Typically, at least in India in prior generations, fixed income was the predominant form of investing – for both right and wrong reasons. As an emerging market, India typically enjoyed high rates of interest as the growth orientation of the economy spurred RBI to maintain high rates to keep the nation balanced between growth and overheating. This no doubt offered high yields on many fixed deposits. At the same time, however, one asset class does not make a portfolio, so many investors sorely missed diversification.
For instance, Indian equities offered ample, if not more, growth opportunities but most investors chose to ignore this and opt for the fixed, predetermined rate of return that a fixed deposit would offer them. “Why go for variable growth when fixed growth is available” – was a common defence to support their thesis of going grossly overweight on fixed income.
However, interest rates, too, are cyclical – and not “fixed” – though the cycle length here might be extended. At some point, either in a rate hike cycle (wherein one can continuously get a better yield should one choose to wait or delay investing) or in a rate cut cycle (wherein one can face the issue of notional or opportunity loss should one exit their investments somewhat prematurely) fixed income investor stand to see some form of losses.
The notional or opportunity loss here also stands for the case of fixed-rate investments since one can always compare the prevalent floating rate with the chosen fixed rate of the FD. Hence, once investors started to appreciate this angle of looking at gains and losses, it emerged that fixed income might not be the only one-stop shop for parking portfolio funds.
Stock markets – or listed equities – typically offer a return dependent on two factors broadly – macro led top-down and idiosyncratic bottom-up. Top-down can be divided into economy-wide factors and sector-related or market cap-related returns. When times are good, stocks generally yield good returns, making listed equities cyclical.
But that is not always the case, as some defensive stocks like consumer-related companies can offer a much more stable risk and return profile. Similarly, stocks with a low beta (correlation with the broader stock market indices) can offer commensurately lower volatility in their returns.
Over the long run, stocks offer better risk-adjusted returns than bonds. Hence, in almost all strategic asset allocations, listed equities should have some allocation, depending on the investor’s risk capacity. The strategic asset allocation should be designed to support an investor’s future liabilities or spending needs.
Accordingly, one can chalk out a required rate of return that the overall portfolio should deliver. This is a chicken-and-egg situation where should equities’ allocation be increased, one can then afford to aspire towards lofty financial goals – but at the same time, the volatility of the portfolio rises as well, which the investor should be able to stomach, and not panic in times of extreme stress as was seen during COVID-19 when markets tanked dramatically.
Taking a staggered approach to building an equity portfolio over the medium to long term could manage emotional stability better and aid in rational decision-making. Considering India’s demography with a young population, one of the fastest growing economies in the world, and improving GDP per capita, equity market investments are the best vehicle to capture this growth and increase one’s wealth while patiently staying invested.
Investing in the stock market, managing risk, and understanding the right allocation per one’s risk appetite are crucial for sustainable wealth creation. Here, one can take the tactical allocation approach and determine one’s comfortable equity allocation range per one’s future needs and risk-taking ability.
With booming markets, if equity weight exceeds one’s comfort range, one can take a tactical decision and trim the same. Vice-versa, they shall increase weight if equity allocation exceeds the comfort range. This process shall aid in sound decision making, and one will be better equipped to handle equity’s volatility, thereby leading to sustainable wealth creation.
Historically, equity has been the clear winner across asset classes over the medium to long run, especially in a country with a growing economy and favourable demography. However, it is not everyone’s cup of tea, as short-term equity movement tends to be even more volatile.
Here, HNIs with the luxury of patient capital are best placed to grab this wealth creation opportunity if they manage risk and make the right allocations while taking a medium to long-term approach.
Rajesh Cheruvu, Managing Director and Chief Investment Officer, LGT Wealth India