Build wealth through mutual funds - chat transcript

Transcript of my chat today on www.moneycontrol.com

http://www.moneycontrol.com/news/mgmtinterviews/chats/detail_new.php?chatid=24&source=mym

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A good investment option amidst volatility

We looked at various asset allocation schemes last time. This time, we will discuss a variation of these schemes - dynamic asset allocation schemes.

Click on the link here to read further.

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The English translation is as under:

Last time, we covered asset allocation funds. This time we will look at a variant of the same, known as “dynamic asset allocation” funds. While we discussed about investing in multiple asset categories, the focus of the discussion was about maintaining certain proportion in each of the two or three asset categories.

However, periodically, when one asset category becomes costly, does it make sense to reduce the allocation? Similarly, should one increase the allocation in the asset that has become cheaper? There is a school of thought that suggests, “Yes, we should”.

Mutual fund companies have come up with schemes that work on such principles. These schemes invest in more than one asset categories – in most cases these invest in two assets. Most such schemes allocate money between equity and debt.

The allocation between equity and debt is altered periodically. In order to determine the allocation to the two asset categories, there are two approaches:

1.     The fund manager alters the allocation based on his/her views on the two asset categories.

2.     The allocation would change on the basis of some pre-decided formula.

In the first case, when the fund manager is bearish on equity market, the scheme would reduce equity exposure. However, when one is bullish about equity, the allocation would go up.

In the latter, most often, valuation determines how much should be allocated where. The allocation would be reduced from (or increased in) the asset that has become costly (cheaper) as indicated by certain valuation parameters. However, some of the schemes only look at valuation of equity. There is at least one scheme that compares the valuation of equity and debt and changes the allocation accordingly.

The valuation parameters:

For the purpose of evaluating equity valuation, most consider the P/E ratio or the P/BV ratio. Both these ratios are popular indicators of valuation. As a thumb rule, it is believed that higher the number, costlier the market (or a sector or a stock). Fund schemes follow a certain pre-defined pattern through which the allocation in equity is reduced step-by-step when the valuation goes up and increased when the valuation goes down.

In one case, the scheme’s allocation is altered based on the gap between the yield on Government Security with 10-year maturity and the “earnings yield” for equity. The earnings yield is the inverse of P/E ratio.

These are schemes designed to reduce short-term fluctuations in the scheme’s NAV. At the same time, such schemes are expected to deliver at least as much as a fund that evenly allocated money between equity and debt.

Very often, investors have compared such schemes to pure equity funds. That is a mistake. Given that these schemes invest at least some proportion and often a large chunk in debt securities, it would be improper to compare these with pure equity funds.

Should an investor consider investing in such schemes? Well, that entirely depends on whether the investor needs such a scheme in the first place. Having said that, one may consider such a scheme with an expectation of reduced price fluctuations compared to a hybrid scheme that does not change the allocation.

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.

Another high on the roller coaster ride

Gujarati edition of my book "Riding The Roller Coaster - Lessons from financial market cycles we repeatedly forget" is available for pre-order now on www.amazon.in

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Chat transcript - 10/10/16

Transcript of chat on www.moneycontrol.com today

Equity investments simplified

Riding The Roller Coaster - Gujarati edition ... coming soon in bookstores

Asset Allocation schemes - managed risk, enhanced returns

Some mutual fund houses have launched schemes known as the “asset allocation schemes”. What are these schemes? How do they operate? Should one consider investing in such schemes? 

Read my article in Mid-day Gujarati edition today on the subject of asset allocation ...

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The English translation of the same is as under:

Some mutual fund houses have launched schemes known as the “asset allocation schemes”. What are these schemes? How do they operate? Should one consider investing in such schemes?

Before answering the above questions, it is important to understand what asset allocation means. It is a process to allocate one’s investments across various asset categories. The reasons behind asset allocation, the reasons why and how much money is allocated to different asset categories could be either unique to the investor or sometimes based on the fund manager’s view on the opportunities in different asset categories.

Since mutual fund companies cannot customize the schemes for individual investors, the logic of investing the fund’s investments across asset categories cannot be done in line with the investors’ needs. Hence, the objective of the asset allocation schemes launched by mutual fund companies would be to generate better risk-adjusted returns. Some people call these schemes offer peace of mind to investors, as the returns are decent, but the price fluctuations are moderate.

For this purpose, money in the scheme is invested across more than one asset classes. Since the market prices of different assets move differently, the scheme’s NAV exhibits moderate movement only.

Let us assume that a scheme has invested in both equity and debt. As we all understand, market prices of equity and debt do not move together. At some time, when the equity prices could be down, debt might have gone up. This is when the down movement of equity would be compensated partly by the up movement of debt prices.

The reverse may also happen when the debt prices do not move much or move in negative direction, equity might be up.

Thus, the opposite movements tend to cancel each other out partly, which lowers the fluctuation in the NAV of the scheme.

The asset allocation schemes may allocate money across more asset categories. in the Indian mutual fund industry, we have schemes that invest in various combinations of equity, debt and gold.

In certain cases, the schemes define the allocation across the asset categories and keep the same fixed. So, a scheme may invest 60% in equity and 40% in debt. At a pre-defined frequency the allocation would be checked and if required, would be restored to the 60-40 ratio.

Some schemes may give some flexibility to the fund manager to alter the allocation marginally, based on his or her market view. Such schemes depend on the portfolio manager’s abilities to improve the scheme’s performance.

There are some schemes that allow changes to the set percentage allocation based on certain valuation parameters. We will talk about such schemes in our next article.

Till then, keep an eye on the asset allocation schemes. In fact, two categories of funds that we have already covered earlier are Balanced Funds and MIP (or Monthly Income Plans). These are also known as hybrid schemes.

One must be careful to check whether the allocation between equity and debt is fixed at a certain ratio or the fund manager has a leeway to change it as per the outlook. For this purpose, one needs to check the following:

1.     The Scheme Information Document (popularly known as the SID) contains the details of asset allocation allowed. Read the table as well as the text below it., and

2.     The fact sheet contains the details of actual investments made by the scheme. Even when the fund manager has the flexibility to change the asset allocation, more often, the same is not used and the allocation is kept fixed.

If the allocation is kept at a near-constant ratio, one is not so much dependent on the fund manager’s outlook on the different asset categories. However, when the fund manager keeps changing the allocation between equity and debt, it requires skills. These skills can add to the returns, but at the same time are subject to the risk of the fund manager’s judgment being wrong.

Happy investing to you all.

-        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.