poor show from IPOs is fairly simple. Not only do a majority of issuers time their IPOs to market highs, they usually demand a very stiff price that cannot be sustained under more sober market conditions.
Playing small-caps
Then there is the persisting fancy for small and mid-cap stocks in recent months. From the shareholding patterns, there is evidence that retail investors have been steadily adding to their holdings in the galloping small cap stocks, even as the FIIs have been cashing out. In every bull market, after frontline stocks have become quite expensive, it is usual for experts to predict a `catch-up rally` based on the discounted valuations of mid- and small-cap stocks.
While this may work in the initial stages of a rally, this bull market has gone on for long enough to make even small and mid-cap stocks look quite expensive. The fact that the BSE-500 today sports a PE of 24 - a marginal premium to the Sensex - and the BSE Smallcap Index trades at a stiff 18 PE, suggests that there isn`t much margin of safety here. Small- and mid-cap stocks are not `value` picks simply because their PEs look low relative to index stocks. Their inherently riskier business means they deserve to trade at a discount.
In contrast to all this, one section of investors that has been playing it extremely safe are the ones in mutual funds. Even as the market (and with it equity fund NAVs) have climbed higher, equity funds have seen outflows shoot up and inflows dwindle. Now, given that mutual funds did see a deluge of inflows at the peak of the previous bull market (October 2007 to January 2008), it is certainly understandable that investors who got in then would want to cash out with a profit.
However, for retail investors, diversified equity funds are certainly a far safer option than IPOs or small and mid-cap stocks. Yes, fund NAVs would suffer damage if the stock market were to correct sharply from current levels. But the damage is likely to be much less than that to individual stock portfolios, given the diversification.
For investors with a more than five-year perspective (which is what equity investing is all about), the Sensex hitting 20,000 should not be cue to move entirely out of equities, stop systematic investing or switch frenetically into those segments of the market that they think are `undervalued`.
Yes, the vertical climb in the markets so far, current valuations and the recent sluggishness in corporate earnings, all suggest that this is the time to be cautious.
However, if you have a long investment horizon and haven`t taken undue risks in the stock market, the best answer, really, is to continue with รข€˜business as usual.`
Stick to the equity allocations that you are comfortable with (don`t increase or reduce them sharply), stay with index stocks or good diversified equity funds through systematic investing.
Resist the temptation to `make up` for the lost time by taking large impulsive bets. The formula should be no different for first time equity investors.
If you have a long horizon and haven`t taken undue risks, the best bet is to stick to the equity allocations that you are comfortable with and stay with index stocks or good diversified equity funds through systematic investing.
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