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Staying in the Middle

As the markets went from one extreme to another, investors found themselves on the same pendulum. Equity, earlier highly sought after, is now almost ignored. A solution to this is staying in the middle

A lot of people are saying that retail investors-small and large-have been scared off stocks for quite some time to come. People have started pulling out money not just from equity but also from equity mutual funds. As we go to press, there are rumours in the fund industry that at least one (and maybe more) mutual fund NFO has had initial investments of an embarrassingly small scale. It's just a few weeks ago that things were at the other extreme. Investors didn't have any hesitation about gambling on just about any momentum stock which they heard of. No one was the least bit scared of trading on small margins-and of borrowing to pay even that margin money. The stock exchanges-obviously-were enthusiastically cheering all this along with products like Chhota Sensex and the Mini-Nifty. To many investors, the swing from one extreme to the other seems natural. They feel that the only variable is who shifted from one side to the other at the right time and who was caught hanging around with the optimists when it was too late. The problem with this approach is that pushes you from one extreme to the other. Two months ago, you thought that it was normal for a stock's price to rise by five or ten times even though nothing had changed fundamentally about the company. Now, you've decided that stocks are dead permanently. Both are equally wrong. At Value Research, we've always talked about a balanced approach that stays balanced on the way up as well as the way down. Let me illustrate what I mean. During 2007, many sector and theme-specific funds that were focussed on the then 'hot' sectors like infrastructure, banking and power gave returns of close to (and for some, exceeding) 100 per cent. As the market turned, this prosperity turned to ruin and some funds have plunged by more than 30 per cent. Compare this to hybrid funds, which are more moderate under all circumstances. Since these balanced funds use a mix of stocks and debt, and more importantly, maintain an asset allocation by shifting gains from the asset class that has risen more, they turn out to be more sensible choices for investors.

Typically, hybrid funds gained 30 to 50 per cent during 2007, which is a lot less than the hot funds. However, when the markets have turned, they have fallen a lot less, with many of them having fallen just a few per cent over the last month. Over the long run, this low volatility delivers very decent numbers. Over five years, there are many hybrid funds that have given returns of around 30-35 per cent or so, with the category's average at 32 per cent. In contrast, equity funds have returned an average 45 per cent. I'm not arguing that hybrid funds earn more. Instead, I'm saying that over the long-term, they don't earn all that much less, and depending on your personal outlook, the somewhat lower earning may be a fair sacrifice in order to get the lower volatility and more peace of mind.

If you're the kind who will invest in equity funds and forget about it for the long-term, then equity is great. But if you're going to swing between an euphoric all-equity situation and a panicked all-debt extreme, then it may be better to stay in the middle all the time.