Automatic asset allocator funds reduce risk factor

The biggest dilemma for investors is to find a fund which could possibly perform in all types of markets. But, it's almost impossible for one particular fund to always perform across the market cycles.

Equity markets for that matter debt markets normally have an alternating cycle. Equities tend to generally perform better during economic expansion or boom in general parlance while debt markets do well during contractionary phase or during economic slowdown.

But, how to spot these cycles and change the allocation accordingly.

Research suggests that of all the market strategies asset allocation forms the key.

For instance, market timing forms about 1.8 per cent of the portfolio performance while security selection where we usually devote more time and energies determines about 4.6 per cent.

Among all the other strategies of portfolio performance, the strongest determinant or variable is asset allocation which is about 91.5 per cent.

As the market gyrates between greed and fear, the investors reaction also varies i.e. their action to interact with the markets. Warren Buffet famously puts that "Be fearful when others are greedy and be greedy when others are fearful".

Unfortunately, its observed that investors often act contrary this great adage and data from the markets actually show this trend.

During the phases of high valuations and higher PE ratio (i.e. the markets are near-peak or at peaks) the overall inflows into the markets have surged and during the phases of low valuations and lower PE ratios, the outflows from the markets have peaked.

Of course, to always sell at high and invest in lows is not an easy task and to perfect it is near impossible as its very difficult to find out which is high or low.

Now we know that its prudent to move to equities during low phases of equity performance and switch to debt during higher valuation of equity, operationally its cumbersome and needs high level of dedication in terms of time and energy.

The very reason that we invest in a passive investment strategy like mutual fund (MF) is to not be bothered again on these management tactics.

To address this, ICICI Prudential has come up with a solution through ICICI Prudential Asset Allocator fund. This fund would handle the re-balancing of the portfolio all by itself when it deems fit without any operational hassles and paperwork from the investor's end.

The fund follows an in-house model which allows it to "buy low and sell high" while keeping the human emotions aside. They have an equity valuation index which is calculated by assigning equal weights to Price to Earnings (P/E), Price to Book (P/B), G-Sec PE and Market Cap to Gross Domestic Product (GDP).

This metric allows the fund house to identify if the time is ripe for partial profit booking on one extreme to other of aggressively invest in equities.

As of March 2019, the model throws result of incremental money to debt which is over the neutral stand a few months back.

To understand the metric's performance, the back tested data suggests that it has recommended to invest in equities during March 2016 while booking profits during January 2008.

The idea of the fund is to follow a simple counter cyclical model which allows them to buy low and sell high.

Going into execution of the fund, the scheme tries to capture optimum allocation of debt and equity based on the attractiveness of one asset class over the other.

This is achieved by investing in equity and debt mutual funds based on the model recommendation. The fund could allocate invested amount in either of ICICI Pru Large and Mid-cap fund or ICICI Pru All Seasons Bond Fund with allocation ranging from zero per cent to 100 per cent.

As the name suggests, equity fund is open-ended investing in large and mid-cap stocks while the debt fund is an open-ended dynamic debt scheme investing across the durations. The fund aims to achieve tactical allocation between the asset allocation ensuring smoother experience over long run.

Thus, the fund aims to generate better risk adjusted returns with an active asset allocation and diversification through regular monitoring and re-balancing.

The taxation of this fund is treated on par with debt providing indexation benefits over the long-term. The fund comes with an exit load of 1 per cent up to one year from the date of investment.

Investors with over three-year horizon could invest lumpsum to benefit more of it.

(The author is co-founder of "Wealocity", a wealth management firm and could be reached at [email protected])