coping with volatility - invest-wise with volatality...in addition to sentiment of specific company...

August 2015

Managing your

investments in

unpredictable markets

Coping with

Volatility

INVE ES ST-WIAn Investor Education Initiative

1INVE ES ST-WIAn Investor Education Initiative

ContentsVolatility is not a bad word .............................................4Managing risk ....................................................................6Clear time frame................................................................8Invest for long term .......................................................10Diversify .........................................................................12 Do not time markets ....................................................14SIP ....................................................................................16 STP .................................................................................18Taming volatility ...........................................................21

Copyright © Outlook Publishing (India) Private Limited, New Delhi.All Rights Reserved.

No part of this booklet may be reproduced, stored in a retrieval system or transmitted in any form or means electronic, mechanical, photocopying, recording or otherwise, without prior permission of Outlook Publishing (India) Private Limited. Printed and published by

Indranil Roy on behalf on Outlook Publishing (India) Pvt. Ltd. Editor: Narayan Krishnamurthy. Published from Outlook Money, AB 5, 3rd floor,

Safdarjung Enclave, New Delhi- 29.The information provided herein is solely for creating awareness and educating investors/

potential investors about rules of investment and for their general understanding. Readers are advised not to act purely on the basis of information provided herein but also to seek professional

advice from experts before taking any investment decisions. Outlook Money does not accept responsibility for any investment decision taken by readers on the basis of information provided

herein. The objective is to keep readers better informed and help them decide for themselves.

August 2015Design: Praveen Kumar. G

DisclaimerAs part of its Investor Education and Awareness

Initiative, HDFC Mutual Fund has sponsored this booklet. The contents of this booklet, views, opinions

and recommendations are of the publication and do not necessarily state or reflect views of HDFC

Mutual Fund. HDFC Mutual Fund does not accept any liability arising out of the use of this information. Any calculations made are approximations, meant as

guidelines only, which you must confirm before relying on them

Mutual fund investments are subject to market risks, read all scheme-related

documents carefully.

2 3INVE ES ST-WIAn Investor Education Initiative

Company profitability Rising inflation Rising interest rates Better returns in other investments, such as bonds

Political issues affecting the country and its economy

Stock market volatility understandably increases investor anxiety. Overreacting to short-term news and normal market move-

ments often leads investors to inappropriately alter their asset allocations, potentially harming their ability to achieve long-term investment goals. The stock market movements are affected due to sev-eral reasons–change in global economy, natural disasters, global/current news flow (for instance, ongoing Euro crisis with Greece), change in cen-tral bank policies, and closer home, policy change by the government impacts the stock markets.

Rather than fear volatile markets, investors should maintain their composure by staying focused on long-term economic and market expectations. By adopting a three-pronged ap-proach of keeping market volatility in perspective,

Why do market prices fluctuate?Stock prices move up and down, and no one knows exactly when the next decline or upswing will occur. There are many reasons why the mar-ket can take a sudden downturn:

investing with composurefocusing on longer investment time horizons and maintaining portfolio discipline, investors will be in a better state to manage their investments. And, though the past is clearly no guarantee of the future, it is equally true that investors who can see beyond short-term volatility will make better investment decisions.


Most often people confuse risk with volatility. Risk and volatility are not synonymous. Risk is usually defined

as the potential for loss, which may arise based on various factors. In comparison, volatility arises from random price movements which occur natu-rally in every market. Actually, without volatility, there can be no profit opportunity. Volatility is what drives markets either up or down and helps form and sustain trends.

In simple terms, volatility is the variations or fluctuation in the price of financial assets such as stocks, exchange rates or interest rates over a period of time. It is important to understand that

volatility is not a fall in markets, it is a series of rise and fall in no particular order. Yet, people are usually most concerned about volatility during periods when prices decrease or go through a correction. It is for this reason that during an ex-treme bull market, most lay investors hardly seem to care that the markets are exhibiting volatility.

Volatility not a bad word1

The graph shows various ups and downs in BSE Sensex. The rise and fall is fairly consistent and in no way shows volatility.

no cause of concern

1-July-1423000

24000

25000

26000

27000

28000

29000

30000

30-June-15

Steep fall starting June 3 till June 17

Steep rise starting Jan 22 till Feb 3


Fact with investments: all stock market in-vestments contain a degree of risk. The risk of losing money is integral with investing.

Risk in this context is broadly determined by vola-tility which is the degree and speed of fluctuations in the value of investments and also the market risk which is influenced by macro-economic factors in addition to sentiment of specific company shares or fixed interest securities.

All investments, other than cash, carry a risk of loss. However, this does not mean that cash invest-ments are risk free. Cash carries the chance that it will decline in real value due to inflation.

One way to handle risk is to categorise investments

investment risk pyramid

into different risk baskets. As such, it is important for all investors to take a medium to long-term ap-proach to investing in equities. Depending on your objectives and risk appetite, the investments used will, therefore, potentially include a blend of equi-ties, fixed interest securities and cash.

Futures and Options, sector and thematic funds

Mid and small cap stocks, Diversified equity funds

Cash and equivalent, liquid funds, bond funds

Although stock market investments have a strong record of recovery from periods of sharp loss, your own circumstances may mean that you wish or need to sell before such recovery is achieved. If you are not prepared to take this risk, you should not invest in stock market.

Low

high

Managing Risk2


Selecting suitable investments as per your investment goals and time frames can im-prove your financial well-being. So, do take

the time and effort to make your selection care-fully. Once you have made an informed decision, hold on to it and let time work to your advantage.

Every financial instrument carries risk, which can be countered by the timeframe for which it is being invested. For instance, equities are gener-ally for the long run, going anywhere beyond 3-5 years. Another way to manage risk is to review your investments with your representative peri-odically and make adjustments to cater to chang-es in your personal needs and circumstances.

time horizon

Risk profile

Money Market Short-Term Low

income Medium -Long Term Low to Medium

Balanced Long Term Medium to high

growth Long Term High

tax Saving Long term High

But, by matching risk and investment time frame, you get to choose the best of both worlds – investment returns commensurate to the risk you can take and manage volatility associated with investments. Ensure you understand the time suited for an investment and the risk associated with it by undertaking risk assessment tests. With the help of the table below, you will be able to un-derstand the risk associated with the investment and match it to the time frame its most suited for.

Matching risk and investment

Clear time frame 3


When the stock market moves unex-pectedly, most investors immediately think about shifting their invest-

ments into something else, like a money market

fund. It is important to note that short-term volatility is not necessarily indicative of a long-term trend. A security can be highly volatile on a daily basis but show long-term patterns of growth or stability. Some investments may maintain pur-chasing power over time, but can fluctuate wildly in the short term.

Assets with higher short-term volatility risk (such as stocks) tend to have higher returns over the long term than less volatile assets such as money markets.

1-year 5-year 7-year 10-year 15-year 20-year

Best return 100.95 43.04 36.77 30.55 26.32 21.10

Worst return -51.22 -2.46 -2.70 2.93 7.25 9.50

Average return 21.96 17.10 16.97 16.96 15.62 15.60

Probability of loss 25.71 12.12 3.44 0 0 0

it pays to be patient

Assuming six types of investors who churn their portfolio every 1, 5, 7, 10, 15 and 20 years regardless of the market movements, the outcome is for all to see; investors who stayed invested the longest earned the safest returns, with investments beyond 10 years losing no money. The data is based on rolling returns on Sensex from January 1, 1980 for each specific time period. (All data in per cent).

invest for long term4


If you have ever heard the saying, “Don’t put all your eggs in one basket,” then you already have a basic understanding of diversifica-

tion. Diversifying your portfolio can reduce risk and volatility if the assets have little or no cor-relation to each other.

The best way to do this is to diversify your portfolio by company, industry, country, and asset class. This is one of the reasons why successful investors have a combination of equity and fixed income investments in their portfolio.

By diversifying your investments into different types of stocks (by company, industry, and coun-try) you spread out your exposure to risk. If one of

the companies faces declining profits, chances are not all of the companies are facing the same situa-tion. The same holds true for the industries in your portfolio. Your investment advisor can help you determine the asset allocation that fits in with your present financial situation, your risk tolerance level, and your long-term investment goals.

Diversify5


Successful market timing requires three key ingredients: a reliable signal to tell you when to get in and out of stocks (or bonds,

gold and other types of investments), the ability to interpret the signal correctly and the discipline to act on it. In reality, this works best in hindsight and not when actively investing in the markets. Conventional wisdom speaks of spending time in the market than trying to time it.

Yes, market timing could be tempting, but it is rarely successful. When trying to time the market, you run the risk of missing some of the best days in the markets or investing on some of the worst days. Attempting to time the market has histori-

In the best case scenario, `1 lakh investment in the Sensex since Jan 1,1980 would be worth `2.14 crore as on June 30, 2015. However, if the same sum was excluded from investments on the 10 best days or the 50 best days of the market, the value of money dips significantly. Missing 50 best days would have resulted in a corpus of just `10 lakh over the last 35 years.

0 50 lakh 1cr 1.5cr 2cr 2.5cr

Missing 50 best days





All days

cally over the very long term reduced returns rather than raised them, so investing regularly through say a systematic investment plan is far sane a thing to practise.

Missing out on the moolah

Do not time markets6


Systematic investment plan or SIP is a path to investing in mutual funds. SIP involves investing a fixed amount of money at

regular intervals instead of investing in lump sum. Under an SIP, one can invest as little as Rs 500 in a mutual fund scheme at pre-specified intervals, monthly or quarterly. This route, thus, allows you to capture the highs and lows of the market and averages your cost of investment over a period of time. By investing regularly in a disciplined manner, SIPs prevent you from timing the market, which in turn keeps sentiments away from interfering with investment decisions based on the market’s volatility. In fact, when markets

fall, investors end up buying more units.There are two ways to register your SIP with a

fund house: through post-dated cheques or via ECS. In ECS, you give your mandate to your bank to debit the SIP amount from your account on a specified date.

Corpus value after monthly investment of `5,000 for 30 years earning @ 9%, 12% and 15% p.a.

01 120 240

50

100

150

200

250

300

350

400

@ 15% @ 12% @ 9%Months

` la

kh

Corpus will be `3,50,49,016

Corpus will be `1,76,49,533

Corpus will be `92,22,356

Discipline pays off

SiP7

360


While most people know about SIP, not many are aware of Systematic transfer plan or STP. STP is a good choice

if you are looking to invest a lump sum amount in a phased manner. Under an STP, an investor can transfer a fixed or variable amount from one mutual fund scheme to another within the same fund house at pre-defined intervals.

Commonly, investors park a lump sum amount in a debt fund, from where a regular amount is transferred at periodic intervals (daily, weekly, monthly or quarterly) into the specific equity-oriented funds. For example, an investor may invest `1 lakh in a debt fund and opt for an STP of

`5,000 on the first of every month for the next 20 months in an equity fund.

The benefit of STP is that such transfers average the cost of purchase and thus mitigates market-related risks such as timing the market and offers the benefit of rupee cost averaging.

An STP is of two types; fixed STP and capital appreciation STP. In a fixed STP, investors transfer a fixed sum from one investment to another. In a capital appreciation STP, investors take the profit

Debt Equity

StP8


The key to successful investing is not predicting the future, but looking at the present with clarity. The volatile and asymmetric returns that are experienced on a daily basis are smoothed over during monthly and annual periods. Expanding the investment holding period over years and decades has historically improved the risk/return profile of your portfolio.

Yes, there will always be uncertainty in the markets; market volatility is a natural part of the investment cycle. Although it may take some time, markets generally do rebound. Your perspective can affect the investment decisions you make during market downturns. Investors who view market volatility negatively can make irrational decisions. A down market can be an opportunity for you to build your portfolio on the back of lower unit costs.

taming volatility

from one investment to invest in another. The working of STP is such that the transfer

from one fund to another is considered as redemption and new purchase for taxation pur-poses. So, when money from the growth option of a debt fund is transferred before completion of three years, it will attract short term capital gains tax, as this will be considered as redemption from debt fund. These gains will be added to your income and taxed according to your tax slab.

coping with volatility - invest-wise with volatality...in addition to sentiment of specific company...

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