Misplaced Anger
With Equity Markets taking a beating, Questions are being raised about the efficiency of pure Equity funds with even AMC heads these days promoting Balanced / Dynamic / Asset Management funds as the better alternative for they haven’t fallen as much as Equity.
Of course, given the fact that most of these fund houses run larger pure equity funds, the current fascination with these funds will last only as long as equity seems volatile. The moment the pure equity funds start generating stronger returns, the focus will once again shift back to those funds.
Most of these funds run based on a simple quantitative model of allocation to equities being dependent on the price earnings ratio of the Index. As markets become expensive, the equity weights in these funds go lower and vice versa. The Portfolio Yoga Asset Allocator too works on a similar frame-work.
If you are comfortable with market returns without the accompanying market risks, these can be good funds to invest given that the Large Cap Equity Premium in India for quite a while has been negligible.
Look at the comparative chart (Source: Valueresearch) comparing Large Cap Index Fund, Mid Cap & Small Cap active funds versus a simple Liquid Fund and ICICI Pru Balanced Advantage which is a Asset Allocation Hybrid Fund.
The best fund from the starting point of this chart – DSP Small Cap Fund {SBI Small Cap fund had similar returns for the said period}.
But this performance did not come with low volatility. In fact, DSP head Kalpen Parekh recently tweeted this
The trade-off to attempt a higher return is by taking a higher risk. Mid Caps are riskier than Large Caps and Small Caps are riskier than Mid Caps. While Mid and Small Cap stocks have more or less been bearish since 2018, the returns are even today substantially better than large caps.
While I don’t know if the trend will continue in the future as well, we can only base our decisions based on past data. But what I am trying to showcase is that there is no free lunch wherein you can have the upside of equity with the downside or volatility of Bonds.
Buy and Hold on Equity has not generated phenomenal returns for investors. But that has been seen in history as well – the returns are lumpy in nature. If there is no Risk Management, you gain in the good days and lose some of that in the bad days and overall hope you can beat a simple fixed income return on the long term.
While some amount of Risk Management by cutting off the fat tails to the left can be achieved by using a trend following filter, there are trade offs to be made and one which may not yield greatly in terms of return but provide you comfort when it comes to Risk.
The Importance of Asset Allocation in one’s investment framework
Managing money is tough regardless of whether it’s one’s own money or the money of others, there is a responsibility of wisely managing it. Most of us wish to outsource this clumsy business to others – mutual funds, banks, etc. In some ways we always feel they with their superior skills will be able to manage our assets better than we ever can.
The question that confronts many is our ability to gauge whether the investment we have done is on the right track. One way experts advise is to forget about returns and concentrate upon whether we are on track to meet the goals. This is actually pretty good advise given that the final objective of our investments is to meet our goals, be it ensuring that we have enough to tide over the years when we will no longer be employed or goals such as ensuring that we can celebrate the wedding of our children or enable them to make choices when it comes to education without worrying where the money is going to come from.
But the problem with the current way of goal planning anticipates a steady return from markets and continuous employment and ability to contribute on a continuous basis. For most, this is the simple way given that we really cannot forecast the uncertainties that may arise in the midst of our journey but one where the long term averages provide us both hope and a sense of being in the right direction.
The current market fall would have created a massive divergence between where you planned to be versus where you had to be. But if you have a long road ahead, the probability is that this glitch will overtime be overcome and then some.
For most, asset allocation ratio is something you plan once and then forget about it. While the equity part is seen as the driver for growth, the debt part is seen as the stabilizer. How much equity you have is based on your risk profile and how long your target time is. Longer the time and higher the risk taking ability, greater the allocation to equities that is recommended.
This fall brings about many lessons. Key among these is that imported templates of debt equity split we bring from the United States is not really applicable to developing countries such as India where Interest Rates are pretty high relatively speaking. India is one of the very few countries to have real positive interest rates while much of the world has negative.
Last year was a lesson in better understanding Debt funds and the risk they come with. This time, its Equity even though the risk was supposedly known.
One common observation among all historic falls has been the panicking of the retail investor. We are nowhere close to that this time around with more funds being added. I don’t think human behavior with respect to Fear and Greed can be changed by uttering the mantra “Mutual Fund Sahi Hai” 1001 times.
To me, this means that the bear market which more or less started for the broader markets 2 and quarter years back and one that started for the mainline indices a month back is nowhere close to where it could bottom.
Time in markets is more important than Timing the markets they say. While this is true based once again using historical data, living through such times is tougher than most anticipated when looking at a long term chart of an Index. To me, this is India’s first real bear market in a long time since it is impacting the common folk as much as the Investor. Key lessons to learn out there for sure.
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