How to manage volatility in your portfolio amid war and crude shocker

News flows about recent themes or topics (be it interest rates, latest technology trends, geopolitical events, election outcomes, etc) dominate media discussions and drive sentiments and market’s near term movements. These news flows are more about macro factors than specific company fundamentals. Many times, the exact outcome of macro events such as policies of central banks, interest rates, commodity prices are very difficult to predict, even for the sectoral experts. However, an enormous amount of time and energy is spent on predicting the near term outlook for markets or prices of specific companies, based on these events.

In the longer run, markets react to a company’s growth, cash flow generation and its competitive advantage. Thus, the high volatility of equity markets provides both an opportunity and a threat to investors. It is more a test of the investor’s temperament than his knowledge.

For long-term success in investing, strong temperament is as important as knowledge of fundamental business and financial analysis. Some of the most exciting investment opportunities have presented themselves in the wake of high volatility and depressed sentiments about future prospects.

Globally, equity markets have traded at mouth-watering valuation levels in the aftermath of the Lehman bankruptcy in 2008 or at the onset of Covid-19 in March 2020. We can see the impact of volatility at a sector level also. Prices of some of the best NBFCs with strong business models and growth prospects crashed in the aftermath of the IL&FS crisis in 2018. Later on, these stocks went on to generate solid returns. The entire IT sector was branded as a low growth sector with least investor interest in 2016-2017, which then turned out to be among the best performing sectors over the next five years.

Volatility and sentiments play on investors’ minds at the top of bull markets also. At the height of the dot com boom, technology sector valuations factored in very strong growth over a very long period. Similarly, in the 2008 top, massively optimistic assumptions were made for sectors like infrastructure, capital goods and real estate. All news flow was positive and it was difficult to believe that things may not turn out to be as optimistic.

The key to dealing with volatility is to keep control on emotions and think in a disciplined manner. Another important thing is to have a longer time horizon. Investors should know what they cannot know. The movement of interest rates or commodity prices, for example. The focus should be on understanding the ‘knowables,’ which are more micro factors that affect the company’s future growth plans.

Equity investors should also have a more positive attitude. In times of crisis, all news that comes out could be bleak. At such times, it is important to remember that human ingenuity has overcome many problems and the same will happen again this time. In the last 25 years, Indian markets faced many negative events such as the Balance of Payments crisis in early 90s, the Asian financial crisis in late 90s, the Kargil war, SARS and weak economic growth following dot com bust, global financial crisis in 2008, high inflation and current account deficits in 2013, corporate NPA problem in 2016-18.

However, the markets continued their forward march despite all such events. Entrepreneurs find a way out of these adversities and grow their businesses. Investors should focus on building a diversified portfolio of good businesses and allow them to grow over a longer time period.

(The author, George Heber Joseph, is CEO & CIO, ITI Mutual Fund. Views are his own)