Investment strategy in troubled times.

Ajay Bagga, CEO of Lotus India Asset Management & chairman of Financial Planning Standards Board (India), shares his investment strategy for the current market scenario.

The global economic and markets landscape has gone bleak over the last 15 months.
As global stock market indices fell, there has been a procession of hedge fund failures, formidable names have gone out of existence and all investors, including the ones in the so called safe US Money market funds, have stared at dwindling portfolios and mounting losses.

Investors have responded with a massive "flight to safety."

As the third quarter of 2008 approached, the crisis exacerbated with major institutions declaring bankruptcy, merging under liquidity pressures or going under government control.

Each such announcement has caused minor market bounces, as venerable market mavens repeatedly, erroneously announced that the worst was factored into the markets already.

Given this background of the last five quarters markets, how should investors best approach a difficult environment?

The first essential is to shut out the market noise. In the short term, as Benjamin Graham taught us nearly 75 years ago, the markets are driven by sentiment. And, sentiment causes markets to over shoot both, on the way up and the way down as well.

As media and analysts shout about the end of the world from the roof tops, the smart money was making money.

Most famously, a major fixed income fund manager, who had huge positions in bonds of Fannie and Freddie, warned of a "financial tsunami" if the US Treasury failed to act decisively on these two entities, virtually pushing these two GSE’s into government controllership and pocketing $1.3 billion of gains in a single weekend.

Similarly, many long short hedge funds made gains shorting financials, till the regulators changed the rules of the game by banning shorting itself.

The second critical action item for investors is to focus on their own asset allocation plan. If an investor is saving for a retirement that is 20 years away, the present market turmoil is only a distraction.

However, someone who is already retired and living off a diminishing portfolio, needs to switch into a preservation mode.

An analysis of their own investment horizon, financial goals and risks appetite, in the present volatile and depressed price environment is an invaluable step in setting investors finances on a firmer footing.

The third action step follows from shutting out the noise and re-evaluating the asset allocation.

Investors need to widely diversify their investments. In a falling market, with the kind of unprecedented events we have been seeing, a lot of thought to be uncorrelated assets start moving in sync.

Or, there could be counter-intuitive moves in a particular category which defies logic. For example, the strengthening of the US dollar against all major currencies since July 16, despite the huge deficit creating programs of the US monetary authorities.

And one final point. Understand the fundamentals. One famous market analyst sensationalised the crisis' impact on India by calling the Indian market over-valued and stated that he would be a buyer at 6000 levels of the benchmark BSE Sensex.

Well, guess what? The expected EPS of the BSE Sensex for FY09 is between Rs 950 to Rs 1020 odd. That puts a 6000 market at 6 times 1 year forward and around 5 times 2 year forward.

And this for a $1 trillion plus output economy growing at 7% in real terms at worst, with corporate earnings growth expected at 13% to 19% for the next two years?

Well you know what, I would borrow all I can and buy all the Indian stocks I can at 6000 levels. And probably at much higher than that levels as well.

So my simple suggestion to investors would be, diversify well, study your investments well, and understand the fundamentals better.

Analysts and commentators make a living by a catchy turn of phrase. That is impressive, but watch them as just one more set of players in the game of life.

Your money and its growth are far too important to trust it to the talking heads and fortune tellers.

Yes things look extremely bleak, yes we could see a multi-year economic slowdown, yes asset values will go down, most probably in sharp bursts.

Yet, all these should not radically impact your asset allocation plan. There is money to be made when there is blood on the streets.

And, to follow the Sage of Omaha Warren Buffet, investors need to be "greedy when others are fearful".

This buying low to one day sell high will work well if investors buy a diversified portfolio, in a systematic and disciplined manner over time. That is one of the best known ways to make market volatility work in your favour.

The focus on fundamentals will make the long term nature of the markets work in investors’ favour.

As Benjamin Graham completed the quote, 75 years ago, markets may behave like voting machines in the short term , but they behave like weighing machines in the long term.

Make those fundamentals count over the long term to create portfolio wealth.
Soutce: - UTVi