Navigating Through
Investment Risks…
A Layman’s Perspective on The Risks in Equity
Investing…
I would like to
address this subject keeping in mind one of the most efficient asset classes for
wealth creation i.e. Equity (Includes Equity Stocks & Equity Indices).
When investing
in equity, one of the most crucial things to understand is Risk. Most
individuals hold a somewhat distorted and/or shallow view of Risk. For the ones
who look at equity purely as a speculative instrument for making quick money,
equity investment, for them is fraught with risks of the extreme kind. However,
for the serious investor, who views equity as a long-term wealth creation tool,
understanding risk and its impact, will help him apply prudent Risk Management strategies
to benefit in the long run.
Broadly put,
there are two types of Risks staring at investors in equity investing. These
are:
1. Event Linked Risks
2. Asset Linked Risks
Event Linked Risks: Event-linked risks arise out of the various developments (Positive as well as
Negative) happening around us and the reactions triggered by these events in
the market. These events/developments could be political, social,
geo-political, economic, etc. in nature. The last three decades have witnessed several
events like The Economic Liberalization, The Harshad Mehta Scam, The Ketan
Parekh Scam, The Tech Bubble, The Global Financial Crisis, Change in Political Regimes,
Demonetization, GST Implementation, Periodic Policy Announcements (fiscal as
well as monetary), Covid Crisis, and the latest being The Russia – Ukraine
Conflict. Each of these developments are interpreted by market participants in
different ways and to different extremes, thus triggering mild to sharp UPs /
DIPs in the markets. However, amidst all these events, the long term story of
the economy has remained intact. It therefore comes as little surprise that
over the long term, the economy and thus the markets have shown a continually rising
trend. A look at the SENSEX chart (below) spanning this three-decade period
shows that anyone who would have chosen to invest even passively during this
period (and would have stayed invested for long) would have ended up making
handsome gains. Active investors with a fundamentally sound portfolio-based-approach
and the patience/discipline to stay invested for long would have made a
killing.
Event Linked
Volatility can thus be best negotiated by staying invested with patience and
discipline over a long period of time.
Image: The SENSEX Journey (THREE DECADES of WEALTH
CREATION):
(Image
Source: https://twitter.com/bseindia/status/1352100012281405441)
Asset Linked Risks: Asset
Linked Risks in this case refer to the risks that emanate from choosing a
particular company for investment. These risks can be further divided into:
1. Liquidity Risk
2. Risk of choosing a Bad Company.
When the stock
in consideration is thinly traded on the exchanges, it gives rise to Liquidity Risk. Because of liquidity
risk, any sizeable buy/sell transaction in these stocks can cause their prices to
move sharply either ways. Liquidity of a stock doesn’t necessarily indicate its
quality. In fact, several stocks with great growth potential find themselves
marred by liquidity concerns, especially in the initial stages of their growth
cycle.
The Risk of Choosing a Bad Company is also a very real threat faced by investors. Despite having done
adequate fundamental research before picking a stock, there is still the
possibility of this risk creeping into your portfolio.
Asset-linked Risks
(Liquidity Risk & Company Specific Risk) can be best managed by creating a
strong diversified portfolio with a balanced representation of Large, Mid and
Small Cap stocks. This approach seeks to minimize the impact of wrong selection
by spreading the risk across the portfolio. It also helps strike a winning
balance between Long Term Growth & Stability.
Conclusion: Even the best of analyses could yield disappointing
results if they fail to account for these risks and their impact on your
investments. Gaining a deeper understanding of how these risks play out will help
you navigate through them effectively, thus boosting the performance of your
portfolio.