Do you need a nuclear shelter for your portfolio? 

With market views from foreign brokerages and money managers flooding WhatsApp and X (Twitter), you are bombarded with investment wisdom and advice from far corners of the world. So, this August you learnt that Warren Buffett a perma-bull on America, has been selling US stocks lately and was sitting on a $147 billion cash pile. In September, you had Ray Dalio, billionaire US hedge fund guru, saying that it was best not to own bonds and to just stay in cash to avoid losses.   

Do you need a nuclear shelter for your portfolio?

For investors already in a tizzy about US treasury yields spiraling above 5%, Fed chief Powell’s ‘higher-for-longer’ warning and the brewing US commercial real estate crisis, the recent Israel-Hamas conflict has been the last straw. Many folks have begun asking if they should book profits on their entire equity portfolio until the threat of war blows over, and re-enter after a good 30-40% correction. Some folks are worrying over whether they should sell everything – stocks, bonds and mutual funds – and simply huddle in a nuclear shelter until the storm of macro risks abates!

Why it won’t work 

If you’re thinking on these lines, please hold off from making such drastic decisions in an effort to create a shelter for your portfolio. It is counter-productive for Indian investors to exit equities or bonds based on US macros or global geopolitical events, for five reasons. 

# 1 Strong earnings

In the long run, the returns on your Indian stock portfolio will be decided only by one factor – the earnings growth managed by the companies you own. There’s currently not much reason to worry about the earnings trajectory of Indian companies. Factors such as a rise in US bond yields, US commercial real estate crisis or US recession do not have a direct bearing on Indian company earnings.

Yes, sectors like IT with a direct dependence on US clients may see a temporary slowdown. But most sectors in India Inc depend more on domestic consumption and investments for their growth than exports. As things stand, even if the US economy slides into a recession next year (there are few signs of it today with a US GDP growth forecast of 1.5% for 2024), India is still likely to grow at 6.4-6.5%. Post-Covid, Nifty50 earnings have grown at a much faster pace than India’s GDP at 22% CAGR in FY20-23. Growth is forecast at 15-20% in FY24

If earnings growth for Indian companies remains strong, there’s little reason for investors to worry about bond defaults either. Indian ratings agencies are in fact talking of the improving debt metrics at India Inc. As to government bonds, the Indian government and central bank were quite frugal with their stimulus packages during Covid. Unlike in the US, where the Fed is sitting on over $8 trillion of bonds it needs to liquidate, RBI has already unwound the excess liquidity it pumped in during Covid. The Centre has managed to shrink its deficit, debt and interest payments post Covid too. All this offers very little reason for Indian investors to fret about debt defaults either by companies or the government. 

# 2 Buying opportunity

If liquidity were to rush out on global events such as a US recession or war, there can be a correction in Indian stocks, even a deep one. But if stock valuations correct while company fundamentals remain intact, that would be an opportunity to buy Indian equities rather than an occasion to bail out of them.

In the past, whenever Indian markets have corrected sharply on the back of global macro risks or geopolitical events – 9/11 attacks in 2001, global financial crisis of October 2008- March 2009, Covid crash of February-April 2020, Russia-Ukraine war in January-June 2022 – they have offered great entry points into Indian equities. Today with the benefit of hindsight, you can clearly see that those periods were great times to buy stocks; but fear was the predominant sentiment when those events were unfolding. 

# 3 Short-lived correction

If your plan is to sell your equity holdings now so that you can buy back after a correction, this idea works only in theory, not in practise. Markets seldom oblige with a deep correction when one is waiting for it. Even if markets do correct, the correction can prove shallow and a rebound can take wing before you even decide what to buy. With Indian household allocation to equities quite low and plenty of domestic money awaiting at the sidelines to buy stocks, recent corrections in Indian markets have proved quite short-lived.

Folks who didn’t deploy all their money in March-April 2020 on a 40% fall and waited for markets to drop further or to go through a prolonged time correction have had to miss out on the breathless rally that followed. The Nifty went from 8,000 to 18,000 levels within 18 months, despite this being one of the worst periods for Indian households due to ravages of Covid.

Even if you manage to sell all your equity holdings just before a crash, rebuilding your portfolio from scratch during a short-lived correction can prove near-impossible. Market mavens like Ray Dalio or Warren Buffett can sit on piles of cash, and swoop in to deploy it all in a correction because they have armies of analysts to tell them what to buy and access to blocks of promoter equity. This is not doable for ordinary mortals.  

# 4 Macro calls can backfire

To decide whether to move from equities to bonds, vice versa or sell everything to keep cash in your mattress, you need to able to gauge the impact of a macro event on the economy, earnings, interest rates, inflation, bond yields, risk premia and so on. But calling how macro or geopolitical events will pan out is a tall ask.

Take the case of US bond yields for instance. Global bond gurus are still slugging it out over why they are rising. One camp believes that US bond yields are spiraling because the US government is teetering on the brink of a debt crisis, which will lead to a recession and the dollar losing its mojo. Another camp takes the polar opposite view that US yields are simply returning to their historical levels with QE being wound down and a strengthening US economy.

Such confusion is what prompted Howard Marks, a great contrarian investor and reader of market cycles, to write this wonderful memo about why he does not react to macro events. He explains that the macro forecasts (like US rates remaining higher for longer) that everyone is talking about, are usually priced into assets. If one agrees with the consensus view on such events, there’s no point acting because prices already factor it in.  But if one takes a non-consensus view, there’s a high probability of going wrong! 

How to de-risk 

If you’re convinced that making drastic changes to your asset allocation based on macro events can backfire, can you still do something to address your worries and create a shelter for your portfolio? You can. You can de-risk your portfolio for better peace of mind during volatile bouts, by doing any of the following. 

Tactical allocation changes

Rather than thinking in black-and-white terms about fully exiting equities or bonds, you can consider tactical changes in your asset allocation to get to a more comfortable space in your portfolio. Today, the Indian debt market offers excellent opportunities for earning an inflation-plus return with 1-3 year government bonds at 7.1-7.3% yield and 1-3 year AAA corporate bonds at 7.5-7.8%.

If the recent bull market has left you with a 70:30 asset allocation in favour of equities, you can think of booking profits on stocks or equity funds to switch to bonds, rebalancing to say, 60:40 or even 50:50 based on your risk appetite, or re-balancing to your original intended asset allocation. While booking profits, be sure to exit low- quality and low-conviction stocks and funds, rather than selling holdings with the most percentage gains (these may be sound long term bets).

We do not advocate completely exiting small or mid-cap stocks or funds to switch to large-caps in volatile times for the same reasons as above; re-entry will be tough. But you can have fixed allocations to small and mid-caps within your equity portfolio to contain risk and rebalance to stick to this. 

Deploying fresh money

If you have fresh money or a windfall to deploy, you can delay buying into riskier assets like equities or credit funds and park it in safer avenues until you are confident or markets correct. Your parking avenues need to offer anytime liquidity to allow quick redemptions and switches in case of a stock market fall. They also need to offer better-than-inflation returns in case the correction takes long to materialise or never does.

If you are fine with a little bit of risk, you can consider the very short-maturity debt funds that figure in the up to 1.5-year horizon in Prime Funds. If you are looking for a ‘nuclear shelter for your portfolio’ level safety, you can directly buy 91 day or 182 day T-Bills which offer 6.9%-7.1% currently on RBI Retail Direct. (Know how to do this here). But whatever you do with your additional investible surplus, make sure that you continue with your normal SIPs in equity and debt funds, as they your best weapon to continue buying when fear’s in the air.  

Allocate to gold

A gold allocation of 5-10% in your portfolio can as a hedge against Black Swan events that roil markets. A 5-10% gold allocation cannot completely protect your portfolio from losses if stocks crater. But as gold tends to rally sharply when equities tank, it can have a smoothening effect on your portfolio returns.

For a bigger cushioning effect, you can peg your gold allocation of 5-10% to your equity portfolio. If you do not have any allocation to gold, you can acquire it by buying gold ETFs (check Prime ETFs for our recommendations) or SGBs (sovereign gold bonds). SGBs are a superior vehicle for the long term because of their interest component and friendly taxation, but they are not liquid. Gold ETFs are more handy if you plan to switch from gold to equities or bonds at a time of your choice. 

Diversify into value

When a correction or a bear market arrives, all stocks do not lose equal value. History shows that portfolios constructed in a value or contra style outperform growth oriented funds during market crashes and the initial stages of the bull market that comes next. PrimeInvestor has always advocated style diversification, so you can add value or contra funds that figure in our recommendations for better downside protection in a bear phase (Read the Why This Fund in Prime Funds to know the style of the fund). This is especially if you hold more growth-oriented funds. In debt funds, you can play it safe by adding more corporate bond or short duration funds if you have a high credit exposure. 

These strategies can help your portfolio weather a lot of shelling, even without a nuclear shelter for your portfolio.

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4 thoughts on “Do you need a nuclear shelter for your portfolio? ”

  1. nikhil.abhyankar

    Do you differentiate the gold holding between tactical asset allocation (TAA) and for psychological or cushioning reasons? How much gold do you recommend one hold, if any, in either of these cases?

    If someone holds gold for TAA, they will shift to equity if stocks crater.
    If it’s the latter, they will hold on to the gold for dear life. Does that help beyond the psychological cushioning for a long term portfolio? Would it be a better idea to hold some physical gold in the case of a catastrophe?

    If the gold is only for TAA, does it make sense to just use an appropriate debt instrument instead of gold?

    1. We recommend a constant allocation to gold at 5-10% of equity allocation. Tactical allocation doesn’t make sense because gold is hedge against black swan events which can’t be anticipated. Buying gold after a macro or geopolitical event raises your entry price and reduces returns. That’s why we have adviced gold in this article only for those with no or little allocation.

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