Stock markets are one of the most efficient avenues that can deliver lucrative returns and can be a source of long-term wealth generation for investors. However, the conflation of numerous factors, including global headwinds, micro-economic factors, sentiment, and more, contributes to the cyclicality of the markets. These movements offer opportunities for investors to initiate investments as well as realise long-term gains, given that they have their investment strategy in place.
However, markets are dynamic in nature, they also tend to change the equation according to economic shifts in the markets. Therefore, one must have an investment philosophy that does not change according to market cycles, yet be flexible enough to work at all times. However, as business cycles shorten, an investor needs to adjust their investment strategy as well.
Having flexibility within your portfolio and the ability to react rapidly to market developments can prevent you from being exposed to an underperforming asset class and enable you to quickly reallocate capital. One must be cognisant of changing business fundamentals.
Just to put it in perspective, 2013-16 saw a massive rally in chemical stocks, during the same period, we invested in over 12 chemicals names such as Vinati Organics, Alkyl Amines, Aarti Industries, Balaji Amines and many more. These names were in their infancy at that point of time when we invested and at dirt cheap valuations compared to where they are right now.
People who have invested in such names in 2022 or 23 made no money, in fact they are on the losing end in contrast to the triple digit returns we made at the time of our investment. Hence, having an understanding about when a certain strategy is to work and shifting from the same during required times is very important.
Numerous factors, including national and international events, sectoral developments, and changes in investor preferences, have an impact on the Indian stock market. Owing to the market's volatility, strategies that were effective ten years ago may no longer be applicable in today’s digital era. Therefore, investors can successfully handle the market's unpredictability by following a dynamic approach.
Investors who remain dynamic can take advantage of trends, make wise judgements, and maximise their investment results by adhering to a consistent basic investment philosophy. Being dynamic also enables investors to profit from market reversals and spot undervalued stocks. Therefore, for long-term wealth growth and accomplishing financial goals, investing must be proactive, dynamic, and informed of the historical events that caused significant shifts in the markets.
Just as we saw above, the period of 2013-16 was the best for chemical stocks, whereas there was not a single chemical stock which made it to the top recommendations in the following years i.e., 2016-2023. This period saw stocks such as Federal Bank, LIC Housing Finance, Muthoot Finance to be the leaders of the pack and continue to perform exceptionally well.
Flexibility in capital allocation
The decision to hold cash during times of market excess and general overpricing in the market is a crucial one. One must have a rational approach and not succumb to rigid practice of being invested even when no near-term lucrative opportunity is available. The shifting between equities and cash should be a factor of opportunities and general under and overpricing of stocks. An investor must stay flexible in his approach vis a vis capital allocation and must be ready to switch between asset classes.
Widen the circle of competence
Since about ten years ago, technological advances have dominated society in such a way that it is now difficult to have a major information edge, and the stock market is not an exception. Therefore, relying on outdated investment strategies is probably going to result in fewer prospects. If you're going to invest in a firm, you need to fully grasp how the company generates revenue, how it spends its capital, and what external factors affect how it operates in its sector.
And in order to realise that, an investor must understand their circle of competence. "The circle of competence" is a phrase coined by Warren Buffett that extensively suggests investing in companies that you understand. It also recommends that it is crucial to understand the boundaries of your circle. However, in a bid to be successful in that, being open to learning, understanding new businesses, and working to expand the circle by leaps and bounds is crucial for proper asset allocation.
One must ensure that risk is managed at both the company and at portfolio level. As Buffett says “Risk comes from not knowing what you are doing”. With that, one must ensure that all aspects of the investment are studied by the investor and the investment should take place when the risk-reward is in favour of the investor. Once an investor has been able to understand the downside risks in each company and have been able to judiciously purchase the security at an attractive level, a composition of several of such stocks make up a portfolio that balances its upside potential with the associated risks.
All things considered
The investment philosophy is in place to serve as a constant reminder that short-term outcomes are unpredictable and transient and that you have no influence over them. It is there to help you maintain your attention on the steps of your investment strategy. If mistakes are made, you have a methodical process for finding them and learning valuable lessons from them.
A clear investment philosophy of what one is getting into, an executable strategy that accounts for downside protection, and an exit strategy are necessary when investing in the stock market. It is analogous to all other areas of life where a reasonable person would be expected to ponder, act, and adjust to a choice they believe to be the one that offers an educated upside with the minimal long term structural downside.
Siddharth Oberoi, Founder, and CIO at Prudent Equity