What if the stock you are waiting to recover never does? What if a company that once commanded a place in India's benchmark index gradually loses relevance, falls out of favour and eventually disappears from the market altogether? For investors who believe in buying individual stocks after a correction and waiting for a recovery, this is a risk worth considering.
S Naren, Chief Investment Officer of ICICI Prudential Mutual Fund, made this point at the ET Wealth Expo in Mumbai, using an interesting piece of Indian stock market history to explain why asset allocation in stocks can be considerably riskier than allocating money across asset classes.
His starting point was the composition of the Sensex in 1990. The index included companies such as ACC, Kirloskar, Cummins, Mukand, Glaxo, Mahindra & Mahindra, Voltas, Indian Hotels, Premier Automobiles, Futura Polyester, Philips, Tata Power, Hindustan Motors and Zenith Birla, among others.
Looking at that list today, it is difficult to imagine that these companies once formed India's benchmark equity index. Yet, that is precisely the point Naren wanted investors to consider.
Only six Sensex stocks from 1990 have survived the test of time
The changing composition of the Sensex offers a striking illustration of how difficult it is to identify long-term winners in the stock market.
Naren pointed out that only six companies from the 1990 Sensex have remained in the benchmark over the years: Tata Steel, Hindustan Unilever, Reliance Industries, Larsen & Toubro, Wipro and ITC. Mahindra & Mahindra also returned to the index after being out for a period.
Apart from these companies, the remaining 24 constituents of the 1990 Sensex are no longer part of the benchmark.
For Naren, this is why investors need to distinguish between asset allocation and stock selection. Allocating money to an asset class after a correction is fundamentally different from repeatedly buying an individual stock in the hope that it will eventually recover.
"Stocks need not mean revert at all, and then you are headed for disaster because you do not know which stock will do well," he said.
His argument is not that individual stocks cannot deliver strong returns. Rather, investors should not assume that a beaten-down stock will eventually regain its former value. Companies can lose their competitive position, fall out of benchmark indices or cease to exist. The risks are particularly high when investors treat individual stocks as though they were entire asset classes.
NASDAQ, US dollar and Indian midcaps among his anti-asset allocation bets
Naren also applied his framework to the current investment landscape, identifying asset classes where investors should be cautious about chasing past performance.
He identified the NASDAQ and the US dollar as two prominent examples of what he considers anti-asset allocation. Both have delivered strong performance, making them popular investment choices.
He pointed to the US dollar's sustained appreciation against other currencies, including the Japanese yen, against which it had moved from 80 to 157.
Gold also featured in his list, although with an important qualification. As he had explained earlier in his presentation, the shift in central banks' attitudes towards gold following the impounding of Russia's reserves gives the metal a structural reason to attract interest. Therefore, while he considers gold part of the anti-asset allocation theme after its substantial rally, he still sees a case for holding a small allocation.
Indian midcap and smallcap stocks were another area where Naren believes investors need to exercise caution. Returns from these segments since 2020 have been exceptionally strong, making them increasingly popular among investors.
However, he was careful to distinguish between the broader asset class and individual stocks within it. There could still be midcap and smallcap companies that perform well, but that does not automatically make the entire segment attractive from an asset allocation perspective.
For investors accustomed to buying individual stocks after sharp falls, Naren's message is a reminder that a lower price does not guarantee a recovery. An asset class can regain favour, but an individual company may never return to its former standing.
