The returns on your equity shares tend to be volatile, by default. That means it tends to fluctuate over a period of time, but more prominently over shorter periods of time. But did you know that there are specific reasons why equity share returns may fluctuate in your case? There may be some structural defects in your portfolio which may making your equity shares more volatile. Remember, when it comes to equities volatility means risk and returns are always negatively related to risk. Here is what you need to know…
You are not diversified enough
This is most likely reason for your equity returns fluctuating. When you diversified sufficiently, then the underperformance of some sector tends to be compensated by the out performance of some other sector. But what if you are concentrated in a particular sector or theme? For example, if all your holdings are rate sensitives then they will tend to underperform in times of rising interest rates. Similarly, if your portfolio is overly exposed to banks or IT then again sector-specific news can make your equity shares volatile. The answer to this problem will be diversification across sectors and themes.
You are buying in bulk rather than phasing your investments
This is a classic problem with a lot of investors. When they have the funds they tend to buy equity shares in one go. If the price falls after that then you are left holding on to MTM losses. A better option will be to phase out your buying. In the first phase you just allocate 20% of your corpus to the stock and you buy more if the stock price falls. This gives you the advantage of rupee cost averaging and over a period of time your cost of holding the stock will come down and improve your returns on equity shares in the long run. It will reduce the fluctuations risk as your cost is much lower.
You are overtrading in the market
More often than not, you try to recover your losses by overtrading in the market. Aggressive is good but blind aggression is not a great idea. When you tend to overtrade in the market you end up incurring more losses and in the process you worsen your capital position. Avoid the urge to overtrade in the markets as panic trading can lead to more losses and make your portfolio performance fluctuate more.
Your time horizon is too short
Equity shares are about the long term. When you take a 6 month perspective, it is estimate that you underperform 36% of the times. When you hold for 3 years, your chance of underperforming is less than 2%. In fact over a 5 year horizon, your chances of underperforming are almost negligible. The shorter your time frame, the more you will be hit by fluctuations.
Global events are shifting against equities
There could be a subtle shift out of equities globally for a variety of reasons. For example, global bond yields may be going up and that may be making debt more attractive than equities. Alternatively, the geopolitical risk in the world may be going up due to factors like war in the Middle East, emergence of cold war, oil economics etc. All these can make equities extremely volatile. We have seen that trend in the last few months and we have also seen equity shares becoming extremely volatile as a result of that. You need to shift your portfolio more in favour of defensives under such circumstances.
Global interest rates are diverging…
This could be one of the major reasons for equities becoming volatile. When some central banks try to hike rates and other central banks try to depress rates. This phenomenon has been quite prominent in the last couple of years when the US Fed has been trying to hike rates while other EU and Japanese central banks have tried to keep rates low. This divergence in monetary policy also leads to fluctuations in stocks and Indian stocks are unlikely to be spared.
Stocks are due for an earnings upgrade / downgrade
This is quite a common reason for stocks to start fluctuating wildly. Typically, volatility is created when stocks are due for earnings upgrades or downgrades. Earnings upgrades or downgrades begin with analyst changes and that creates a lot of volatility in the stocks. If you are holding equity shares that are subject to such downgrades or upgrades then you may witness volatility and fluctuations in your portfolio.
In markets, it is very important to understand the difference between systematic and unsystematic risk. While unsystematic risk can be diversified, as you are supposed to be doing, the systematic risk cannot be diversified away. It is this risk that you need to be compensated for. While the fluctuations caused by systematic factors are across the board and impact all stocks, the volatility caused by unsystematic factors will be restricted to only a handful of stocks. Therein lays the difference!