Guide To Investing In Stock Market (Part VII)

Investors should have a Long-Term Horizon

While one continues to remain optimistic about the prospects of Indian Companies, one should believe that the re-rating of Indian equities over the last 3 years had led Nifty P/E to go from about 12 in 2003 to over 21 now. This level of P/E when compared with the historic average of about 17 is a result of large arrears from the past and partly an advance from the future. This gives a reason for one to participate in equity in a measured manner for incremental investments.

In other words, one has to appropriately adjust the time horizon returns to realize acceptable returns from equities. Moreover, the most crucial economic changes that has triggered a growth phase in India is a change in interest rates. The lower rate of interest has led corporates to go for "capital expansion" and encourage consumers to go for" consumption expansion", but the honeymoon period for the interest rates seems to be coming to an end.

Due to the concern of an asset bubble, RBI has outlined the possibility of hardening interest rate environment. If this happens, the pace of capital formation and ongoing consumption boom might be rationalized. Therefore, the equity investors would look forward to a greater risk premium, which would translate into a need for longer investment horizon. As we know, risk reduces with time in the market.

But the investor has to realize that to capture the upside of a going Indian economy; he needs to have a long-term horizon, more so at current valuations.

The almost meteoric rise in index over the last few months is also a result of liquidity flow in the market. Over a long period, it is expected to continue or even grow, as more household savings are allocated to equity asset class. One other interesting observation over the last few months is a negative flow from FIIs into the market getting counter balanced by the rise in mutual fund assets. This is very positive for the Indian markets. In short term, the liquidity flow may be volatile, hence, in an endeavor to participate in the upside of equity markets, investors also need to limit the downside risk of investment.

Moreover, investors need to focus on quality at this point of time and they should be selective in direct equity as well as in funds. Investors should realign their investments and move into funds, which can endeavor to preserve the capital on the downside.