Monday, June 27, 2016

Asset allocation funds - reduce volatility without compromising on the returns

Is it possible to reduce volatility of the scheme NAV without reducing the fund returns? Read my article in Mid-day Gujarati edition today ....

http://epaper.gujaratimidday.com//epaperpdf/gmd/27062016/27062016-md-gm-17.pdf

The English translation is as under:

“Stock markets likely to be volatile next week” – we often see such headlines in the newspapers or similar stories on the television. Volatility, though natural for the stock market, scares majority of investors. In order to reduce the volatility without compromising much on the potential upside, the mutual fund houses have innovated. First they came up with hybrid products. We covered two types of hybrid products – the more popular ones – Balanced Funds and Monthly Income Plans in our earlier articles. Due to the allocation in debt as well as equity, these funds exhibit lower volatility. However, the scheme returns may be lower than equity funds, especially during a secular bull market.
Today, we will discuss about some other strategies adopted by certain fund houses. Such strategies allocate money between equity and debt assets, but change the allocation based on certain parameters.
First of all, let us spend some time on understanding one important principle related to investments. If you combine two or more asset categories, which may be individually risky (volatile) but each one may partly cancel the volatility of the other. Thus, the portfolio would exhibit lower volatility.
This is where the fund houses came up with schemes that invest both in equity as well as debt. Both these asset categories exhibit different price movements at different points of time and in turn partly cancel out each other’s volatility.
Let us say, we start with allocating 50% in each equity and debt. After some time, if the equity market has run up, the percentage allocation to equity would be more than 50%. In such a case, the portfolio must be rebalanced to the original levels, i.e. 50% in each asset class. On the other hand, if the equity market is down, the allocation would be higher than 50% in debt. This time, one would have to sell debt and buy equity.
In either case, one is buying the asset priced lower by selling the one that has appreciated and hence is priced high. This is the classic “buy low, sell high” strategy in action. Now, a fund with static allocation between equity and debt would be achieving this through rebalancing on a regular basis.
The balanced funds and MIPs have delivered reasonably good performance over the years. Rebalancing, as explained above, has played a good role in that performance. Through reduction in volatility, the funds have been able to deliver performance that was average of the two categories.
Now comes the next question. Is it possible to do better than that? That is where funds have launched schemes that do not stick to a desired percentage allocation, but change the allocation based on some formula. This formula depends on the valuation of one or both the asset classes.
Some of the schemes in the market use equity valuation parameters like Price-to-Earnings ratio, or Price-to-Book Value ratio, or a combination of both. One of the schemes uses Price-to-Earnings ratio for equity while simultaneously comparing it with the yield on 10-year Government Securities.
These funds have lived up to the promise – lowering the volatility without reducing the returns too much.
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.




Saturday, June 25, 2016

33 years ago, on this day, we made history ...

Exactly 33 years ago, around this time, many Indians were quite nervous. This was their date with destiny and the meeting was scheduled in the afternoon at the Mecca of cricket, the Lords cricket ground. The occasion was the final of the 3rd Prudential World Cup of cricket. It was a final match between the minnows - the Indian team - Kapil's devils and the mighty superpower of cricket and the title holders West Indies led by Clive Lloyd. While reaching the finals was unthinkable for the Indians, what they were about to face was a wounded lion. India had beaten WI once in the tournament on the road to the finals. Incidentally, just before the world cup, Indians were visiting the Caribbean Islands and had defeated them in a ODI match at the Indians' favourite venue the Port of Spain.

In the finals, the Indians were to bat first and could put up a paltry 183 all out on board. West Indies required to score 184 in 60 overs match to retain the trophy.

What happened afterwards, is HISTORY.

Well, here is an article I wrote in 2011 quoting the significance of this win. How such a match help us understand the concepts of personal finance. Click here to read the story.

Monday, June 13, 2016

Questions regarding mutual funds - answered during the chat session today on www.moneycontrol.com

Click on the link below to read the transcript of my chat today on Moneycontrol.

http://www.moneycontrol.com/news/mgmtinterviews/chats/detail_new.php?chatid=2667

It is important to understand the nature of investment and the risks associated before thinking of taxation

The other day I received a query from someone. This person was advised to invest his money in fixed income funds since the money was needed in around two years’ time. He wanted a second opinion.

His question was: “Should I not look at equity funds since the returns on fixed income funds would be taxable, whereas capital gains on equity funds after a holding period of one year would be exempt from long term capital gains tax. Similarly, I can also opt for dividend option, too as dividends are also tax-free.”
Here is my article published in Mid-day Gujarati today


The English translation is as under:

Should you invest in equity funds since these are more tax-efficient?
The other day I received a query from someone. This person was advised to invest his money in fixed income funds since the money was needed in around two years’ time. He wanted a second opinion.
His question was: “Should I not look at equity funds since the returns on fixed income funds would be taxable, whereas capital gains on equity funds after a holding period of one year would be exempt from long term capital gains tax. Similarly, I can also opt for dividend option, too as dividends are also tax-free.”
He quoted an oft repeated line “It is not what you make, it is how much you take home after taxes that counts”.
He was also convinced that equity funds have potential to offer higher returns that fixed income funds.
This combination of potential higher returns coupled with lower (zero, in this case) tax makes equity funds appear far superior to fixed income funds.
Both the arguments in favour of equity funds are right – potential for higher returns and that the tax-efficiency is far superior. What is missing here is the risk involved. The risk is very high that even a well managed and well diversified portfolio of equity shares may lose value periodically. Though such drops in value may be temporary, they do exist and sometime for long periods of time.
It is this risk that should be considered first before worrying about paying taxes. Many investors make this mistake of looking at the taxation first. This results in highly tax-efficient but sometimes highly risky portfolios. It is not just in case of equity, we have seen this fascination towards saving tax in many other areas of personal finance. However, we shall restrict our discussion in this article only to the question we started with.
While equity funds have the potential for providing higher returns than fixed income funds, such a statement is more likely to be true if the holding periods are long. The price fluctuations in the short term would render the fund vulnerable. One is likely to experience a highly volatile NAV in case of an equity fund as compared to a fixed income fund.
These fluctuations may result into a situation that the value of investments could be lower when one needs money. Our investor had a need for taking money out of investments in around two years.
To answer the investor above, what he was advised was the correct investment option. With a two year investment horizon, it is prudent to invest in fixed income funds. To put it another way, it would be too risky to consider investing in equity funds if the investment horizon is two years.
Consider the nature of investment first – the risk involved before you look at the taxes.if the value of the portfolio is down at the time of redemption, there would be no taxed, anyway. It is often better to pay taxes on investment income than to see a situation when the investment loses money.
Use equity funds for your long term needs and fixed income funds if the need is short term in nature.
-        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.



Sunday, June 5, 2016

Concentration v/s Diversification : What to choose? - from the archives

Whether to follow the adage "Do not put all your eggs in one basket" or "Put all your eggs in one basket and watch the basket carefully" depends on your strengths or the lack of the same in the respective areas and this is especially true in case of investments. Amit Trivedi explains why


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