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Wednesday, January 29, 2014

Investment strategies in an election year – a guest post

Once again, general elections are upon us – an expensive exercise where Indian citizens get to elect their representatives to Parliament. India is a democracy – which is both good and bad. Good because everyone has a vote; bad because voters are forced to choose between candidates who are mainly in the fray for the money.

Opinion polls are pointing to a BJP victory. Such an outcome is likely to be good for business and economic growth – as per promises being made by the party’s PM nominee. How he will untangle the knots of bureaucracy and vested interests remains to be seen. A fractured mandate – which is a distinct possibility – could be disastrous for the stock market.

In this month’s guest post, Nishit looks at possible election outcomes and discusses investment strategies to navigate through post-election scenarios. Do you have an opinion on Nishit’s strategies? Feel free to express it.

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The National Elections are round the corner. So how does one play the elections? Elections tend to generate extreme reactions from the stock market. The Congress won in 2004 with Left support and we had 2 lower circuits. The Congress won in 2009 without Left support and we had a historic upper freeze in the market.

It would be interesting to see what happened in the months after that. In May 2004, the market hit a down freeze. The low point of May 2004 was never again breached by the market. This marked an important bottom for the market.

In May 2009, the market hit an upper circuit after the Congress victory. The market did give a buying opportunity in July 2009 but thereafter never dropped to those levels.

Let us see how the scenarios can play out. There are 3 possibilities after the election results.

  1. BJP-led coalition wins
  2. Congress-led collation wins
  3. Third Front government comes to power

If there is a clear mandate for either a BJP or a Congress led government, then expect the market to rise. If a Third Front comes to power, expect the market to have a free fall.

We have seen in 2004 and 2009 that the market always gives a chance to buy. Right now the market has already touched 6300 and there can be a possible 10% up side from here.

What one can do is start accumulating cash in Liquid Funds and keep the cash ready for any eventual fall. Liquid funds give a return of 8-9% easily per annum.

Also, one can keep buying quality stocks. These stocks eventually give returns and can always be averaged out at lower levels.

One thing is very clear - one needs to have some portion of cash ready for buying after the elections. I would say at least 20% cash to capitalise on post election scenario.

Another alternative - if one has already bought stocks and has lower cash levels - is to hedge using Put Options. Options are a hedging mechanism and if used properly can insulate one’s portfolio against sudden falls in the market.

So, there are 3 options one could possibly take:

  1. 80% stocks and 20% cash to buy on dips post elections
  2. 90% stocks and hedging using Puts to hedge against any falls in the market post elections; the money from the Puts may come in handy
  3. 70% stocks and using a mix of Puts and Calls to hedge one’s portfolio against election swings

It is essential to keep some portion in cash ready for buying after the elections. The opinion polls are pointing towards the BJP but polls can be unreliable. Opinion polls can point to a general trend but not the exact outcome. For all one knows, we may end up with a hung Parliament and a period of uncertainty.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

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