Forest fires & Markets

Published On: 31-Oct-2018

Forest fires always start by one of two ways - naturally caused or human caused. Natural fires are generally started by lightning, with a very small percentage started by spontaneous combustion of dry fuel such as sawdust and leaves. Fires caused by human intervention can be due a range of reasons from carelessness (for eg a carelessly dropped cigarette) to arson.

But what causes a forest fire to thrive – is the presence of combustible material. An abundance of dried leaves, twigs and shrubs. Dry weather & strong winds also help a forest fire spread. Forest authorities normally carry our controlled burns before the summer season and develop fire-lines to reduce the risk of large-scale fires ahead of time.

In other words there are the immediate reasons for a forest fire- natural or human and then there are the pre-existing initial conditions – presence of combustible material, dry weather & winds that determine how damaging the fire eventually proves to be.

The reason I refer to this framework is the question that I am being asked the most in recent days-why is the market falling and how could it fall so sharply with wide spread damage? The reality is that periodic corrections are part of the nature of equity markets. And those who can stomach the higher volatility of Equities earn superior returns from the asset class over time. By the way even forest fires are arguably a part of the natural eco-system, but that is beyond my domain.

Was it the Oil prices, current account & fiscal pressures or rising rates or Fed tightening that caused this fall? We can never be sure of the reasons or know beforehand.  But I would also submit that one of the initial conditions that precede a sharp and damaging correction as witnessed this year is typically valuations in the expensive zone. The subdued volatility that was witnessed in 2017 may also have raised complacency. In other words when you have the pre-existing condition of high valuations, the chances of a damaging forest fire that spreads quickly causing much damage, also goes higher.

That is just the way it is. That is why every investor or his financial advisor must have a plan that accounts for the outbreak of forest fires. You can never be sure of the natural or human forces that will cause a forest fire or the exact initial conditions that precede the outbreak. Note - forest fires can break out in any asset class- fixed incomes, equity, Property, Gold and hence the need for diversification across asset classes. Diversification across asset classes is not to be interpreted as a maximization strategy, it is a means to ensure that the risk along the journey to your financial goals is something you can tolerate and live with. And one of the key considerations in your asset allocation framework needs to be “valuations” because it contributes significantly to the conducive conditions for the outbreak, spread and damage from forest fires.


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Author Bio

Vetri Subramaniam
Vetri Subramaniam is Group President & Head of Equity at UTI Asset Management Company Ltd. He has been in this role since January 2017. UTI MF manages assets of Rs. 1,717 bn* and the total assets under management of UTI are Rs. 10,981 bn*. At UTI MF Vetri leads a team of 19 persons including analysts and fund managers. The total equity assets managed and advised by the team are Rs. 1,077 bn*. Vetri has over 26 years of work experience. Prior to joining UTI in January 2017 he was Chief Investment Officer at Invesco Asset Management Ltd. He was part of the start-up team at Invesco (then Religare Asset Management) in 2008 and helped establish the firm¬タルs proprietary investment process and the team. During this period the firm established a strong track record. The firm also launched several offshore funds investing into India from Japan, Mauritius & Luxembourg. Vetri started his career at Kotak Mahindra in 1992 after passing out from IIM Bangalore with a PG Diploma in Management. His experience in equity markets & investment roles at various firms from 1994 includes Kotak Mahindra, SSKI & Motilal Oswal. He was also one of the founders of (now Sharekhan BNP Paribas) where he led the research & content team. He has also worked as an advisor to a UK Hedge fund Boyer Allan on its equity investments in India during 2003-2007. He is a frequent contributor to the media and regularly speaks on equities and investing at various forums - including the media & educational institutions. *The Month end AUM figures are as of December 31, 2020.