Equity markets are a confusing place. The market, which fell to its decade low three month ago, is now seeing an upward move of 40-45% from the lows. Will the Bull sustain, or will the Bears take over as we see a sharp disconnect between economy and markets is constantly on investors’ mind. More importantly, they are thinking about how do they weather the storm?
Well, volatility is never easy to handle. Unfortunately, it is also a reality of the investment world – a feature of investing, not a bug, as we say in software parlance. Good investors are those, who instead of trying to predict volatility, create volatility-proof portfolios. There are many ways to do this, but my favorite is the Balanced Advantage Fund (BAF) or Dynamic Asset Allocation Fund (DAAF).
Here are three reasons why.
One, BAFs help investors navigate volatility. These funds dynamically manage equity levels, based on a pre-decided model, thereby reducing volatility and leading to smoother investment experience. The volatility of the average BAF over the last five years has been 12.6%, compared to a Nifty volatility of 18.5%. The lower volatility helps the process of compounding. As a result, over the last 5 years, BAFs, despite holding only 50-60% equity on average, have delivered reasonable returns, compared to broader market returns, and with lesser volatility. If markets remain volatile due to the uncertainty around the pandemic and pace of economic recovery, BAFs can help investors navigate easily.
Two, we all hate losing money, much more than making it. And you should, because if you lose 20%, you need to make 25% to recover your losses. Worse is if you lose 50%, you need to earn 100% to earn back your capital. Losses are the blackhole of investing. The more you lose, the deeper you fall into the well, the harder it becomes to come out of it. BAFs help contain the size of losses.
The fund holds both equity and debt and shift between them based on a model. The model could be a
trend-based model that sharply cuts exposure during a fall, or a
valuation-based model that holds lower equity levels at peak valuations, but this dynamic management of equity exposure does protect downside. The average BAF/DAAF Category fell -13.1% in the market fall of March, compared to -23% for markets, a testament to this downside protection.
(Data is average of all BAF/DAAF returns in the month of March. Source: ACE MF. Past performance may not sustain).
Finally, BAFs help manage investor’s behavior and their biases. Multiple studies suggest that investor returns on an average is less than market returns, and the primary reason is their emotions getting better of them especially during extremes. Extremes and volatile times bring out the worst of investor behavior – redeeming at lows, investing at peaks, typical herd mentality. Investors often ask me, “why do I need a BAF to manage asset allocation, when I can do it myself”. My reply is, “Yes, you CAN, but you DON’T because your emotions dominate you.” Automated asset allocation is a hedge against emotions.
In this volatile and uncertain phase, I believe BAFs should form a core part of your portfolio, though staying invested through cycles is the most important. My single biggest learning from 2008, is that low volatility investing helps you stay invested, and in fact, I’ve been a happy BAF investor for many years.
(Radhika Gupta is the MD & CEO of Edelweiss Asset Management Limited (EAML).