The Capital Markets had a dream run in the recent past and equity funds too have generated phenomenal returns. But the previous two weeks gone by has been the testimony of the fact that volatility is the integral part of the market and market moods are difficult to gauge. Untill recently the markets which were reluctant to factor in any of the negatives, suddenly found wobbled by the beers and witnessed massive corrections. Sensex, to everyone’s surprise registered a record fall of 826 points in a single day on tragic Thursday which spilled over to the next day as well plunging by another 452 points. The other day it swung 575 points in intraday trade before eventually closing a shade in positive. Certainly the markets are no more a place for the weak hearted - Just in one week Dalal Street slipped below 11000 levels eroding shareholder wealth by Rs 3.9 lakh crore which is more than the size of entire Indian mutual fund industry.

Though the markets have bounced back most of the time but concerns over stretching valuations and volatility requires investors to relook at their asset allocation and focus on the stocks that preserve the downside better, yet allowing them to participate in any upside. Going forward judicious asset allocation would be the key factor influencing returns in the event of downturn. Investors who are not comfortable with high risks associated with equity diversified funds should give a thought to other safer options like Dividend Yield Funds and Derivatives funds

Dividend yield funds which primarily look to invest in stocks having high dividend yield are based on the premise that when markets are volatile it makes more sense to stick to the safer option of stocks that give a return nevertheless, in the form of dividends. Thus it helps investors gain from the dividends in a bear phase and also provide the opportunity of capital appreciation during the bull-run. Historically investing in stocks with high dividend yields is perceived as 'Defensive Investment Strategy' as the share prices of companies having high dividend yield are less volatile than growth stocks and enjoys low valuation. The reason being high dividend yield (measured as dividend paid to the current market prices) implies that stock concerned is trading below the intrinsic value.

Also the companies, which have a track record of dividend payment, are perceived as 'Shareholder Friendly'. High Dividend payouts often signal that there is enough cash generation in the business and the stock may be currently under priced in spite of higher cash generating ability of the company. A careful selection of these stocks could therefore unlock the potential growth in the long-term, which eventually gets reflected in the share prices and could achieve higher returns without taking undue exposure to the vagaries of stock markets. However, in a rising market when the stock prices are rising, the dividend yield falls. It becomes difficult to identify such stocks in a bull run as the prices keep escalating and the dividend yields keep falling. This explains the underperformance of the most of the dividend yield funds as compared to its equity diversified counterparts in recent times.
Another good investment option in these choppy times could be funds which actively use derivatives to hedge the portfolio against downside risk and may also look to generate returns in a falling market by going short on stocks. Examples of such funds are Reliance Equity fund and the ongoing NFO of Tata Equity Management Fund.
Corrections though so aggressive in nature like the one we witnessed last week, may be unnerving, but should be considered healthy in the long term, especially in the markets which virtually had non-stop rally of 5000 points. Serious investors should look to get in the market with renewed enthusiasm when the cloud lifts.