STP’s (Systematic Transfer Plans), when used properly, can be a great way to invest into equity mutual funds. For those who aren’t aware, an STP is nothing but a standing instruction to transfer a fixed sum of money, at fixed intervals, from one mutual fund scheme to another.
In effect, STP’s have two potential applications. One, they can be used to de-risk your portfolio systematically by transferring moneys from equities to debt in a staggered manner. Two, they can be utilized as an entry mechanism into equity funds, by transferring money from short term debt funds to equities in a phased manner. This article will exclusively focus on the latter.
The sole purpose of STP’s is to help you manage the risks associated with tempestuous equity markets, by ensuring that you do not commit a lump sum amount at a specific point in the market cycle. By staggering your money systematically into equities, you’ll be ensuring that a sudden, unexpected market fall doesn’t leave you tottering in despair, succumbing to all sorts of behavioral biases as a result.
STP’s are not a magic formula. They can, in fact, work against you in rising markets, as you’ll be starting off with a 100 per cent debt allocation and gradually building up to a 100 per cent equity allocation, missing most of the ride in the process.
STP’s, unfortunately, remain a vastly misunderstood investment mechanism. Leading the pack of STP-related misconceptions is the misguided notion that the STP duration (for instance, 2 years) needs to coincide with the actual investment duration. This is wrong.
For instance, let’s say that you’d like to invest Rs. 5 lakhs into Franklin India Bluechip Fund (FIBCF). In effect, you’ve got two options – go all out and invest the Rs. 5 lakhs as a lump sum amount, or invest Rs. 5 lakhs into a short-term debt fund by the same fund house; say, Franklin India Low Duration Fund (FILDF), and issue a standing instruction to transfer, say Rs. 21,000 per month, to FIBCF. Under this arrangement, the unit balance in FILDF will be completely exhausted in around two years, as the total corpus would have been transferred to FIBCF. Where investors go wrong is in their assumption that the investment can be redeemed at the end of the STP period (2 years), whereas in reality, the adequate holding period for any equity mutual fund is 5-7 years. This indicates that one should ideally hang on to their units of FIBCF for at least 3-5 years longer.
Put differently, an STP-led investment into equities will consist of two distinct phases: the deployment phase, and the holding phase. The key question is, how does one determine the length of each phase? Fortunately, I’m going to provide you with a simple thumb rule.
All the skepticism regarding its overt simplicity notwithstanding, the P/E (Price to Earnings Ratio) of the broad market (say, the NIFTY), remains an excellent indicator of the medium-term (24-36 month) swing that one can expect in the markets. History has proven time and again that a P/E of over 25X is a danger zone, whereas a P/E of 12X or below essentially indicates that stocks are, by and large, available at a deep discount.
For instance, the P/E of the NIFTY stands at 23X or so these days, indicating what may be termed a mild over-valuation in stocks. Some have argued for a “re-rating” for India’s P/E ratio, which essentially means that one shouldn’t feel jittery while deploying equity money even at these levels. I beg to differ; personally, I believe that a P/E re-rating isn’t quite on the cards yet - although it may be a year or so down the line, once global uncertainties smoothen, GST gets rolled out, and interest rates come down further.
Leaving the re-rating argument aside for a moment, let’s focus on a key concept. When markets are overvalued and a correction is imminent, would you want to deploy your money into equities immediately? No, because you’d want to stagger it longer to de-risk yourself. For instance, those who started a 3-year STP at the peak of the 2008 market crash would have staggered their entry into equity mutual funds beautifully, reaping handsome returns over an overall investment period of 5 years from 2008 to 2013 (2008 to 2011, deployment and 2011 to 2013, holding). Note - the P/E ratio at the peak of the bull market in 2008 was 28X. And let me add that experts were hollering “re-rating” even at the time!
Conversely, what about the situation when markets have already corrected and have sunk to the depths of cheapness – say, a 12X P/E? At such a time, STP’s make scant sense – you’d want as much of your money firmly packed into equities at those kinds of levels. Staggering your entry will just mean missed opportunities.
In light of the above logic, here’s a simple formula to self-determine the optimal structure of your STP investment using the trusty old NIFTY P/E as a yardstick:
P/E < 12X: forget STP’s and deploy the money as a lump sum – it’s going to be party time soon!
P/E 12X – 16X: 12 month STP, 48 month holding period
P/E 16X to 20X: 24 month STP, 36 month holding period
P/E 20X to 24X: 36 month STP, 24 month holding period
P/E 24X to 28X: 60 month STP, 24 month holding period (notice the increased advised holding period at these stretched valuations)
P/E > 28X: run for the hills and wait until markets correct and start making more sense!
End Note: the holding periods mentioned above are the bare minimums. When investing into equities; the longer you stay invested, the better. Additionally, as is the case with thumb rules, this is a ‘quick and dirty’ way of deciding your STP duration. There may be better decision frameworks available.
