Franklin Templeton's decision to shutter six of its credit risk schemes has stunned investors of not just those schemes, but the investing community as a whole. The debacle comes at a time when the market is still trying to come to terms with meltdown in stock prices from the COVID pandemic. And yet, these and other similar episodes don’t tell us anything we should not have already known—at least to an extent, given that COVID-19 is an unprecedented pandemic.

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Here are some lessons investors can draw from the experience, which are not far removed from past experiences.

Behind rewards lie risks

As seen in recent cases of cooperative banks and now with Franklin Templeton debt funds—though not strictly similar comparisons—is that higher returns on fixed income investments can only accrue with higher credit risk. In other words, if you want higher returns, be ready for a higher loss as well.

So, if one bank is offering you 8 percent on a 1-year fixed deposit, and another 7 percent, you need to ask, why? Same applies to fixed deposits of NBFCs vs banks—they invariably offer higher returns, but come with lower credit quality as well. And there is liquidity risk as well. The returns will be good as long as the schemes holding the securities can sell those easily in the market.

Given that India’s debt markets are quite illiquid (other than for government securities) and even equity market volumes are concentrated in the top 100-odd stocks, you need to assess where you put your money.

There are no free lunches

Top performing fund managers are often lionised by the financial media, lending an air of glamour to investing. But at its core, investing is about long hours spent poring through balance sheets, a fair bit of legwork to ascertain facts, and in case you decide to put in money, a long wait for the rest of the market to agree with you.

There are many investors in the equity markets who had got lulled into believing that stocks can only rise, given the almost secular uptrend for the past few years. The result: much of their gains in equities over the past 5-7 years may have got wiped out in less than a fortnight. Reality is that there are no bull markets without bear markets—check out 2008, 2000 and even further back. It has long been said that bear markets are more rational.

Question is: If you were buying stocks at price-to-earnings multiples of 50, 60, 70 or 80 times in the run-up, should you be complaining now? You should have seen this coming. If you had just stuck to the basic knitting of investing in equities, you would have fared relatively better in the post Covid-outbreak carnage.

Cash flow and liquidity is king

Today, leverage has become a dirty word. Market pundits are now proclaiming that cash is king in a post-COVID milieu. But, isn’t cash always king? And shouldn’t it be? When evaluating whether to invest in a company or not, one of the first things to check is sustainability and continuity of cash flows and the ability to repay in good times and bad, but more so in the latter.

It is better to stay away from companies with weak cash reserves and accruals. Like we evaluate fixed income instruments by focusing on credit ratings, so should we when investing in equities. If you stick with AAA-rated or high investment grade rated companies in your equity portfolio, you will likely fare better even in your equity portfolio.

Leadership suggests quality

While frontline indices have seen a lot of change in their constituents over the years, with the old order making place for the new, there have been a few leaders that have stood the test of time. For instance, Hindustan Unilever, Reliance Industries, Larsen & Toubro, ITC and Tata Steel have been part of the frontline benchmarks for much more than a decade. What this tells us, is that, while there will be new winners, some leaders will stand the test of time. And this, not only because of the sectors they are in, but also because of the ability of the to adapt with the times. In fact, perhaps the most important factor when investing in a company is the quality of the management team. A good set of hands at the helm can work wonders. So, before you invest in a company try and learn a little more about the management of the company. The success of Reliance or HUL or TCS or Larsen & Toubro or HDFC Bank, for that matter, has much to do with who drives the business.

Value investing isn’t dead

If you think Benjamin Graham’s philosophy of value investing has outlived its utility, look around.. Many investors have burnt their fingers by buying into stocks at stratospheric valuations in the recent past. But today, like in earlier bear markets, if you look for deep value in terms of simple parameters, like price-to-earnings (PE) or price-to-book value (P/BV), you could position yourself for big gains when the markets recover—and they will, though not necessarily in a hurry. Conversely, stocks trading at high PE multiples could prove to be traps for the not so savvy investors, who might view the optical percentage decline in their value as a buying opportunity. To illustrate, for a company whose stock trades at 50 times earnings per share (EPS), it would take 10-years of compounded 17.5 percent EPS growth for the forward earnings to be discounted 10 times at today’s price. So, unless you can foresee a high growth trajectory for the business over a decade, it may be foolhardy to expect returns on any such investment, while the downside could be significant if the company fails to meet expectations.

Passive beats dabbling

Stock picking isn’t everybody’s cup of tea. It also cals for a lot of hard work. So unless you have the knowledge, skills and time, taking the passive route is always better. Here you have the option of choosing from actively managed equity mutual funds and benchmark-linked index funds. Here again, unless you are the kind who can take both outperformance and underperformance in your stride to try and eke out a little extra returns, active funds are not for you. The safest bet for those looking to invest in equities with low stress, is to invest in benchmark index funds or Exchange Traded Funds. What this ensures is that you’ll generate returns in line with the market, but you won’t pay a heavy price for any imprudent, aggressive bets by your fund manager.

History will repeat itself

Markets and economies go through cycles and therefore an economic boom will be followed by an economic slowdown. It is almost as if the world has an auto-correct switch that gets triggered when we venture into extremes or get hit by shocks not foreseen. So, this bear phase will be followed by a new bull phase, and so on. But not everything will be the same, and that is where we need to be choosy in our investments. Asset classes will not go out of fashion, but what will perform within them could change. And again, as in several past occasions, the weak will make way for the strong. The leaders across sectors will emerge stronger and more dominant, and they would likely lead the recovery and capitalize on the gaps emerging from the weak being driven out of business.

Better safe, than sorry

The most important lesson to take away from Franklin Templeton’s decision on winding down of 6 credit risk funds and the carnage in equities and commodities is to be disciplined in investing . The first is safety through diversification—spreading your money across asset classes helps you to mitigate the impact of any mishap in any one market. Next, you must tailor your portfolio in a way to adjust for your risk appetite. So, don’t invest in credit risk funds if you can’t stomach losing part of your invested principal. Alternatively, only take a limited exposure to such funds that will allow you to gain from a kicker in returns without compromising on the overall safety of your money. In equities, stay with index funds or highly liquid blue chips, if you are risk averse. Venture into mid-caps (either directly or via mutual funds) only if you are alright with seeing large swings—possibly, 30 percent gains or 30 percent losses—in your exposure. Such stocks are not for the faint hearted.

Also, don’t blame the market for your mistakes. Plan well, invest well, knowing what you are getting into. There is little point in crying over spilt milk.