Number theory
“Buy low, sell high” or “buy when others are fearful and sell when they are greedy”. These phrases are often used to describe ideal investment strategies. Easier said than done, is it not?
What if there was a systematic way to actually do it, i.e., buy equities when prices are low and sell when they are high? This is what Dynamic Asset Allocation (DAA) strategy aims to do.
Different asset classes seldom behave in tandem. We carried out a study on the performance of debt and equity represented by the CRISIL 10 Year Gilt Index and the Nifty 50 Total Return Index. This performance was for one-year periods ending on March 31 each year. Starting March 31, 2002 until March 31, 2019, out of the 17 years, equity outperformed debt on 12 occasions, whereas debt outperformed equity on five occasions. Between March 31, 2019, and July 31, 2019, the Nifty 50 TRI delivered absolute negative returns of 3.76 per cent, with an annualised standard deviation of 16 per cent. On the contrary, the CRISIL 10 Year Gilt Index delivered an absolute positive return of 9.23 per cent with an annualised standard deviation of 5 per cent. Fair to say then, every asset class goes through its performance cycles.
In the context of Indian mutual funds, investors can opt for DAA or a Balanced Advantage Fund (BAF) that falls under the broader category of hybrid schemes. The DAA strategy fundamentally involves increasing allocation to equity as it becomes cheaper and vice-versa. That way, the portfolio value will fall less compared with a pure equity portfolio, though it may underperform in a bull market. However, the big advantage is that such funds tend to have significantly lower volatility than pure equity funds, and hence, can be viewed as less risky from an investor’s perspective.
Most funds in the BAF category use certain quantitative models which give an indication of how expensive the equity market is and accordingly suggest the optimum allocation to equity. Fund managers use various factors such as price to equity, price to book value, interest rates, and dividend yield for this purpose. This allows the funds to be managed in a disciplined and objective way rather than the fund manager forming a subjective opinion about how expensive the market is.
Taxation
The DAA/BAF category of mutual funds also tend to be tax-efficient because they always try to maintain a gross equity exposure of 65 per cent so that they are treated as equity funds for taxation purposes. That way, investors can claim the benefits of long-term capital gains if they sell the units after holding for a year. This is achieved by judiciously investing a part of the money in arbitrage positions that are fully hedged. The remaining money, which can be 0-35 per cent of the assets, is usually held in relatively low-risk debt instruments.
The real beauty of BAF is that it takes the trouble of timing the market away from investors. That is because the fund itself tends to have a mechanism which in a way decides on the timing.
The writer is CEO of of Union Asset Management Company. Sources: AMFI, MFI Explorer