Be fearful when others are greedy, and greedy when others are fearful” is quite possibly the simplest and yet most profound investment advice dispensed by none other than the Oracle of Omaha, Warren Buffett, himself. And yet, it’s no secret that most small investors, buffeted (no pun intended!) by their surging emotions of greed and fear tend to do the exact opposite.
An exhibit published in a report by Ambit Capital last year tells the story quite succinctly. Even in the face of a steady decline in the consensus Sensex earnings per share (EPS) in 2015, retail inflows into mutual funds remained robust — notably achieving its one-year peak in June 2015, after a significant decline of close to 10 per cent in the consensus EPS in the previous 12 months! Illogical? Yes, but since when has logic really dictated retail investor behaviour?
It’s no wonder then, that small investors in mutual funds tend to burn their fingers often by selling low and buying high; only to tread the same treacherous path time and again until they either run out of investible capital or their risk appetites dwindle to the point where only risk free, fixed income securities appear suitable for them. In short, ignoring the ‘sine qua non’ of equity market investing (buy low and sell high) costs them dearly.
The mutual fund industry has been grappling with this issue for quite some time now. Fund managers are constrained to invest their equity fund corpuses into the stock markets, even if indicators are pointing to the markets possibly being grossly overvalued.
Asset management companies (AMC) are also afflicted by the reverse phenomenon of maximum redemption requests coming through after markets have taken a drubbing, often forcing them to liquidate their carefully chosen stock picks at rock bottom valuations, when most long term investors would be rubbing their hands in glee at the prospect of the upcoming ‘bottom fishing’ party.
The broad industry-wide charge to promote SIPs (systematic investment plans) as a more efficient long-term means of taking an exposure to equities is a definite step forward in the right direction. It is estimated that the monthly industry-wide SIP inflow now stands at Rs 3,500 crore across 1 crore live SIP folios, up nearly 40 per cent from a year ago.
SIPs are excellent for retail investors who are looking to channelize their monthly surpluses towards their long-term financial objectives — but what about investors who are looking to deploy lump sums of available money for a medium- to long-term timeframe? Dynamic Asset Allocation funds provide an elegant solution.
Having accepted that their fund flows will most certainly be subject to the vagaries of retail investor behaviour, some forward thinking AMCs are effecting a subtle shift of focus to a category of mutual funds known as Dynamic Asset Allocation Funds. It’s not a new hypothesis that asset allocation is one of the key determinants of long-term risk-adjusted performance – several studies over the years have corroborated this fact.
“Since markets are cyclical in nature, Dynamic Asset Allocation Funds give the investor an opportunity to take an exposure to an asset class on a risk adjusted basis,” advises Nimesh Shah, MD and CEO, ICICI Prudential AMC.
Put in simple terms, Dynamic Asset Allocation funds utilise proprietary strategies to arrive at an accurate estimate of where stock markets stand as on date, valuation-wise. Post this evaluation, this data is plugged into a model which determines just how much of the portfolio should be in equity assets and how much in debt. In order words, Dynamic Asset Allocation funds follow a “top down” approach; first determining the optimal asset allocation, and then proceeding to pick the best securities within these asset classes.
“Lump sum investments into dynamic asset allocation funds like ICICI Prudential Balanced Advantage Fund is where the impact could be reasonable, due to the asset allocation feature”, says Shah.
Dynamic Asset Allocation funds serve two critical purposes. One, they take the steering wheel away from the hands of more mercurial retail investors; thereby saving them from their own behavioral traps. Two, they allow retail investors to “shut and forget” their investments without really having to worry about timing their entries and exits.
“Dynamic Asset Allocation funds are suitable for investors who appreciate that they must invest in equity, but can’t digest volatility and are prone to reacting,” says Aashish P. Somaiyaa, Managing Director, Motilal Oswal AMC.
All Dynamic Asset Allocation funds do not follow the exact same approach to rebalancing. Some schemes utilise fairly simple, widely available data such as the NIFTY P/E (price to earnings ratio) or yield gap. Others use their own proprietary models, such ICICI Prudential Balanced Advantage Fund, which uses an in-house model to rebalance its portfolio on a daily basis. Similarly, Motilal Oswal Asset Management Company, which has recently launched a New Fund Offer in this space called Motilal Oswal MOSt Focused Dynamic Equity Fund, relies on “MOVI” (Motilal Oswal Value Index).
“At the time of writing this, the MOVI is around 109, and that suggests a 55:45 split in favour of equities,” says Somaiyaa.
Although Dynamic Asset Allocation funds are designed to cut back on their equity exposures as stocks progressively become expensive, the fact that they are essentially 50-70 per cent equity oriented renders them unsuitable for those who are strictly risk averse.
aniruddha@businessworld.in
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