The Mutual Fund Show: Can Targeted Returns Strategy Help Tide Over Market Volatility?
Vijai Mantri of JRL Money explains how strategy of targeted returns can help investors tide over volatile markets.
When it comes to investing in stocks and mutual funds, the ‘buy and hold’ strategy is regarded among the best. Yet, it isn’t perfect.
That’s because periods of market volatility can keep share prices down, dissuading even the steadfast among investors.
The strategy of targeted returns can help investors tide over this problem, Vijai Mantri, founder promoter and chief mentor JRL Money, said on this week’s episode of The Mutual Fund Show.
That can be achieved with what JRL Money calls the “safety valve approach” when one’s financial targets are met, Mantri said.
According to this approach, when returns exceed expectations of a benchmark rate in a bull market, the incremental returns are transferred to a liquid fund. And the converse holds true.
When markets fall, they pull down net asset values of mutual funds, Mantri said. And when the invested corpus drops below the targets set earlier, the shortfall is made up from the corpus in the liquid fund.
Watch the full show here:
What is a safety wall strategy or targeted return strategy? Why is it that this becomes so important from a behavioural perspective?
I think theoretically it is known as value averaging at the flip side of SIP. In our opinion, there are basically three-four ways to make money in the market. The first and best way is to ‘buy and hold’. But this strategy has its own challenges. We have seen in the past one year, three years and even five years that the mutual fund has delivered sub-optimal returns. There’s a phase and this phase comes after the market has had a huge rally—we have seen post 2008 as well as post 2000. For every four or five years, there is no return in the portfolio not even beating bank deposit.
But if you hold for a longer period of time, seven to 10 years then the probability of beating bank deposit is almost 100 percent in most mutual funds.
Investors will not digest the volatility. The data clearly suggests that when the investor sees return on the fact sheet, at that time the maximum buying happens. It’s everywhere— stocks, real estate and gold. Whenever people see immediate past returns looks great, that is the time the buying happens.
The second strategy is what you do in a ‘base of view’ base investing—where the government will do something, what kind of budget will come, who will form the government. The challenge with this kind of strategy is that sometimes you can be right, sometimes you can be wrong. Also, you can’t be more than 50 percent wrong. If you are over 50 percent wrong in business of investing then actually it’s a zero-sum game, we don’t make money.
The third strategy is to look at market fundamentals. So, look at the P/E multiple, you look at the price-book value, you look at dividend yield, you look at the yield gap, you look at GDP to market cap. Now, the challenges with all these data are that they give contradictory signals. So, today P/E multiple is telling you that the market is overvalued. Price-to-book value is telling you that the market is undervalued. Another question is what data should you take? Should you take past data or forward data?Definitely this strategy cuts the volatility—the fundamental basis of investing—but also cuts the upside return. What most investors understand very simplistically is ‘how much money am I making?’ So this is a targeted-end strategy. It is a very popular strategy, theoretically called value averaging but practically, it is very difficult to implement, and we spend close to three years figuring out how to implement it and today we are ready to implement it. So, how this strategy works is that—you do counter-intuitive thinking. Basically, most people invest when the markets are rising and take money out when the markets are falling. The best monies are made when the markets are falling, you invest and when the markets are rising you sell. But nobody can do it. It is actually easier said than done. So, we have created a structure. This structure forces investors to behaviour discipline them. This is the theme and it is the first time ever in India that this kind of a strategy perhaps is being discussed on a media platform.
So, in a targeted return strategy is where you have set a target for yourself, and and once you hit a particular target; you take some money off the table? Is that the simple way and then we’ll of course explain the strategy as well.
It’s a discussion investors should have with their financial advisers. What should be my targeted return in equities? We are right now talking only about equity and I’m talking about mutual fund. So, someone says 10 percent, someone says 12 percent someone says 14-15 percent. So, whatever is your target, you take it and what you do is you put lump sum money in a mutual fund scheme. Suppose you have invested Rs 1 crore in a mutual fund scheme and your target return is say 10 percent, so after one year, the Rs 1 crore should have become Rs 1.1 crore. But suppose at that time, but the 1 crore has become one Rs 1.3 crore, 1.4 crore. So whatever is an excess of Rs 1.1 crore, you take the excess money out. Here we have taken an index fund. So, we have assumed that someone started on Jan. 1, 2006 and that person set a target return of 10 percent. So, at the end of one year from Jan. 1 2006 to Jan. 2007, this Rs 1 crore should have become Rs 1 crore 10 lakh. The actual value is Rs 1 crore 37 lakh. The actual illustration is that, you have Rs 27 lakh excess. So, what do you do? You take out Rs 27 lakh at that time, then you drag this portfolio on monthly basis.
Let’s go step by step. You withdraw these Rs 27 lakh and you put that in a liquid fund. The reason being, liquid fund gives a slightly better return than a savings bank account.
Yes, liquid fund gives 6.5-7 percent return. But another purpose of this strategy is that, not only you take money out if the markets are rising but also when the market starts falling you dip money from the liquid fund and feed back into equity fund.
What next?
Observe it every month. So, every month since you’ve taken a 10 percent target, next month it has to grow 0.87 basis points because we are we are compounding at a monthly basis. So, next month this should have been at Rs 1,10,87,000. Your targeted money should have been there. But the Rs 1,10,00,000 (Rs 1,37,00,000, out of which you have taken Rs 27 lakh) next month has become more than Rs 1,14,00,000. So, the market has gone up say 12 percent around that time. So, what you do is, the excess—the difference between Rs 1,10,87,000 and Rs 1,14,53,000—Rs 3,65,000 you take out. Again next month, the Rs 1,10,87,000 needs to compound at 10 percent CAGR. The money should have been Rs 1,11,00,000. But next month if the market falls, the fund’s NAV would also decline. So, the value has become Rs 1, 03,00,000. Your expectation was Rs 1,11,00,000. So, what do you do at that time? Whatever money is lying in liquid fund—Rs 31,00,000—you take out Rs 8,00,000 and claw back into equities. Then you track it month-on-month. So, when the markets are rising, you take money out and when the markets are falling, you feed into equities from that liquid fund.
And the process continues?
The process continues. So, if you look at this illustration, you started with the NAV of around Rs 28 in this index fund on January 2006. After one year, the NAV may become Rs 38.48. So, you took out Rs 27 lakh, then the NAV became Rs 40. Again, you took out more money. Then, the NAV fell to Rs 37. You fed money back into equity fund, next month the NAV became Rs 39.89. Again, NAV rose you took money out. So, what does it do is that, in the rising market, if the market is rising more than your expected rate of return, you’re booking a part of the profit and feeding into a liquid fund. Whenever the markets are falling less than you targeted return, then you take money out from the liquid front and feed into equity portfolio.
How long does an investor continue doing this?
Mantri: This you can continue forever. What this study does after four-seven years is that, money at risk becomes almost zero. What it means is that, the Rs 1 crore you had invested, you have taken out the entire amount. So, the money lying in liquid fund is more than Rs 1 crore but there’s still money available in the equity scheme because you took money out when the market was booming. So, in five-seven years, the money at risk almost becomes zero.
Have you tested this performance? As to whether this strategy works better than some of the other strategies?
Mantri: As I said the ‘buy and hold’ is the best strategy but investor returns and fund returns are two dramatically different things. So, a fund may deliver very good returns but investors haven’t got those kinds of returns and the very critical part is the behaviour of investors themselves. Now, one can’t go and teach investors how to behave. So, you need to create a productive structure which takes volatility away and improves the performance for the investor. So, it does wonderfully well in most market situations.
The data that we have shows that it’s actually done better than the ‘buy and hold’ strategy because the return from the targeted strategy is at peak.
Let me explain you this. So, what we did is that, we took these market scenarios— peak, bottom of the market and the side-way market. The market peaked say in January 2008. Suppose, you started investing through this strategy, from that date till today, the IRR on equity component is close to 10 percent. The IRR on buy and hold strategy is 5.3 percent.
Then we looked at the bottom of the market. The Nifty from 6,000 came to 3,000. Suppose you started on that day in March 2009. Suppose you started a one-time investment and it delivered you 15.3 percent CAGR over the last 10 years, but provided you were able to catch mass in 2009 where there was complete negativity and everybody was giving a very bad review whether what will happen to Indian economies; people. The mutual fund numbers will tell you at that time that the mutual fund net sales numbers were almost negative. The equity component delivered 19.2 percent CAGR.
Then, we looked at January 2012 when IRR has been 14.1 percent against 13.2 for ‘buy and hold’. And when the market touched peak in August 2015 and when the Nifty closed at 9,000, from there the buy and hold delivered 8.2 percent CAGR and this strategy delivered close to 9 percent CAGR to the investor.
So why do you say buy and hold is better than this?
Buy and hold is better because there are some time periods, suppose you’re able to catch the bottom of the market, from there the Nifty has gone up five-six times. Now, in this strategy after one year suppose in March 2009, you invested Rs 1 crore in buy and hold. In one year, the market almost doubled. So, what you did is, your Rs 1 crore has almost become Rs 1.8 crore.
In buy and hold you kept Rs 1.8 crore. In this strategy, suppose your target was 15 percent, so in excess of Rs 1 crore 15 lakh, Rs 65 lakh you took and put in liquid fund. That Rs 65 lakh delivered liquid fund return, but the Rs 1.8 crore in 100 percent equity continued to grow but they also are subject to higher volatility in the portfolio. So, the right thing to look at is even in that strategy look at absolute value of the portfolio. If you look at the peak of January 2008, when we are saying this strategy delivered 10 percent CAGR, the total amount of money invested through the value of the investment is Rs 5.3 crore through the strategy and the amount principal is Rs 2 crore. Suppose you invested Rs 1 crore and after one year the market fell 50 percent, then at that time my strategy asked to pull more money out of the saving bank account or whenever it is available. So, on Rs 2 crore investment, your portfolio value is Rs 5.3 crore. In buy and hold, Rs 1 crore investment is Rs 1.82 crore. So, with this strategy you invested Rs 1 crore more, but this strategy delivered you Rs 3.5 crore more for Rs 1 crore additional investment. Rs 1 crore has become 1.82 in buy and hold. But that was the peak of the market.
Let’s see what happened at the bottom of the market. In March 2009, Rs 1 crore investment in this strategy is Rs 4.75 crore. Rs 1 crore in buy and hold is Rs 4.5 crore. If you look at other strategies, again it continues to add more value in various market conditions.
A lot of people have advised that if you have lump sum money, a systematic transfer plan is a great option. Now, let’s say people buy that argument that an STP is a good option. Can someone club this strategy? If someone wants to do an STP; how do, we compare a systematic transfer plan and then try and combine this strategy within that?
So, before that let me answer one more question. The illustration which we took right now of Rs 1 crore becoming Rs 1 crore 37 lakh; the reverse can also happen. The Rs 1 crore could have become Rs 60 lakh, Rs 50 lakh. The question people then have is that, I don’t have money at that time. So yesterday, he will ask you to put Rs 50-60 lakh money at that time. The solution to that is, if you have Rs 1 crore to invest, invest Rs 60 lakh into equity, keep Rs 40 lakh in liquid fund and then observe it. After one year, suppose 60 becomes 40, then you have money. You can plow back from the liquid fund and put it back into equity scheme. Your question on STP is very interesting. Suppose you have Rs 1 crore to invest in an index fund or any fund, so we only advise 12-month STP, 15-month STP, or 18-month STP. For our assumption, we have taken 18- month STP. So, per tranche is, Rs 5,55,000. Again, suppose you take a target of say let’s assume 15 percent CAGR you want to make. So, what does this strategy do? Now, if you look at this illustration. Jan. 1, 2008, we have started with Rs 5,55,000 STP. In normal STP, these Rs 5,55,000 remains fixed for the entire tenure of maybe 12 month or 15 month or 18 months. What this strategy does for us is that, you take 5 lakh 55,556 and then for next tranche, what it does is a very interesting thing. Suppose you have taken 15 percent CAGR as your target return. These Rs 5,55,000 next month should become Rs 5,62,000 because your we want it to grow at 15 percent CAGR but actual value of portfolio is Rs 4,67,000 because the NAV of the fund has fallen from Rs 59 to around Rs 47. This is an actual illustration. What has happened that, you started it at the NAV of 57.39. On Feb. 1, 2008, the NAV is fallen to Rs 48. So, the value from 555 has come down to 467. Now your target; your expectation was 562 but it is 467. So, the next tranche should be 555 plus the difference between these two; 562 minus 467 so you’ve added more than around Rs 95,000. So, you did a 555 tranche at the NAV of Rs 47 but when the NAV fell at Rs 48 instead of 555, you invested Rs 1 lakh more.
So, your total investment became 650?
Then again, we looked at next month, the NAV has come down to 46.84. Now, on total investment of yours, you should have expected 1,130 as the value but the value is 10.84. So, next month you invest around Rs 55-56,000 more. Same thing happened in April 2008. When in April 2008, NAV fell to Rs 42; so, in that month, you invested Rs 7,33,000. In May 2008, NAV rose back to Rs 46; so in that month, you invested less amount of money. So, even in STP instead of doing a normal STP, this structure allows you to do STP through this safety wall strategy; where if the NAV is more than your target return, you invest less and when NAV is less, then you invest more. On average, 80 percent plus of the plus time norm compared to normal STP, this STP adds anything between 0.5 percent and 1 percent additional alpha to the portfolio of investors while at the time just feeding into equity funds.
There’s a performance differential from the peak trough, trough and peak the similar thing that we did the last time and I presume you can clearly see that while the difference is not dramatic as compared to the other one, there is still a difference.
There’s a difference. We are adding 80 basis points in most cases. 80 basis points to almost 1 percent in most cases. So, in an index fund if you’re able to add that kind of value to the investor and CAGR, it’s grown from 2008. We are looking at 11 years; and in 11 years suppose I am able to add 60 basis points to 1 percent to the investor’s overall kitty, and not only do I that but at the same time, I reduce the volatility very significantly for the investor. Then, I think we have one a decent job for the investors. This strategy works even in STP. How do you use the strategy to invest? One is that, if you have a lump sum to invest, then our advice is to split it in two. If you want to feed into mid and small cap, then 60 percent should go into small cap, 40 percent should go into a liquid fund. Suppose you are putting it in a large cap fund or multi cap fund, then 70 percent should go into large and multi cap and then 30 percent should go into a liquid fund. That’s one way of doing it. The second way to participate in this structure is that, if you say, whenever you need money, I can give you money. So, then you feed into this fund straight away Rs 1 crore, wherever you want to invest. The third way to participate is that, you have lump sum money- park that lump sum money into liquid fund and then feed from liquid fund to equity fund using this strategy. On an average, 0.5 percent to 1 percent alpha will added to your overall IRR.
I heard a couple of announcements from people or a couple of conversations wherein people are being sold perpetual bonds. You have some thoughts here? People should keep in mind a few things before going out for buying into perpetual bonds.
One, it’s very interesting if the same bunch of people who sold IL&FS FD, debentures or DHFL FDs are now telling people to buy perpetual bonds and why perpetual bonds because you’ve seen challenges in the debt mutual fund, you’ve seen challenges in the corporate FDs, the bank deposit rates are coming down, so if SBI bank deposit rate is 6.5 percent, the perpetual bond is 8.5 percent, 2 percent extra return, it is a no-brainer; go and invest. So, that is a very simplistic explanation given by people. If a normal person gives this kind of information, no problem but a financial advisor talking about it is a bit...
Why are you saying that? What should people keep in mind?
Three things people need to remember. One is that, these are not bonds. These are not secured as FDs or money lying in a saving or in a current account. It is a Tier-II Capital. So, the quasi equity. Point number two, these are perpetual only from the customer’s side. Banks can call it back any time after five years in most cases—the one that one needs to keep in mind. Suppose a Rs 100 bond you bought at 105 and after you bought it, suppose within 3 months, the bank calls it back. Then, the bank will only give Rs 100, the bank will not give Rs 105. You have potential capital loss of Rs 5. The third factor people need to keep in mind is that there’s a very clear proviso in the offer document of this bond that in a year in which the organisation or bank doesn’t want to declare interest or want to pay interest for whatever financial reason, then that year interest is foregone and it is not a default. So, it is not that it will get accumulated and paid in next step. Once it is not declared, it is foregone. The fourth factor is that, in an eventuality of weakness in the financials of that organisation, then part of these bonds can be capitalised. Suppose you have invested Rs 1 crore in those bonds and suppose 20 percent of that gets capitalised, then Rs 20 lakh becomes the capital of the bank and you have only Rs 80 lakh liability. So, if you’re buying these bonds, keep this thing in mind before you plunge into it.