How Important Is Knowing Your Risk Apetite?

Off-late, we have seen tremendous amount of volatility in markets, and people have started wandering where they should put their money. Ofcourse, I am not authorized to guide you on where should you put your money, but I am just presenting my views on overall scenario at present.

The Repeated Market Behavior:
               Time and again, we face situations where markets starts behaving violently in series of global events, which triggers fear among many investors including the large institutional investors. However, they as an investor or trader, have full time job in market, and they will definitely find a way of making profit even out of the worst scenarios, may be few of them!!!
However, we as small investors, have lesser choices, and we mostly prefer deploying our money in equities, and that too, mostly as medium/long term investor, rather than being a trader. We go by this method, as we are not able to spend enough time in market activities, and be a full time trader.

This probably can prove to be the biggest boon for us, if we are in long term bull market, and similar could prove to be worst of curse in longer term bear market. Hence, we need to understand what we are capable of, and then take our actions.

The Concept Of Risk vs Reward:
              I, as an investor has followed one policy from the beginning and that is, I will invest only that amount in equities, which I can afford to lose. So, in circumstances, where I see a risk worth taking, I don't mind going ahead with it. Simple example being, that after buying Granules India some 3.5 years back at 18 Rs (adj), it went down to 9 Rs (adj) within 3-6 months, where it became highly risky and people were hesitent in buying the same. However, I had some risk apetite and I utilized the dip to buy more, because I was ready to lose my money. if anything goes severely wrong from there. Now after 3 successful years for the company, we know it is not the same company it used to be then, in the eyes of investors today. Obviously, that can change anytime based on future performance.
This may not be true for every company and the policy might not be the same for everyone.
I have seen people investing in markets with a sole purpose of earning few extra bucks, even at the cost of risking the much needed money in hand.
Thirdly, there are also people who are relatively safe players and not ready to take risk in smaller companies even if they like their fundamentals.

The theory says that the amount of risk that you are ready to take is, most of the times, directly proportional to the reward you are expecting to get out of your investment. That happens because of the fact that reward is generally more in micro to small caps where value unlocking is pending, and we invest in those names considering the possible bright future of the company based on our conviction. Now, that can lead us either ways. In good scenario, the company will outperform consistenly and slowly move on path of transforming from small -> mid -> mega, whereas, in some bad scenarios, the company might not be able to sustain in highly competitive market, and finally investors might lose their hard earned wealth. Any stock which was discussed earlier on this blog with market capitalization of less than 1000 Cr can be considered in this category.

On the other hand, most of the companies, which has strong presence in markets, and are growing at 20-25% CAGR, which is also likely to continue for next few years, because of the growth visibility in the respective companies, are most of the times faily valued, and one can expect mediocre returns out of it, if market is stable/good. The good thing here is that in case there is a major downfall in overall market, the downside risk is limited in such companies, atleast less risky than some of the small cap companies. For e.g. companies like PI Ind, Ajanta Pharma etc today.

The Best Facing The Worst:
        Obviously, the scenarios mentioned above are not considering any major postive or negative news flow, which can drive stocks to any levels. The examples of worst being happening to some of the best names can be seen in case of Kitex Garments and Marksans Pharma off-late. There may be more names, but these are the ones I am aware. In bear market, investors/traders are looking for that one trigger which could lead to heavy downside in any company with any sort of fundamentals they have or had before the trigger.
Both the companies has lost more than 50% from their highs on account of different reasons.
Kitex was once considered a model company, and people used to study its details for good understanding of a fundamentally strong company. However, now every body seems to be off-loading their stakes in the company, as many people have found corporate governance issue, many have found results to be very poor, and few have some issues with Balance sheet.
In Q1, company said that their order book is full for the year, and they are not going to take any more orders for this year and they are expecting about 600-650 Cr revenue in FY'16. However, after Q3 results, it is highly unlikely that company will be able to reach those numbers.
Conference call with the management will be very interesting this time.
In case of Marksans Pharma, everything was going buttery smooth, until there was a news on Economic Times which stated that "Marksans Pharma Goa plant get notification of deficiency in GMP from UK MHRA. 40% of Marksans Pharma revenue comes from UK."
As per the clarification from management, it seems those were minor observations, and company has responded to those observations in time. They also mentioned that their supplies to UK has been continuing, as of now.
Now, there is either a disappointment because management was not prompt in reporting the same to SEBI as and when the observation were informed to them, or there is something unexpected coming out from company sooner, which few insiders may be aware off. Lets see what happens in coming days now.

These sort of things are quite common in markets from time to time, and hence I used to mention, again and again, that distributing your money in various companies is the way to go and not lay all your eggs in one basket. Sometimes, it takes only one quarter for a company to become fundamentally weak from being fundamentally strong in the eyes of investors.

The Zero Risk Investment:
             If you are a highly safe player and are looking for zero risk investments, then also we have options in equity markets called Liquid Bees. It is an Exchange Trade Fund (ETF) by Goldman Sachs. The price of single unit of this fund is 1000 Rs (face value), which will not change. The only way to earn is by getting dividend which is calculated on daily basis and deposited to your account on monthly basis. If I am not wrong, you will not get dividend in form of cash in your account, but as new units of same fund. One can check internet for more details on the same.

The Final Word:
                The conclusion out of all these would be to first figure out your risk apetite in the market. If you are looking to take risk, then always assume as if we are not that far from dooms day and then decide what is the amout that you are still ready to invest (ofcourse if you want your lost wealth to not affect your health :) ). If you are a long term investor and want to play relatively safe, then you can look at some of the decent companies, with good history, good management, good balance sheet, and good growth visibility.
For poeple who are new to markets, it is always advisable that you first be aware of all the basics and history about market & its behavior and then invest your money wisely into the same.
The most important thing, especially for new investors, is to make sure that you are not investing in markets only to earn, but to learn and invest in good companies, which you can be proud off. Earnings will definitely follow, sooner or later.
All the best!!!

These are solely my views and I will add more to this later.

Discloure:
I am not a research analyst, nor an investment advisor. Through this post, I am only putting my views, and which has nothing to do with any action that can be taken by readers on any specific company.