Greed, prudence and lessons from history

In the realm of investments, a pattern reminiscent of Peter Lynch's famous cocktail party theory seems to be unfolding. Peter Lynch had this theory of predicting market movements by attending dinner parties. People paid little attention to him when the stock market was sluggish or range-bound. But when it picked up, people would ask about stock picks and the right investment timing. Even people like dentists would offer stock suggestions to the seasoned fund manager.

Today, we witness unprecedented enthusiasm and optimism in the market, particularly regarding certain market caps. Some of the inquiries I have been getting from some of my investors are:

• "Why don't we create an exclusive small-cap portfolio?"
  
• "Why have we initiated a systematic transfer? Can't we invest all at once?"
  
• "Considering 'China + 1' and the formalisation of the economy favour small-cap companies, can we allocate more of our investments in sectors such as defence and manufacturing?"
  
• "I wish to build a portfolio solely comprising sector-specific funds and time it perfectly with market trends."

Such questions are bubbling in the investor community, and understandably so. The market is buoyant, after all.

But remember that past returns do not guarantee future results. Instead, they often lure investors towards sectors and themes performing well at that particular point. This pattern of prioritising greed over prudence is nothing new; it is a recurring theme in every upcycle.

History lessons

In the early 2000s, when I entered the asset management industry, the AUM of Indian mutual funds skyrocketed by 46.5 per cent to Rs 1.03 lakh crore. A significant portion of the equity money poured into IT sector funds. But after the market crash, witnessing NAVs plummet by as much as 80 per cent was heart-wrenching. Numerous investors lost a substantial portion of their hard-earned savings.

A similar scenario unfolded in the history of the Sensex. By 1992, it had surged 267 per cent, climbing from 1,168 to 4,285. Yet, the index closed at 2,281 the following year, with a 47 per cent correction in a single year. Retail investors who invested at the peak of the frenzy would have incurred a loss of 2 per cent even after a decade. Such examples are crucial to remember, as they tend to fade from memory. However, even now, in certain pockets of the market, the prevailing mood seems to be "invest now, investigate later".

Understanding the small-cap attraction

A closer look at the net flows in July 2023 reveals intriguing trends. Small-cap funds attracted net inflows of over Rs 4,000 crore, while the flexi-cap category, which predominantly leans towards large-cap investments, witnessed a negative flow of Rs 932 crore.

Furthermore, consider the small-cap fund, mid-cap fund and sector-oriented fund categories. Allocating nearly 50 per cent of a portfolio to them may not be advisable, even for the most aggressive investors. But that's what's happening. The gross inflows in these categories constitute 82 per cent of the total equity. Even when reviewing year-to-date (YTD) net inflows in equity, these categories account for 86 per cent of the total. At this point, one must question whether the market is behaving rationally.

But this raises another question: Why are investors more confident in small- and micro-cap stocks compared to large-cap companies?

Simply put, these categories have delivered exceptional returns in the past year. The one-year return of the Nifty 50 stands at 10.8 per cent, while the Nifty mid-cap and small-cap indices boast 26.5 and 29.6 per cent returns, respectively. Such significant disparities naturally draw investors toward them.

Be cautious

If you are a long-term investor rather than someone with a three-year view of the market, you must exercise caution and avoid getting caught up in the race. Stick to your planned asset allocation and avoid following the crowd blindly. As Warren Buffett famously advised, "Be greedy when others are fearful, and be fearful when others are greedy."

Shyamali has been navigating the asset management world for over 20 years, working with everyone from the seasoned super wealthy to absolute beginners. She has a knack for understanding the human side of investing and empathising with investors, something that shines through in her writing. She can be reached at [email protected]

Also read: The irrational rationale