Lessons To Be Learnt From The Recent Correction

The recent correction in stock market gives investors a good opportunity to re-assess their expectations from their investment portfolios and also their tolerance to risk. When markets are in a bull run, investors are rarely aware of the risk they are exposing themselves to. But it becomes all too apparent when the market corrects. The apparent problems, which an investor can face, can be:

1. Concentration

If the portfolio has a small number of scrips with high weightage, then undue change in value of any of them, will excessively impact the total market value of the portfolio. The answer to this problem is diversifying across more stocks. But again too many will again make it impossible to track and study, and there is also a good likelihood of below market performance of the portfolio due to excessive diversification.

2. Equity Oriented Portfolio

Check the asset allocation profile of the portfolio. Does it have too much equity, if not only equity? Equity is among the most volatile asset classes available. By having a balance between equity and bonds in the portfolio, the overall risk of the portfolio can be brought down. If your portfolio size allows it, have a mix of bonds, real estate and equity.

3. Midcap Exposure
Shares of mid cap companies tend to be more volatile than large cap companies. This is because of the shallow market for such stocks. Small quantities of selling or buying can swing the prices a lot. Further, small companies, because of their size, are more vulnerable to economic downtrends than large companies. Investors in mid cap stocks should be prepared to keep them for the long haul for them to become multi baggers.

4. High Single Sector Exposure
Having too many companies in the same industry sector (for example cement, IT etc) renders the portfolio sensitive to their fortunes. Any negative news on the sector can create havoc.

5. High Beta
Beta is a statistic, which indicates the sensitivity of a share price relative to the broad market movements. A high beta for the stock indicates that the share price moves in proportions greater than the index movement. A conservative investor should always opt for low beta stocks

Diversification in all manners serves to mitigate risk. The diversification may be by asset class, capitalization, time or sector. Conversely, super returns can be had only by taking undue risk or by taking a higher risk than what exists in the market as a whole. Ultimately, matching portfolio design to your expectations of upside and downside holds the key.

In conclusion, corrections during a BULL run are healthy for the markets and should be used to pick companies with strong fundamentals for the long-term.

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