Friday, November 25, 2011
Bearing downside risk !!!
Downside risk is the risk your investments will lose money due to a depreciation in value. In bear markets, investing in equities will have downside risk. The risk differs depending on the security involved. The index (Nifty or Sensex) will have the least risk followed by large cap stocks, mid-cap stocks and small-cap stocks. Certain levels in equity bear markets may look good in terms of many factors, including valuations. However, every level will be tested by the markets. For example, the Nifty may have looked good at 5,500, 5,300, 5,000 and 4,700. Investors buying into the Nifty at 5,500 with a long-term point of view will hesitate to buy the Nifty at 4,700, as they have already seen a 15 percent depreciation on their investments. The 15 percent depreciation is the downside risk the investor is taking when investing in the Nifty at 5,500. Investors, unfortunately, do not see it that way. They think that instead of making money, they lost money and that prevents them from staying invested or investing further sums of money at lower levels. It is a common investor trait and has no rationale attached to it. The truth is, no investment will make money from day one. Markets, by nature, are volatile and there will be upsides and downsides. In bear markets, investors will have to suffer downside risk when they buy, and in bull markets, investors have to suffer upside risk when they sell. Hence investing in today’s markets, with the Nifty at 4,800 levels and the Sensex at 16,000 levels, with return expectations of over 25 percent will come with downside risk that the Nifty and Sensex could slide further by 10 percent. Investors have to judge the downside risk they can bear. If they can tolerate higher downside risk, they should look at individual stocks, but if they are capable of only tolerating limited downside risk, they should stick to the index. Bear market investments will always lose money first before giving higher-than-average returns.