The Mutual Fund Show: How To Minimise Losses During Downturns
Here’s what investors can do to protect their investments from major downside risks.
In the past nine years, the Sensex has delivered only 9.5 percent annualised return as the business cycle turned after hitting a peak in 2007-2008 before the U.S. subprime bust. An investor entering at those levels would have seen return on investments fall nearly by half since then.
While financial advisers and market experts often talk about when to invest and staying put during volatile periods, not much is said about protecting investments. Sunil Jhaveri, founder and chairman at MSJ MisterBond Pvt. Ltd., advises his clients to protect investments from major downside risks as opposed to just following the traditional ‘buy and hold’ or ‘SIP karo, bhul jao’ (invest via SIPs and forget) path to maximise returns.
Jhaveri uses a combination of price-to earnings and price-to-book ratios, among others, to read market signals. “Based on this approach, an investor can identify when the markets are in the red zone (expensive), yellow (reasonable) and green (cheap) zone, and can switch from an aggressive asset class like equity to a more conservative alternative like a dynamic equity fund or a balanced advantage fund,” he said on this week’s The Mutual Fund Show.
He cited an example:
- If a person invested Rs 1 crore lumpsum in June 2001, the value of his investment would have been 38.21 crore at the end of June 18, 2019 under the ‘buy and hold’ model.
- By comparison, the investment would have been worth more than Rs 52 crore if an alternative or exit-based strategy to cover downsides was deployed.
Watch the full show here:
Here are the edited excerpts from the interview:
Why do you believe that when everybody is talking about SIP, buy and hold, that the exit is as important?
Let me explain you from analogy of what Warren Buffet says. He is the biggest investor in equity markets. He says that the first rule is to never lose money and the second rule is to never forget the first rule. If he says that then there has to be some exit strategy in place more importantly than the entry strategy. Most investors talk about when to invest, the right time to invest; Nobody talks about when is the right time to exit. According to me, exit is more important than the entry strategy.
From your data, it is arguably evident to see that at times when Nifty has not done well, the 10-year index could have done well and vice-a-versa. This is anecdotal evidence which is obviously true. How does one make use of it?
Asset allocation does that. At the right valuation, it reduces the exposure to equity and at right valuation it increases the valuation to equity. The debt portion becomes the parking vehicle. Instead of getting wedded to an asset class which can be equity as an asset class as far as you are concerned as an investor, it is better to understand and sensitise yourself with the market signals. Market is giving us signals on a day-to-day basis.
If you divide the markets into red zone, which is an expensive zone, or no zone which is reasonable valuation zone, and then the green zone which is a cheap valuation zone. I have divided the market in three zones based on Nifty P-E and P-B which is the simplest way of doing it. I have realised over the past so many years that instead of getting into too many complicated things, if you keep it simple, your results will be much better. If somebody is crossing a signal on the zebra crossing and somebody who is moving zigzag in a car, who do you think is going to be crossing to other side safely? All probability that somebody is crossing at the zebra crossing. Investors must realise that market is giving them signals on a regular basis, but we are ignoring them.
We have been given three months by the finance industry. By and whole, do SIP, forget and do not time the market. According to me, they are counterproductive. Since 1995, when private sector mutual funds became popular, if buy and hold were working then how come the statistics say that investors in equity stay invested for not more than two-three years? Somewhere we are going wrong.
In 2008-09, when markets corrected by 60 percent, did you panic or not?
At that point of time, as every equity investor would tell you that it is very difficult to go out and time the peak. Jeremy Grantham says the time spent out of the market seeing the market move up is as painful as time in markets when markets move down.
I totally agree. But at the same time when you put certain parameters and checks and balances in place in your investment patterns; I have put my investors’ money in certain patterns. In October 2007, we got a signal saying that markets are expensive and exit. The signals were PE and PB. So, some discipline is better than no discipline. It is the starting point.
The Nifty movement or the PE ratio was higher than 19, then the way the returns are minimum average or maximum returns are startling lower than the other two times wherein it is 16-19 times or sub-16 times.
If you had invested in Nifty as an asset class, when the Nifty PE was less than 16 which I call it as a green zone, the minimum return was 10.5 percent and average return was 27 percent. When you come into yellow zone, the average return which is 16-19 PE came down to 15 percent and minimum return came down to 4 percent. In the red zone, minimum return came down to negative 1 percent over a five-year period and average return came down to 7.5 percent. Should you or should you not time the market?
Your parameters are PE and PB and historical evidence as per you say than when people exit at PE levels of 19 times
Not 19 times. My algorithm is designed differently. So, it may be higher than 19 but if 19 is showing you 7.5 and negative 1 percent, so I don’t know what 29 currently will show you.
If the trailing earnings are northwards of 19, then they typically tend to do better if you exited the equity fund and do something else.
If you exit from equity as an asset class, don’t get into debt. If you are into 100 percent equity, you exit into a dynamic equity fund or balanced advantage category in the mutual fund space. These schemes rebalance between debt and equity based on market valuation. Even if markets are extremely high, they will be maybe 30 percent in equity and if markets are extremely cheap, there will be 100 percent equity. They are doing what they are supposed to do based on market valuation. In and out, buy low, sell high regularly. If the markets remain irrational, the way they have been since July 2017 to now, last two years have been in the red zone. But in spite of that if you were in a dynamic asset allocation fund, it still delivered 8 percent return. Instead of getting into a liquid fund and debt product, once you exit out of equity component, do not get into debt because markets remain irrational for the next five years, will you, as an investor, be happy when you see Sensex and Nifty going at all time highs, not knowing that mid caps and small caps are bleeding further? Having seen that highs would you be happy staying in a liquid fund? You will not be. If you are in equity as an asset class through a dynamic/balanced advantage fund, let the markets be irrational for next 10 years. It is doing asset allocation the way it is supposed to based on the valuation.
Investors who have exposure to large cap equity schemes wherein they are more in sync with what the Nifty does, should they employ this strategy? What if investors have investments in small cap funds or mid- and small-cap fund?
There was a query which said that he had started SIPs in mid and small caps, and stopped it in September 2018. He was now a conservative investor and should he or should he not continue with SIP or switch it to large cap. My answer was that you are like a driver at the toll naka. When they see that the lane is moving very slowly, they switch lanes but in the bargain, they see their lane which they left behind. Exactly like Murphy’s law. These investors are doing the same thing. Till 2017, mid caps and small caps were doing well and so they started investing in mid caps and small caps. All of a sudden, they see carnage happening. They are asking whether to switch to large cap. Large caps are at an all-time high in terms of valuation. Tomorrow if markets correct, the large caps will start correcting first and with the sentiment, the mid cap and small caps will also correct. Nothing will be left behind when market sentiments become bad. It will be a global scenario and it could be any of the triggers which could happen and that will take the markets down because at 29 PE, how long will it be sustainable?
Does anecdotal evidence show that the returns when you move from an equity scheme to a balanced advantage fund when PE is higher than 19 as delivered higher returns across time periods? Does it work across time periods?
I have done analysis on monthly five-year rolling returns from 2003 onwards. That data shows that every five years, the buy-hold strategy versus rebalancing of equity in a conservative asset class. We are saying that get out of a aggressive asset class at extremely high valuations. You define the high valuations by yourself. Get into a conservative asset class like dynamic equity fund or balanced advantage fund or vice-a-versa. On a five-year rolling basis, this strategy has outperformed buy-hold strategy.
Lumpsum investment of Rs 1 crore in June 2001, the returns if there is only equity scheme where somebody invested Rs 1 crore and parked in an equity scheme and forgot. The number of Rs 34.49 at 21 percent CAGR is not bad. But you are saying that there can be a better number which can be achieved.
If you would have done in and out of these equity schemes and into dynamic and vice-a-versa— and this happened only five times in last 18 years— it is not happening everyday. The green zone is not available to you on a daily basis.
I want to work around investors’ behavior and bias. He becomes extremely greedy when markets are in his/her favor and they start panicking when markets are against him/her. If I were to sit on 70 percent cash and the markets are correcting, as an investor, will I not be happy that markets are correcting? All of us know the investor’s behavior of greed and fear but nobody has worked around it. At extreme high valuation, if you are converting a 100 percent equity into a 30 percent equity and then thereafter the markets correct, which investor will be happier? When I take my investor into a dynamic asset allocation fund, I tell them to pray that markets should correct because they are sitting on 70 percent cash. I want to deploy that 70 percent cash at better valuation. When markets are going down, I will start buying more and more equity for you at better valuation. At some point of time, of dynamic equity fund, I will convert that into pure equity fund as market valuations are so low. So, this happened in 2008-09 when markets corrected. It happened in 2010-12. So, these green zones are very difficult to come by.
Your study suggest that this is not only for a lump sum investor but also for an SIP investor.
From 2005-2008, we did SIP of Rs 10,000. That Rs 3.6 lakh becomes Rs 7.5 lakh in one of the cases. You said, do SIP and forget which has continued his SIP. In March 2009, his SIP value had grown to Rs 5.10 lakh and that came down crashing to Rs 3.8 lakh. After some time, that Rs 7.5 lakh which you accumulated through SIP is nothing but lump sum which needs to be protected from volatility. So, my exit strategy from SIP says that you remove that lump sum amount which you have collected over a period of time into SIP which was Rs 7.5 lakh in this case, convert that into a dynamic asset allocation fund but continue your SIP.
What will the balance advantage or dynamic asset allocation fund do? It will buy equities when valuations are cheap and sell out of equities when valuations are expensive. Something you are doing with your fund, the fund does with equities inside it.
We are doing two asset classes, pure equity and balanced advantage fund. I am switching between two asset classes.
Why are you choosing balanced advantage?
I want to be in equity as an asset class at all points of time and balanced advantage fund is in equity, an asset class, from taxation point of view and otherwise, too. The construct is, based on internal valuation of each AMC, somebody may be following PE or PB and some dividend yield model, etc. They will be doing is that when valuations becomes more and more expensive, they will start reducing equity exposure and the minimum exposure which SEBI allows in all these BAFs are 30 percent in equity. That means if the markets are extremely expensive, there will be 30 percent in equity and 70 percent in cash or cash equivalent. When the markets start correcting, they will start deploying that cash back into equity at better valuation. So, they are actually doing ‘buy low and sell high’ on a daily basis. Some may be doing it fortnightly basis or monthly basis. But this is the way balanced advantage funds work and that is actually asset allocation. Let’s assume that you want to do only asset allocation from balanced advantage fund and doing nothing else, over next 10-15 years, you will still be okay.
Staying put in BAF throughout 18 years will also not be a great idea because when the markets are at the trough and they are going to move up, you would rather be in a pure equity fund as opposed to balanced advantage fund.
That is exactly I am switching you from BAF to pure equity fund when market valuations are cheap in my strategy.
At the current point of time, did you tell your investors to get out of equity funds and park themselves into BAF?
My last trigger happened in July 2017 where I switched out from pure equity to BAF. From July 2017 o January 2018, we underperformed because markets went one way up. I can’t time the market at top or at bottom. But from July to now, mid caps have delivered 0.5 percent, small caps have delivered may be negative 10 percent, multi-caps have delivered 7-8 percent. BAF has delivered 7-8 percent. On a risk adjusted basis, we are 70 percent cash versus 100 percent equity in multi caps. So, at the current levels if the markets correct, you can imagine what will happen with these two portfolios.
But you are still comfortable holding on to BAF scheme.
Absolutely.
All your equity fund investments as of July 2017 are in BAF for your clients.
Of the respective AMCs
You are in 100 percent BAF currently.
Yes, 100 percent. I tell investors that don’t be Abhimanyu who are stuck in equity chakravyu with no exit option available to you. Start with an exit strategy first and the entries will be taken care of.