Is it possible to reduce volatility of the scheme NAV without reducing the fund returns? Read my article in Mid-day Gujarati edition today ....
http://epaper.gujaratimidday.com//epaperpdf/gmd/27062016/27062016-md-gm-17.pdf
The English translation is as under:
http://epaper.gujaratimidday.com//epaperpdf/gmd/27062016/27062016-md-gm-17.pdf
The English translation is as under:
“Stock markets likely to be volatile next week” – we often see such
headlines in the newspapers or similar stories on the television. Volatility,
though natural for the stock market, scares majority of investors. In order to
reduce the volatility without compromising much on the potential upside, the
mutual fund houses have innovated. First they came up with hybrid products. We
covered two types of hybrid products – the more popular ones – Balanced Funds
and Monthly Income Plans in our earlier articles. Due to the allocation in debt
as well as equity, these funds exhibit lower volatility. However, the scheme
returns may be lower than equity funds, especially during a secular bull
market.
Today, we will discuss about some other strategies adopted by
certain fund houses. Such strategies allocate money between equity and debt
assets, but change the allocation based on certain parameters.
First of all, let us spend some time on understanding one important
principle related to investments. If you combine two or more asset categories,
which may be individually risky (volatile) but each one may partly cancel the
volatility of the other. Thus, the portfolio would exhibit lower volatility.
This is where the fund houses came up with schemes that invest both
in equity as well as debt. Both these asset categories exhibit different price
movements at different points of time and in turn partly cancel out each
other’s volatility.
Let us say, we start with allocating 50% in each equity and debt.
After some time, if the equity market has run up, the percentage allocation to
equity would be more than 50%. In such a case, the portfolio must be rebalanced
to the original levels, i.e. 50% in each asset class. On the other hand, if the
equity market is down, the allocation would be higher than 50% in debt. This
time, one would have to sell debt and buy equity.
In either case, one is buying the asset priced lower by selling the
one that has appreciated and hence is priced high. This is the classic “buy
low, sell high” strategy in action. Now, a fund with static allocation between
equity and debt would be achieving this through rebalancing on a regular basis.
The balanced funds and MIPs have delivered reasonably good
performance over the years. Rebalancing, as explained above, has played a good
role in that performance. Through reduction in volatility, the funds have been
able to deliver performance that was average of the two categories.
Now comes the next question. Is it possible to do better than that?
That is where funds have launched schemes that do not stick to a desired
percentage allocation, but change the allocation based on some formula. This
formula depends on the valuation of one or both the asset classes.
Some of the schemes in the market use equity valuation parameters like
Price-to-Earnings ratio, or Price-to-Book Value ratio, or a combination of
both. One of the schemes uses Price-to-Earnings ratio for equity while
simultaneously comparing it with the yield on 10-year Government Securities.
These funds have lived up to the promise – lowering the volatility
without reducing the returns too much.
It’s a good category to explore for investors. However, a deeper
analysis is warranted since the alternatives can have significant differences
among them.
-
Amit Trivedi
The
author runs Karmayog Knowledge Academy. Recently, Amit has authored a book
titled “Riding the Roller Coaster –
Lessons from Financial Market Cycles We Repeatedly Forget”. The views
expressed are his personal opinions.
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