4 ways to protect your profits from equities

By Sandeep BhallaMany stock investors are in a congratulatory mood because markets are close to all-time highs and their equity portfolios are showing healthy profits. But along with the satisfaction, there is also a fear of an imminent correction. Should they sell some of their holdings and book profits? And, if yes, where should they park funds thus released?An investor’s asset allocation should be set thoughtfully and should be changed only if there is a significant change in his life position or an extraordinary market risk. I can’t comment on the life positions of individuals – that is for each to personally evaluate. And the current state of the market does not represent an extraordinary level of risk.So, should anyone sell equity to protect profits at this stage? Two groups of investors come to mind. First, those with ‘allocation creep’. Upsurges in the stock market increase the equity allocation within portfolios, especially where a bulk of the investments were made when markets were low. This is a good time to recalculate your asset allocation. Don’t be surprised if it turns out different from your last calculation. And if equity allocation is significantly higher than planned, it might be a good idea to correct now.There are also those with ‘time creep’. Revisit the timelines of impending financial goals (house purchase/ renovation, car purchase, child’s education, child’s weddings etc.). Some timelines may be much closer now than when you last checked. If expenses are likely within the next 18-24 months, calculate how much you would need to meet those expenses and protect that portion out of your equity holdings.Go for liquid or arbitrage fundsThe first option is to sell equities and redeploy the proceeds in liquid or arbitrage funds. It is a clean and simple move and entails very low risk. Liquid and arbitrage funds have very little volatility and your money will grow steadily as you wait for a more opportune time to enter bond funds.The flipside is that the returns from these schemes will be quite low. Don’t expect more than 3-4% post-tax returns from liquid and arbitrage funds. A bigger problem is that if the market declines drastically, you might need to reverse the divestment from equities to restore your allocation. This could get messy and costly due to repeat transaction costs and higher tax liability. You would lose the long-term exemption and could end up with short-term capital gains.Invest in INVITs, REITsThis move is also easy to execute and carries low risk. Infrastructure Investment Trusts (InVITs) and Real Estate Investment Trusts (REITs) are high credit quality investment vehicles (usually AAA) holding assets with steady annuity streams from commercial real estate or infrastructure assets. The returns might be marginally higher than the first option while the tax will be lower for those in the lower income brackets. However, though these instruments are very liquid because they are listed on exchanges, the risk in InVITs and REITs is marginally higher than the first option. Also, it may not be very easy to reverse the divestment if you want to get back into equities.Hedge with put optionsThis strategy allows an investor to retain full upside of his equity holdings. Instead of selling off the stocks, the investor hedges his position with put options. However, put options are complex financial products and one should dabble in them only if one has access to dependable professional advice. Buy options only if you are conversant with their features and how they work.The flipside of the strategy is the cost it entails. The prevailing cost is about 0.5% per month (for protection up till December 2021) depending upon the strike price chosen by the investor.Buy structured market-linked debenturesThese are considerably complicated products that give downside protection to the investor by setting a “Knockout Level”. If markets decline, or remain flat, you get the principal back. But if markets move up beyond the Knockout Level, the investor earns returns in the range of 12-14%.Apart from the downside protection and upside gains, these products have favourable tax treatment if held for more than one year for listed debentures (three years for unlisted). However, these instruments carry significant credit risk since the underlying transaction is a loan to an NBFC. If the NBFC defaults, you would suffer a credit loss. So choose the underlying issuer very carefully. These products also have a very high minimum ticket size of about Rs 50 lakh so not everybody can participate.(The author is former banker and now works as a consultant.)

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