Understanding Equity Market Valuations And The Importance Of Asset Allocation

Brijesh Dheman
Consultant, Candura Advisors

Imagine you have to save Rs.50 lakh for your child's higher education expenses within 20 years. Your child is exceptionally talented and you want to give her/him the best education possible. You know equities/stocks are potentially the best asset class in the long-term and decide to use this route to save & invest. You find out the Sensex is at 40,000, bank FDs offer 7% annual interest and gold is quoting at Rs.39,000 per 10 gms. What would you do?

Investors become uncomfortable about investing when they see Sensex, Nifty absolute levels. As a result, the financial goal is put on the backburner or the investment is put in some low-yielding investment avenues. Ideally, what they should do is assess the value of each asset class and understand the relative attractiveness of each before investing in a mix of assets.

Investing is a long journey. If you cannot afford to take a plane, you must take a train & a bus to continue your quest. Later when you can, take the plane and travel faster. But, most investors avoid this smart route and waste precious time and money. These are the reasons why investors must understand the importance of equity market valuations and how they fit into the asset allocation pie.

Valuation is Understanding Worth

Despite what you read or hear about stock markets, the truth is your financial goals need to be fulfilled. Low return is not the biggest risk. Loss is not the biggest risk. In fact, not meeting your goal is the biggest risk. So, investing has to be done. Over the long-term, equities/stocks are your best bet because they can potentially beat inflation and generate good enough gains compared to other asset classes like debt/fixed income, gold, real estate, or cash.

Instead of fretting over Sensex and Nifty levels, try to understand the valuation of Sensex and Nifty. Stocks have two values - intrinsic value i.e. real value and - market value i.e. the current price. For an investor, the value that matters the most is the 'intrinsic' value. If the current market value is less than intrinsic value, then you should definitely invest. How does a person understand this? There are different valuation metrics that try to estimate the value of stocks.

The basic objective behind employing any valuation tactic is to assess whether the stock you plan to buy is cheap or expensive. In the same manner, there can be a valuation for the market i.e. Sensex or Nifty. The valuation of the stock market is a good indicator of whether you should be aggressively buying stocks or going slow.

When you build a portfolio for a financial goal, some assets will act as the core. But moving in and moving out of them, and at the right time, is extremely important too. This is where investment solutions that rely on in-house valuation models, with high accuracy, really help investments.

Asset Allocation Importance

What if the valuation of stocks at the moment is expensive? Should you avoid buying equities? The emphatic answer is NO. This is where asset allocation comes into play. Remember, investing is a long journey that you have to continue despite the ups and downs. If your financial goal is to have enough wealth to last your post-retirement period, not investing will not help. You have to keep on investing in a mix of assets that suit your goal the best.

Asset allocation helps you spread your money into different assets such as equities, fixed income, cash, and gold. Every asset has a place in your portfolio. Equities offer growth potential. Fixed income provides stability. Gold usually does well when other asset classes don't. Cash acts as a cushion during declines. Different assets behave differently at different points in time.

The multiple-asset approach ensures a few important things. One, your money will be working as hard as you in a combination of assets depending upon their relative attractiveness. Two, your money will be taking baby-steps to attain your goal even if some asset classes are expensive. Three, the right asset allocation will help you stay in the game, rather than sit out or wait for the perfect opportunity in a single asset class.

Despite what many believe, financial returns from an asset class are not the major determinant of a portfolio's success. Studies show that optimal asset allocation is what drives the success of a portfolio. With proper asset allocation, you will be present in various asset classes and in varied proportions.

The writer is a Consultant, Candura Advisors 
Email : investments@canduraadvisors.com
Website : www.canduraadvisors.com