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Right strategies to grow their portfolio in a rising Stock Market

As the market swings higher, investors need to choose the right strategies to protect and grow their portfolio

 


   THE Bombay Stock Exchange (BSE) Sensitive Index (Sensex) crossed the 20000-mark barrier on September 21, 2010 after a gap of almost 21 months. With the Sensex getting closer to its previous peak, most investors are getting jittery about the safety of their stock holdings. Most investors are struggling to find answers to questions like: What should they do with their portfolios; will the market crash from the current levels or should they completely exit the market?

Valuations Lag Previous Peak:

There is no need to panic and withdraw completely from the market right now as the valuations have not yet reached the previous peak's level. A look at the adjacent table will give you some cues about the valuation differential — the Sensex price-toearnings ratio (P/E) on at around 20K was only 24.18 compared to 28.51 reached on January 8, 2008. A look at the other valuation parameters like price-to-book value (P/B) and the dividend yield also confirm that the Sensex is yet to reach the valuations levels of 2008. The conclusion will be similar if one looks at the valuation parameters for other BSE indices — BSE Mid Cap and BSE Small Cap. "Do not sell out just because the markets are nearing previous highs, instead maintain a core equity portfolio of quality stocks.

Tweak Your Equity-Debt Exposure:

If you have not restructured your portfolio recently, the equity component may become heavier now. So use this opportunity to bring it down to the desired asset allocation level. For instance, if you started with an asset allocation of 60% in equity and 40% in debt instruments and your stocks double in value with debt earning 8% return, your new asset allocation will change to 74:26 or 74% equities and 26% debt. This is surely an equity-heavy situation. It is better to rebalance your asset allocation. Put simply, sell some of the stocks and invest that money into debt instruments and bring the asset allocation to the earlier level of 60:40. Asset rebalancing, done by setting tolerance limit to asset allocation or at regular intervals, ensures that money moves from one asset class to another unemotionally and, thereby, protects your wealth.

Go For Large Caps:

Once you decide to reduce your equity exposure, the next important question is about the type of stocks you should keep in your portfolio. Since the market has already reached higher levels, it will be better to exercise caution and focus more on large caps. This is because mid-cap and small-cap stocks are riskier (i.e., they tend to move up and down faster) compared to large-cap stocks. Though there is no clear definition about a large-cap stock, a market capitalisation of 5,000 crore can be taken as a benchmark for this.


   Another reason for concentrating on large caps now is the changing preference for 'smart money'. When a rally starts from beaten-down levels, largecap stocks are preferred over small- and mid-cap stocks given attractive valuations. Over a period of time, investors shift their preferences to mid-and small cap stocks. But as the rally takes the broad markets to high levels, the smart money again moves to large-cap stock ideas, given the relative safety.


   Liquidity (i.e., the number of shares traded) is usually less among mid- and small-cap counters and in a bull market like this offers the best opportunity to get out of these illiquid duds. If the market comes crashing down from the recent peak, the volume will dry up in the mid-cap and small-cap stocks, which increases the impact cost for the investors, thus increasing the risk. In a liquidity-driven rally such as the one we are into, it makes sense to be with large-cap stocks. You can always move to mid-cap stock ideas later if the rally sustains.

Save On Taxes:

Tax treatment is another parameter that you need to look at while deciding to exit individual stocks. Sell investments held for more than one year, and take money home tax-free.

Insure Your Portfolio:

The steps mentioned above will reduce your portfolio risk drastically. Still worried about higher levels of the market? To protect profits, you may consider buying "portfolio insurance". This is done by buying the put options, so your portfolio is protected if the broad market corrects from current levels. But the main problem here is the high cost of put options and also the fact that you may lose the entire premium if the market doesn't correct. For example, the October put option of Nifty at 6,100 (nearest to October 8 close of 6,103) is priced now at 86. So a smarter strategy will be to buy put options of Nifty at much lower levels, popularly known as "out of the money put options". For example, the October put options of Nifty at 6000, 5900 and 5800 are priced now at 54, 33 and 20 respectively. And these out of the money put options will come in handy if the market suddenly turns ugly.

 

But there's a caveat: Buying out-of-the money put option on Nifty works if and only if your portfolio has characteristics similar to Nifty and has beta close to 1. The premium you pay for buying such out-of-the money put is to be seen as cost of buying peace of mind in extreme situation.

 

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