WHAT TO INVEST IN A BOOM AND IN DECLINES

I have been watching the NAV movements of open ended equity schemes, balanced schemes and monthly income schemes for the past two years. During the period from 17.01.2008 to 7.03.2009, popular equity schemes fell by 48 – 66 per cent and balanced funds by 39 – 45 per cent. Monthly Income Plans have hardly seen a 6 – 10 per cent fall. So, am I correct in concluding that in a booming market, you should go for equity or balanced funds and in difficult times, switch to MIPs to protect capital? Is such an inference / strategy warranted by analysis for longer periods?

Your observations are right. There has been a wide divergence in performance between equity funds, balanced funds and monthly income plans over this period, mainly due to their differing allocation to stocks. While equity funds typically have over 85 per cent of the portfolio invested in stocks, balanced funds have 60-75 per cent and monthly income plans less than 15 per cent, with the balance in debt instruments.

But you should also note that while a lower exposure to stocks helped balanced funds and MIPs in the falling markets of last year, you will find the situation exactly reversed in 2009. Over the last six months, equity funds have gained 53 per cent, while balanced funds have gained 38 per cent. MIPs are far behind with a 9.5 per cent return.

Theoretically, it would be ideal for investors to have a high allocation to stocks and equity funds in a bull market, and cut it to near zero (holding cash or liquid funds) when the market is in a downturn, thus protecting capital.

But this strategy is quite difficult to practise, as this will require you to correctly predict both a bull market and a downturn ahead of the event. The events of last year have proved that practically no one was able to tell us in advance that the Sensex would peak in January 2008. Similarly no one was sure in early March this year that it would recover to this extent.

Investors who sold equity funds during last year’s fall will, in fact, tell you that they completely missed the rally since March, as they failed to re-invest this money when the Sensex bottomed at 8000 levels. Getting out of equity funds after a fall has started; and trying to get in after the market has gained, may lead to wrongly timed moves, which can further destroy wealth.

This is the key reason why experts advocate that maintaining a steady asset allocation: a predetermined mix between equity, debt and other avenues, is the best way to ensure that your portfolio is not too affected by the swings of the equity market. Once you try and maintain a fixed allocation between equity funds and debt options in your portfolio, you will automatically sell when markets are high and buy when they are low, to re-balance your portfolio.

In order to avoid the worst of equity market losses, it is necessary to maintain a diversified portfolio, without an unduly high equity exposure. Balanced funds are a good option for investors who are comfortable with an over 60 per cent equity exposure.

Gold ETFs can be a good diversifier, as they may perform when equity funds don’t. But we wouldn’t recommend MIPs as an option to investors looking for a “safe” component to their portfolio. Bank term deposits, the small savings schemes and liquid funds (if liquidity and not returns, are your priority) are the best places to park the “safe” portion of your portfolio. Park only that portion of your money in equity funds that you don’t require over the next five years.