To stop dancing when the music stops

The RBI is spot on, when it says the valuation of Indian equities is overstretched. The price-to-earnings ratio for the Sensex is a steep 29.31. The price-to-book ratio is 3.7. Should investors exit India’s zooming equity market that has outperformed major equity indices this year, or follow former Citigroup CEO Chuck Prince’s dictum, back in 2007, on following the music, ‘(w)hen the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance.’? Today, Wall Street firms and brokerages are said to be turning circumspect on Indian equities, highlighting the downside risks to investment returns due to stretched valuations.

There could be short-term losses, but in the medium term, the Indian economy’s prospects remain bright and strong companies will drive the nation’s growth. Investors who want to protect their money from being exposed to volatile markets should exit. The good news is that the economy is steadily recovering. Higher government spending will consolidate recovery and also offset the effects of the tapering off of asset purchases by the Fed that would see capital flee emerging markets. Growth in the real economy will justify valuations over time.

However, risk-averse investors would do well to employ skilled asset managers to diversify risk across asset classes, and opt for relatively risk-free assets. The National Pension System (NPS) is a viable option for most. Professional fund managers can try to balance their portfolios to optimise risk and reward. The NPS, which manages pensions of civil servants who joined in or after 2004, and of people who voluntarily save in the NPS, allocates funds across asset classes and has been generating decent returns.


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