4 ways to de-risk your portfolio

As the stock market climbs relentlessly, sitting on big gains on your equity portfolio can be quite an uncomfortable feeling. Being extra-cautious and exiting equities will mean missing out on further profits, if the rally powers on. But doing nothing can lead to sleepless nights too, as you are constantly in fear of losing your fat profits to the next big market meltdown.

There are four key middle-of-the-road solutions that professional fund managers use to de-risk your portfolio.

The simplest way to convert some of those paper profits into real profits is to sell some stocks and raise the cash/debt level in your portfolio. Some equity funds in India which take dynamic calls have the leeway to go all the way from a 100 per cent stock portfolio to a 100 per cent cash/debt portfolio.

But taking that kind of cash call can backfire badly if you get your timing wrong. To de-risk your portfolio, you can consider more moderate cash positions of 20 or 30 per cent.

The flip side of taking cash calls is that it is difficult to decide when to get back into the market. Deciding which stocks or funds to sell also poses a dilemma.

The best way to solve this problem is to set quantitative triggers for profit-booking. To time your cash calls, you can use market valuations as the benchmark as fund managers do. Successful dynamic funds typically move to a ‘less stock, more cash’ portfolio when the Nifty PE soars above 24 times on a trailing basis.

They go back to being fully equity-invested, when the PE drops below 16. While booking profits, selecting stocks with the highest valuation multiples is a better strategy than selling those with the maximum percentage gains.

When taking cash calls, make sure that the cash is immediately redeployed in a good bond or debt fund. That can reduce your opportunity loss from idling the money.

If the market corrects sharply, you must brace for all the stocks you own to suffer losses. But the degree of losses will depend on the kind of stocks you own. Therefore, one good way to de-risk your portfolio without making drastic cash calls, is to switch from more risky stocks to less risky ones.

Switching from micro/mid-caps to large-caps, from also-rans to sector leaders and from fancied stocks to less fancied ones, can be good to de-risk. You can use market PE as a guide to own a more aggressive portfolio when valuations are low, and a conservative one when valuations are high.

But portfolio switches can entail missed opportunities too. In a trending market, for instance, mid-caps/micro-caps can continue to outrun large-caps.

To deal with this, you can switch money from individual stocks to good equity funds that bet on the same theme. This will help diversify your risks and the fund manager will churn his portfolio to keep up with market twists and turns.

While both cash calls and portfolio switches can be difficult to execute, deciding on a fixed asset allocation for your portfolio and rebalancing to it, at six-monthly intervals, is an easy way to contain risk.

Three years ago, assume that you invested ₹10 lakh, with a 70 per cent equity allocation and a 30 per cent to FDs.

If your stocks/equity funds managed a 20 per cent CAGR over the last three years, the ₹7 lakh invested in stocks would today be worth ₹12.1 lakh. The ₹3 lakh invested in FDs, at an 8 per cent return, would be worth ₹3.8 lakh. Your asset allocation is now skewed 76 per cent in favour of equities and 24 per cent in FDs. To rebalance, you need to sell 6 per cent of your portfolio invested in stocks and plough it into FDs.

Over the next year, if the stock market corrects by 30 per cent, your ₹11.1 lakh stock portfolio of today would shrink to ₹7.7 lakh, reducing your equity allocation to 60 per cent. You then have to buy equities until that hits 70 per cent again.

Broadly, your asset allocation must depend on your age, life stage, financial goals and risk appetite.

One strange feature of the ongoing bull market is that both stocks and bonds have delivered high returns in tandem. But gold Exchange Traded Funds (ETFs) have delivered just a 2 per cent return over the last three years. This makes it a good time to diversify into gold.

Owning gold has proved a good hedge against market corrections for Indian investors. When global stock and bond markets fall, investors flock to gold as a safe haven asset. Market falls in India are usually triggered by foreign investor pullouts, which also sink the rupee.

Thus, domestic gold ETFs make gains both from rising global gold prices and a depreciating rupee. It therefore, makes eminent sense for investors with equity-heavy portfolios to diversify by allocating, say, 10 per cent to gold ETFs.