THE INDIAN STOCK MARKET has delivered a strong 11 per cent CAGR over the past decade, with positive returns for eight straight years. This consistency has led many investors to view equity returns as predictable―when, in reality, they are anything but. Today’s investment environment is increasingly complex. Forces like geopolitical tensions, slowing earnings growth, FPI (foreign portfolio investor) outflows, and high valuations, are adding uncertainty. As a result, many portfolios have shifted toward high-return pursuits, drifting away from balanced risk management.
Why predictability matters
Periods of strong performance can sometimes create a false sense of security, leading investors to overlook risks in pursuit of high returns. A few years ago, investors balanced their portfolios across equity, debt, and hybrid investments. Today, however, portfolios are skewed toward equities, particularly in mid- and small-cap stocks, driven by the sharp rallies. The Nifty Midcap 150 and Nifty Smallcap 250 indices, for instance, recorded robust CAGRs of 22 per cent and 28-29 per cent, respectively, over the last three to five years.
This focus on high-growth segments carries hidden risks. During market downturns, mid- and small-cap stocks tend to see sharper declines than large-caps, amplifying potential losses. In 2020, for example, while the Nifty 50 fell by 34 per cent, the Nifty Smallcap 250 dropped by 40 per cent. Such downturns illustrate the impact of volatility.
The risk in averages
Imagine a river with an average depth of five feet. For a six-foot-tall person, it might seem safe to cross. However, some parts of the river may be just two feet deep, while others plunge to nine feet. This average masks the riskier areas. Investing can be much the same. Average returns can look attractive but may hide periods of extreme volatility. High returns, while appealing, often come with high risks. Without a full understanding of potential fluctuations, investors may find themselves in “deeper waters” than expected.
Variance, or volatility, in investments can create a disconnect between projected and actual returns, often derailing long-term goals. For example, consider an investor aiming for a 12 per cent average annual return over 25 years to grow their retirement fund. While this target seems achievable based on historical averages, the reality is less predictable. Fluctuations can lead to different outcomes: if returns vary widely―say, with highs of 30 per cent in some years and losses of 20 per cent in others―the average masks the impact of these ups and downs.
A better path
In unpredictable markets, investors’ priorities are shifting. As economic and geopolitical challenges continue, more investors are seeking stability over high-risk, high-return options. Gone are the days when aggressive highs and lows were broadly appealing. Now, a smoother journey―one that emphasises resilience and steady growth―has gained favour.
Looking at historical data, stability-focussed portfolios have performed consistently, even in tough times. For instance, the Nifty 100 Low Volatility 30 index has posted a solid CAGR of 18.4 per cent in the last two decades, outpacing even the Midcap (18.1 per cent) and Smallcap (16.9 per cent) indices. This stability-focussed approach has effectively managed both upsides and downsides, capturing a large part of the bull market gains while significantly limiting losses during crises like Eurozone crisis, Fed Taper Tantrum, and Covid-19 shock. By limiting volatility and drawdowns, such strategies allow investors to maintain confidence and stay on track.
Who benefits most from stability
Approaches that focus on minimising volatility and managing variance provide a solid foundation for growth, helping investors stay aligned with their financial goals even as markets fluctuate. By choosing equity strategies such as minimum variance, investors can achieve consistent growth without the stress of extreme ups and downs.
Investors may want to invest in the new fund offer (NFO) by ICICI Prudential Mutual Fund, the ICICI Prudential Equity Minimum Variance Fund, open from November 18 to December 2, 2024. This scheme is well-suited for those seeking long-term capital appreciation and equity exposure while minimising the impact of market volatility.
The writer is CEO, Finozone Financial Services IMF Pvt Ltd.