The Mutual Fund Show | Static Or Dynamic Asset Allocation: What Works Better?

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The Mutual Fund Show | Static Or Dynamic Asset Allocation: What Works Better?

Asset allocation is a key element of investing. But what's better—static allocation funds that retain the portfolio mix or the ones that actively alter allocation based on relevant trends?

An investor spends too much time or focus on trying to “time the market”, which yields less than 2%, while ignoring asset allocation that constitutes more than 90% of investors’ returns, according to Swarup Mohanty, chief executive officer at Mirae Asset Investment Managers. It’s impossible to predict which asset class will outperform as winners keep on rotating; so asset allocation remains the middle way to give equity-linked returns with much lower volatility, he said on BloombergQuint’s weekly special series The Mutual Fund Show.

And since volatility is the only trend in equity market, static allocation funds—that allocate a pre-decided percentage to different asset classes—will work better across time periods, and are the better way to invest, Mohanty said. Aggressive hybrid funds, which are balanced funds that invest primarily in stocks with some allocation to fixed deposit-like instruments, have done better than dynamic asset allocation funds.

Salonee Sanghvi, founder of My Wealth Guide, a financial planning advisory, however, differs. While she acknowledged the importance of asset allocation, Sanghvi prefers dynamic asset allocation funds—that make alterations in the proportion of assets based on market fluctuations.

For a new investor, stability of the performance would matter more than the return, she said on the same show. Instead of an investor taking the risk of an aggressive hybrid fund, they are better off segregating the equity and the debt portfolio themselves, and investing in pure-play equity funds and pure-play debt funds separately, Sanghvi said.

On BFSI funds, Sanghvi said that since most large caps and flexi caps already have 30-40% exposure to financial services, in line with the broader index, a separate BFSI fund is not necessary. But for aggressive investors, a BFSI fund could form a part of their satellite portfolio, she said.

On debt funds of less than six months, Sanghvi said safety of capital and liquidity is of prime importance, advising investors to look at money market funds that are expected to yield 4-4.5% with a portfolio of largely A1+ rated and treasury bills.

Watch the full interview here:

Read the edited excerpts from the interview:

Swarup, tell us where you are on the static versus dynamic asset allocation argument?

SWARUP MOHANTY: On the argument, not only me but my fund house stands very clear, being invested to your asset allocation always is a superior strategy. Looking at the market and trying to time the market never works in the long run. There is enough study and enough results which say that as long as you stick to your asset allocation and do a review and rebalance periodically, and that review and rebalance has to be very thorough and uniform across the timeframe, then the results are dramatically higher than any market timer.

I’m very clear that static allocation is a superior tool. Now, yes, it’s boring, so it may not appeal to many people, dynamic has the a side of knowing about tomorrow and today, but in the fields of investing more often than not, you’re always caught on the wrong side because the market is dynamic and the market is definitely smarter than you.

How do you recommend people go about doing this? What people should ideally do if they’ve taken the decision to invest—like fill it, shut it, forget it, is that the principle that you’re advocating right now from a mutual fund investor’s perspective?

SWARUP MOHANTY: When you invest and especially when you’re investing across asset classes, it’s a very simple planner role that you allocate a certain percentage to a certain asset class because typically the assets are cyclical, they have their own play, so it’s better to be invested across asset classes. So, suppose, just for simplicity, let’s take debt and equity as two asset classes and I have decided that I’ll be 60-40 or say, 70-30. Now I follow that 70-30 rule as my benchmark and suppose I do a yearly rebalance. So, at the end of every year, I see where that 70 stands, suppose it’s gone up to 75, I’ll rebalance it back to 70. That is how static allocation works across asset classes. On the other hand, dynamic asset allocation might look at other factors in the market or the changing dynamics on the market and reflect on the asset allocation. Some take the P/E, P/B route. If the P/E is expensive, then they would cut asset class or take various other routes. Some follow the cyclical way if the market goes high, they increase that equity portion and when it falls, they cut their portion. Some just remain tactical at their own whim and they allocate differently, but the simpler and more powerful way, according to us, and that’s why we are a fully invested fund always, for us 2-3% cash in an equity fund is a lot of cash, irrespective of market cycles. I mean it’s very interesting that if you look at the overall market this time, post the comeback in April, it is per se that the entire market was fully invested that it caught the entire J-curve of the market. If you reflect on the same situation in 2008-2009, a lot of funds went into cash because that’s what is supposed to be done when the markets fall down but, on the rebound, a lot of funds did not catch it. So, a fully-invested strategy as per your asset allocation in the long run has its own merits.

I concur with you on one part which is that nobody can time the bottom. I doubt many people caught 7,500 on the Nifty in March, but just a quick follow up there. You are basing this not just on the theory that you guys have within the fund, but I think there is some study or research you’ve done, and I was wondering to get from you the data as well wherein you’re saying that actually aggressive hybrid strategy has worked better than dynamic asset allocation?

SWARUP MOHANTY: Data has to be historic and I’m quoting historic data. You take this data one year, two years, three years or three-year rolling for that matter, in all circumstances as on date of course, the aggressive hybrid would outperform the dynamic asset allocation plans. Yes, one can debate that when market falls, the dynamic asset allocation typically outperforms the static allocation but in a falling market anyway you’re not making money. You invest to make money, right? So, when the markets normalise and I would say a three-year rolling return is a very interesting timeframe, check that data and you be the judge.

Salonee, tell us a bit about how long have you been doing this and what is your view on this?

SALONEE SANGHVI: I have been in the financial services industry for over 16 years in various roles including equity analysis. I was working with Rakesh Jhunjhunwala for eight years and that is when I realised that there’s a huge gap here in terms of solid unbiased advice and then I decided that wealth management is the space where I want to be. I agree with Swarup that obviously your asset allocation is very important and it’s decided based on the risk profile of the investor. But I would also add in one more feature which is also your duration to goals. For example, if someone has an aggressive risk profile but their goal is in the next three years, then they should not be probably investing 60, 70 or 80% in equity. So ideally, I recommend it as well that you kind of break your debt and equity investment instead of having one fund. So, have two funds or more to that view but in reality, what happens is, a lot of people, especially new investors don’t follow asset allocation. So, for them, obviously an asset allocation fund can be a good introduction to equity, and also because they lack discipline to rebalance a portfolio as and when needed because of various circumstances.

So, I feel asset allocation funds are great for new investors that are entering the market. That being said, I prefer dynamic asset allocation funds because what happens is, in equity, for me the most important principle is protecting the downside. If you can protect the downside, then the upside takes care of itself which is why I like trend following dynamic funds which kind of protect your downside but then also give you a large portion of the upside as well.

But Salonee, if we look at one year, two years, three years, five years and seven-year and even 10-year timeframes, aggressive hybrid has actually outperformed dynamic asset allocation in all of these. Data seems to not be supporting dynamic asset allocation in absolute return terms.

SALONEE SANGHVI: I agree with you because obviously, aggressive hybrid fund has almost 75% in equity. So, over a longer term because equity outperforms it will outperform. I would ideally recommend a dynamic asset allocation fund to somebody who has a more balanced or moderate risk profile. So, not for someone who has an aggressive risk profile because for that person, a higher proportion of equity is obviously more recommended.

Dynamic asset allocation funds would have anywhere from 30 to 70% ideally in equity depending on the market conditions. This is more suited for someone with a balanced risk profile versus someone with an aggressive risk profile.

Swarup, let’s work with an assumption with what Salonee is saying that on a relative basis, aggressive hybrid is more suitable for aggressive investors versus a balanced or dynamic asset allocation, and the skeptic would argue that if indeed the investor is aggressive enough, why even go for an aggressive hybrid fund which has got both of these? Over a 10-year timeframe we anyway know that equities outperform by a wide margin, at least history shows that, so why don’t give pure play to a 100% equity fund?

SWARUP MOHANTY: There is merit to that story if you can do a 75-35 on your own, you should actually go and do that on your own but there’s a lot of truth in what Salonee says. It’s very difficult to implement on your own. So probably, that’s why people say, okay, dynamic asset allocation is a better way of doing it. There’s two three points which I’d like to point out. When you come to a static allocation, you know what you’re getting. You’re getting a 75-25 story or a 70-30 story you already know. In a dynamic asset allocation, you don’t know. It can go up to 80% equity also, you don’t know. The other part which I’d like to point out is that when you look at asset allocation through a fund, a fund is a pool of investors sharing the common financial goal. That is the goal of the fund, all the people in the fund have to concur to that one goal and my asset allocation might be very different. So, when it comes to using dynamic asset allocation for individual asset allocation, then whatever is the asset allocation of the underlying fund, it is because of my asset allocation. That is a given. So, while the characteristics of the fund are in its own place but why I only think about dynamic versus static is, when you get into the fund you know very well that you’re getting this asset allocation but, in the dynamic, it can go anywhere.

Just a quick follow up there. That will be true for some other pure play equity category as well, right? To an extent, I mean the deviations may not be as severe as this but I’m presuming and please correct me if I’m wrong but, in a flexi,-cap fund as well, there would some degrees of changes that would happen within the market cap that the fund manager would exercise, right? Flexi-cap funds are doing very well I think it’s in some of your schemes as well if I’m not wrong, you guys have done really well and people have been advocating Nilesh’s funds. So, the same argument holds true there too, right?

SWARUP MOHANTY: Again, I bring to the table that yes, theoretically, it is possible but if you look at the difference between the large cap and now the flexi-cap, which was the erstwhile multi cap, is that large-cap funds by mandate now to have 80% in large caps. Flexi-cap on an average have 75% they don’t go to that so called cash component, it never happens in the industry and as the size grows, it is impossible to do that kind of churn anymore, let’s face that fact also. So, when these are large funds, these are possible when they are small 500-700,000 crore funds that can be fleet footed. It is very difficult to execute those strategies at larger sizes. So, one has to keep that in mind when you look at that proverbial statement that yes, flexi-caps can change but do they change as per the data which I’d like? That’s why we don’t have two funds, because essentially what it would mean is giving the same portfolio in two funds and taking two cheques from the same investor. So, we have refrained from that, and we’ve stuck to one fund in both the categories, this was before the categorisation.

Salonee, if we look at it from perspective of a first-time investor, then the arguments can be sliced and diced in multiple ways, and your answer will be right, Swarup’s answers would be right and if God forbid, if I have an answer even that would be right. So, from the perspective of somebody who’s not necessarily a newbie, has spent some time, wants to invest in the market, but also as normal asset allocation should be there wants some bit of debt in the portfolio. Why would the strategy that Swarup is advocating, not be better than dynamic asset allocation? Not for a first-time investor, not for a new investor or somebody who is reasonably seasoned?

SALONEE SANGHVI: Actually, I think the strategy that Swarup has mentioned would be correct for that person because obviously the person knows a little bit about investing, about equity and about the market so they’re also able to handle the volatility that comes along with it. Also at that stage, they would have a better idea of what their risk-taking abilities are as well because, a lot of people initially say I can take the risk, but the when the markets fall 30-40%, they actually can’t. So, someone who’s a slightly more seasoned investor would have a better indication of that. So, for somebody like that, I think what Swarup mentioned is exactly the correct strategy to follow.

Swarup, how can one take advantage of the amazing data that you’ve given, the points that you’ve spoken about right now, if they want to use Mirae as a house, what is the offering from your stable that you believe somebody can invest in and what kind of investor should take that up?

SWARUP MOHANTY: Obviously, here I’m talking about my aggressive hybrid fund. It’s completed five years of track record and we’re quite satisfied with the track record across the horizon because it saw a fair bit of market traction in these five years. It’s beaten the benchmark throughout and that’s the strategy I’m talking about. Interestingly it hovers between 70 and 77% of equity. Above 75% of equity we normally rebalance that, that’s been the track record so far but interestingly Salonee, I would really request you not to compare my fund but please compare the standard deviation of Crisil’s 35-65 hybrid index which is what this category is about versus the Nifty 50 on volatility. It is a very low volatile fund. Now, what’s happened in the industry is very different from what the reality is. The story of the dynamic asset allocation has taken a very big step and actually the story of aggressive hybrid took a back step because some of these were sold on monthly dividends, which was a mis-sell but standalone if you take out these two, man to man, for a person looking at good returns over a period of three to five years, this is a good fund and a good category but like Salonee said, different people have different objectives and we can both be different and still be right.

Salonee, have you by any chance analysed the Mirae offering on the category that Swarup was speaking about or any other offering within this category and what is your view on the same?

SALONEE SANGHVI: I have not explored in detail the funds on the aggressive hybrid category because in general, as I said, if someone has the expertise, they can look at delineating the two funds and have a separate equity fund and a separate debt fund because there are some fantastic standalone equity funds. It also gives you more flexibility in terms of even the market size. So, whether you want to be in large mid or small-cap, it gives you more flexibility to manage your asset allocation in that sense as well. So usually this is not a category if I were to recommend to somebody that I would. That being said, if someone is looking at a DIY approach to investing or as a newbie investor then definitely that’s the category that they can take a look at.

But you firmly believe that for an investor if she or he is willing to take an exposure to an aggressive hybrid category then might as well do it herself or himself by alienating the two and taking equity exposure directly and taking the debt exposure directly?

SALONEE SANGHVI: Yes, that is what I would believe.

Since we are talking about equity and some debt, and since we are somewhere around the middle of the year Salonee and for people who want to put in some bit of money to work from a six-month perspective so to say, in the debt category, what is the ideal category to invest in and why?

SALONEE SANGHVI: I think if you see in the current scenario what is happening is, most banks have been revising fixed deposit interest rates downwards. HDFC also recently just cut rates and there’s a penalty or a lower interest rate which is valid when there’s a premature withdrawal.

So, for anyone who is looking to invest for less than six months, safety and liquidity is of prime importance, for this I would recommend money market funds, which are expected to return about 4-4.5% and the portfolio is largely A1+.

That's the highest rated short-term debt that there is, and treasury bills which is obviously issued by the government so it's extremely safe. In money market, in terms of taxation, it is obviously taxed at the investors tax slab. I recommend in this category the Aditya Birla Money Manager Fund, it is among the largest fund in the category and has been delivering better returns versus the other funds in the category. This is not just over a one-year period, but this is over a prolonged period, even if you were to take a three-year, five-year horizon or look at rolling returns. It has delivered 4.6% in the last year and over 7% over a three-to-five-year horizon. So, I feel, given that for a six-month period, safety is of particular importance. It is very important to put your money in a fund where you know that your capital will be returned and more than return it would basically be return of capital versus return on capital.

Can I ask you what the return on capital is likely going to be since we don’t quite know whether the RBI will hike rates or no, but judging by where the rates are currently what’s the expected return if somebody puts in the money to work in this category or this fund that you spoke about?

SALONEE SANGHVI: In money market, people can expect for 4-4.5%. This is marginally higher than fixed deposit rates which for most banks hovers around 3.5% for a six-month period. Obviously, if they hold funds for longer than three years then they have the taxation benefit as well.

If somebody has a duration which is slightly higher than six months, it may be extended up to nine months but less than a year, then would you recommend a separate category of funds or is this good?

SALONEE SANGHVI: I would still recommend the same. There is another category of funds called ultra-short-term funds but the problem with that category is that they also invest in bonds or debentures which could be of a longer duration and given that NPAs are expected to rise over the next few months—we don’t know what is going to happen. So even if it’s a AAA rated debenture, there could be something on that front. So, I think for now given the economic situation and given the situation on the NPAs, this is the safest investment that you can make at this point.

Let’s assume the investors who are fairly aggressive and want to take advantage of the belief that the banking space may do well assuming the NPAs are all provided for, and maybe the equity markets are not giving the large banks their due and therefore these people want to invest in thematic BFSI funds. One, are you recommending such funds to your clients right now in the current juncture, based on whatever your thought process would be? And which are the funds that you believe will give the biggest bang for the buck?

SALONEE SANGHVI: Financial services, obviously is one of the most crucial industries in the success of the economy and it follows the growth pattern of any country. In India, the segment accounts for almost 30% of the Indian GDP so it’s definitely a segment that you need to have exposure to and in fact the Nifty Financial Services Index has outperformed Nifty across all timeframes specially if you were to look at a rolling three-to-five-year horizon. Now, the thing is that a lot of large-cap, flexi-cap funds already have a 30 to 40% exposure to financial services in line with the main index as well.

So, for most investors a separate Banking and Financial Services Fund would not be necessary but for aggressive investors or investors who want to take a tactical call or who believe that they want to be overweight on the segment, this could form a part of their satellite portfolio because obviously a banking and financial services fund is more concentrated and is also far more volatile than the broader index.

So, the higher return, higher risk follows. If I had to recommend a fund in the category, the fund that I like is the SBI Banking and Financial Services Fund. It has basically delivered a CAGR of 18.5% over a five-year period versus 15% for the benchmark. It is also far less volatile than the benchmark because it has a beta of only 0.9. The top five stocks mainly the banks—HDFC, ICICI, Axis, SBI, Kotak—account for 65% of the portfolio. I like this fund versus investing just in the passive ETFs in the segment because this also gives you exposure to NBFCs, insurance companies and credit card companies. I think over time we'll see more companies in the space being listed. So, those would also be added to this portfolio.

So a bit of track record, the kind of exposure that they have and the lower volatility, makes you believe that this is a good fund to invest into?


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