The ‘naive’ investor wants to enter the markets when he sees equities go up.
And ‘smart’ investor believes she needs to do the opposite. So she wants to exit equities when markets go up.
Many mutual fund distributors and investment advisors recommend adjusting allocation to equity, based on parameters like Price to Earnings ratio, Marketcap to GDP ratio etc.
There are specific mutual fund schemes also run by professional fund managers where this strategy called ‘Dynamic Asset Allocation (DAA)’ is followed.
Is it a good strategy? Should you do that in your portfolio?
We reviewed the recommendations made by a large mutual fund distributor who runs a model portfolio where DAA is followed. The recommended asset allocation changed as follows depending on market PE :
And according to the changes recommended above, we back tested some data using Index fund for equities and Liquid fund for debt.
And this is what we found :
Fixed Asset Allocation –
Lumpsum – A lumpsum investment in 80% Equity Index and 20% in Liquid funds without changing asset allocation throughout the 8 year period would have given returns of 13.10%. Rs.1 lac investment would have become Rs.2.52 lacs
SIP – A Rs.10,000 SIP throughout the period without changing asset allocation would have given 11.80% returns. Rs.9.10 lac investment would have now become Rs.14.30 lacs.
Dynamic Asset Allocation
Lumpsum – A lumpsum investment changing asset allocation as per the above schedule through the 8 year period would have given returns of 13.30%. Rs.1 lac investment would have become Rs.2.53 lacs. In the process of selling and repurchasing, a tax amount of Rs.9,000/- would have become payable. Net of taxes, an investment of Rs. 1 lac would have become Rs.2.45 lacs.
SIP – A Rs.10,000 SIP as per asset allocation given in the chart above would have given 11.30% returns. Rs.9.10 lac investment would have now become Rs.14.00 lacs.
Since 2013, we have seen good markets, bad markets and average market years as well.
And through this period with almost 18 opportunities to change asset allocation, the net in hand returns for the client who invested lumpsum or through SIP has ended up being less in dynamic asset allocation options than when asset allocation is not changed.
How have Dynamic Asset Allocation Mutual Funds performed?
Frankly, not very differently…
Source : valueresearchonline.com
Why then is Dynamic Asset allocation still popular amongst advisers and investors?
- Action Bias – the tendency to take action over inaction whether or not it benefits us. It looks impressive and less embarrassing to take some action instead of just sitting there like a duck waiting for the truck to run over.
- The seduction of pessimism – ‘Optimism sounds like a sales pitch. Pessimism sounds like someone is trying to help you’ – Morgan Housel. When an adviser tells you markets are over heated, lets book some profits and stay in debt waiting for an opportunity, they sound very smart 🙂
How do you invest?
- I identify the right asset allocation based on my goals and time period and stick to it
- I change the asset allocation depending on market indicators
- I change asset allocation but stay within a range