Category Archives: The Daulat Blog

Every investor must have come across the term “India VIX”, but what does it mean? India VIX stands for India Volatility Index. Before going into the details of this index, we must understand what market volatility even means and the risks associated with it. 

Volatility is an investment terminology that describes periods of unpredictable movements in the securities market. These sharp price movements are not necessarily associated with the decline in prices; there might also be sudden price rises.

In statistical terms, volatility can be described as the standard deviation of a market over a given period. If the price fluctuates significantly in a short period, the market is supposed to be highly volatile. If the price remains relatively stable, it is said to be less volatile.

But what causes these fluctuations?

There can be a plethora of reasons; some of them are:

1. Government decisions on trade and legislation.
2. Economic reports, including inflation data, quarterly GDP, consumer spending figures, etc.
3. Industry-specific factors like a weather event in a major oil-producing region can increase international oil prices.
4. Positive or negative company performance.

While volatility might seem scary initially, it is a normal part of long-term investing. By accepting volatility as an inevitable part of investing, investors can be better prepared and more likely to react rationally.

What exactly is India VIX? 

India VIX or India Volatility Index is a volatile index used to measure the anticipation of volatility in the near term, i.e., 30 days. In India, the index was first introduced by NSE in 2003 to help investors better understand the market before making their next investment or to keep track of their existing investments.

India VIX is nothing like the price index. 

It is imperative to understand that India VIX is not similar to price indices like the NIFTY FIFTY in any way. While the price indices are calculated by considering the price movement of the underlying equities, the volatile index is determined by considering the order book of the underlying index options and is represented in percentage form.

How is the value for India VIX derived?

The value of India VIX is derived using the Black & Scholes (B&S) Model. It is an equation used widely to price option contracts and requires five input variables: the strike price of an option, the current stock price, the time to expiration, the risk-free rate, and the volatility. Bid-ask spreads of NIFTY futures contracts traded on the NSE’s F&O segment are used to calculate the India VIX. Volatility is directly proportional to the India VIX level; hence a higher index level indicates greater volatility.

For example, a VIX value of 17 for India indicates that over the next 30 days, traders anticipate a 17% increase in volatility. That is, during the next 30 days, investors expect the NIFTY to fluctuate between +17 and -17 per cent from its current value.

Further, historical patterns imply an inverse relationship between NIFTY and India VIX. When the India VIX index drops, the NIFTY tends to increase, and vice-versa.

The theoretical value of the VIX fluctuates between 15 and 35. Low volatility would be indicated by a reading of 15 or less, while a reading of 35 or more would indicate high volatility.

What elements are considered while calculating the India Volatility Index? 

The volatility index, or India VIX, is calculated by taking into account four key factors: time to expiration, interest rates, forward index level and bid-ask. Let us discuss in the following points:

1. Time of Expiration – To attain the level of precision demanded by the traders, the time to expiry is computed in minutes instead of taking days.
2. Interest Rates – When calculating the risk-free interest rate for the respective expiration months of the NIFTY options contract, the applicable 30-to-90-day tenure rate is considered.
3. Forward Index Level – The forward index level determines the out-of-the-money options contract that is considered when computing the volatility index. It also determines the at-the-money strike, which aids in choosing the said options contract.
4. Bid-Ask – The ATM strike price, accessible at a little lower level than the forward index level, serves as the strike price for the NIFTY option contract. India VIX is calculated by taking into account the bid and ask prices for the options contracts.

How to utilize India VIX? 

1. The VIX accurately measures market risk for stock traders. It shows intraday and short-term stock traders whether market volatility is rising or falling. They can adjust their strategy accordingly.
2. Long-term investors also benefit from VIX. Short-term volatility rarely bothers long-term investors. Institutional investors and proprietary desks have risk and MTM loss limits. They can hedge with puts when the VIX rises to play the market both ways.
3. Options traders can leverage VIX too. Volatility usually determines option purchases. Options buyers win more when volatility rises. Option sellers will benefit from time value waste as the VIX falls.
4. VIX accurately gauges index movement. Since VIX’s debut, VIX and NIFTY have had a negative association. This knowledge is helpful for index trades.
5. Portfolio and mutual fund managers utilize VIX regularly. They can increase their exposure to high beta equities when the VIX peaks and low beta stocks when it bottoms.

India VIX has most definitely proven to be a dependable tool to asses market volatility and is helping alleviate the fears of investors and stock traders.

PMS vs Mutual Funds — This is a topic that confuses a lot of people. It can be challenging to decide which of the two to choose. Mutual funds and Portfolio Management Services (PMS) are both professionally managed investments where the portfolio is managed by a licensed fund manager. They assist investors in achieving their financial objectives and give them access to the capital markets (equities or debt). What makes the two different, then? The latter is open to everyone, but the former is only available to wealthy investors. Read on to learn more about PMS vs Mutual Funds.

What is a PMS?

A professional fund manager maintains your portfolio as part of a wealth management service called portfolio management service (PMS). Your money is invested in equities and securities by the fund manager following extensive market research. They either make independent investment decisions, obtain your approval prior to each transaction, or offer advice services but need you to carry out the transactions yourself. They offer their services in exchange for a fee, which is typically a cut of the earnings or a portion of the investment. The portfolio is also tailored by the fund manager based on your financial objectives, level of risk tolerance, and length of the investment.

What are Mutual Funds?

Investments known as mutual funds pool the capital of multiple investors and make stock and security purchases in accordance with the fund’s aim. Investors have no input in any decisions a fund manager makes about a portfolio because they are all taken independently. Prior to selecting the assets for the portfolio, they do in-depth market research and charge the clients a nominal fee. Mutual funds must disclose information on a daily and monthly basis and are controlled by the Association of Mutual Funds in India. Investors can choose from a variety of mutual funds on the market based on their financial objectives, the time horizon for investing, and the level of risk tolerance.

Advantages of a PMS

• Professional management: In PMS, your portfolio is managed by an accomplished fund manager. They know how to handle a portfolio in various market situations and effectively manage your investments to boost returns over time.
• Portfolio customization: Fund managers alter the portfolio in accordance with your objectives, degrees of risk tolerance, the time horizon for investments, and age. Before deciding on the securities for your portfolio, they will take all of this into account.
• Transparency: As a PMS fund investor, you have access to full details on every transaction. Additionally, you don’t need to wait for the fund house to provide reports on a monthly, quarterly, or semi-annual basis to know the state of the portfolio and its holdings.
• Regular monitoring: The fund management will keep a close eye on your portfolio’s performance. They will instantly change the portfolio if they discover any deviations.

Advantages of Mutual Funds

• Low entry threshold: You need only 500 rupees to begin investing in mutual funds. You don’t need to invest a lot of money in them.
• A variety of investment methods: You can use a systematic investing plan to make one-time or recurring investments in mutual funds (SIP). You can select one of the two alternatives based on your needs.
• Transparency: The fund house is obligated to routinely disclose the portfolio holdings, expense ratio, and net asset value (NAV). Your investments will be transparent as a result.
• Diversification: By investing in a single mutual fund, you can access a wide range of equities and assets. This makes sure that the various securities in your portfolio are well-diversified.
• Professional management: It is used when managing mutual funds. They are well-versed in their disciplines, have a wealth of expertise, and know how to manage a portfolio in various market conditions.

PMS vs Mutual Funds: The differences

The following are the key distinctions on pms vs mutual funds:

Investment amount

While the minimum ticket size for PMS is Rs. 50 lakhs, the minimum investment amount for mutual funds is Rs. 500 through SIP. Therefore, unlike PMS funds, mutual funds are readily available to all investors.

Fees

Investors in mutual funds are subject to a predetermined fee that is deducted from the fund’s net asset value (NAV). There are no taxes due by investors on specific transactions.

In contrast, PMS employs a hybrid structure where it charges a fixed price and also takes a portion of the earnings. It also charges a performance-based fee by taking a cut of the profits.

Professional leadership

In mutual funds, which are professionally managed investments, a knowledgeable fund manager chooses the stocks and other securities for the portfolio after conducting extensive market research. Investors have no influence over the portfolio, and the managers choose the stocks based on their assessment.

Before making any investments in PMS funds, the fund manager consults the investor. Sometimes they operate autonomously and decide everything related to investing only after receiving investor consent. The majority of the time, investors must, however, approve every transaction.

Flexibility in the portfolio

Despite severe market conditions, mutual funds are required by law to maintain their equity and debt asset allocations. For instance, a fund can only be considered an equity fund if 65% of its assets are allocated to stocks. The fund manager cannot reduce the equity asset allocation in a volatile market to sustain performance.

Depending on the state of the market, the fund manager may alter the asset allocation in PMS funds.

Individualized portfolio

An investor’s needs cannot be accommodated by a mutual fund portfolio. This is such that personalization is not possible when there are several investors in a mutual fund, which pools money from a number of investors.

According to the investor’s objectives, level of risk tolerance, age, investment horizon, and available resources, the fund management tailors the portfolio in PMS funds.

Transparency

All information pertaining to mutual funds must be published on a regular basis. Thus, before investing in a fund, investors can examine its returns, costs, and portfolio.

The fund’s information in PMS is not accessible to the general public. All information about the fund and its transactions is only visible to the investor. As a result, it can be challenging for investors to contrast two PMS funds before selecting one.

Taxation

Investors in mutual funds only pay tax on their investments when they redeem them. Depending on whether the gain is long-term or short-term, the tax is applied.

Investors must pay tax on each purchase and sale of stocks when investing in PMS funds, though.

Documentation

Mutual funds are well-liked investment options that might be bought with no paperwork from the fund corporation or any site that provides them. However, because there is so much documentation required, investing in PMS funds is far more difficult. The procedure of creating a PMS account takes time as well.

Conclusion

You can invest in stocks through mutual funds as well as PMS funds. However, it’s crucial to choose which one best suits you at what time. If you have limited resources are getting started with investing for the first time and want the convenience to invest regularly, mutual funds can be the ideal option for you. If you have complicated financial needs and at least Rs 50 lakhs, you can consider a PMS. However, always consider the tax implications of both options and choose the one that best meets your goals, wants, budget, and requirements based on the advantages and differences listed above on pms vs mutual funds.

The world is full of uncertainties. No one knew that COVID-19 would disrupt our lives and create a “new normal”. Many of us were unprepared for a global pandemic that led to many problems ranging from job losses to health emergencies. To be well prepared for any such unexpected occurrences in the future, it is essential to have an emergency fund.

So, what exactly is an emergency fund? 

Emergency funds refer to a corpus of funds set aside for unanticipated financial shortfalls. They are kept explicitly for crises and must not be used for routine tasks.

But why do you need an emergency fund? 

Primarily, having an emergency fund increases your financial security. People often do not have money preserved for unfortunate times, and when bad luck rings their doorbell, they must rely on external debt or other savings like the retirement fund to keep themselves afloat. The need for emergency funds can arise anytime in the form of car repairs, home repairs, medical bills, or loss of income. The requirement may be big or small, but it is always recommended to have liquid funds available for emergencies.

The peace of mind that comes with knowing that you have a certain amount of money put aside to deal with unplanned emergencies is priceless.

The next big question is how much you should put in your emergency fund. 

The short answer is it varies. It depends on several factors, including your income, expenses, way of living, pre-existing debts, etc. Maybe for someone living alone, 3 months’ worth of expenses could be sufficient for an emergency fund, but for someone who is the family’s sole breadwinner, they might have to save 6 months or more of their expenses.

How to calculate the fund requirement? 

A good safety net is to keep at least 6 months’ worth of your expenses in the emergency fund. For that, first, make a list of all your necessary expenses in a month. This requires you to distinguish between extravagant expenses and essentials. Here is a reference list:

What necessary monthly expenditure includes:

1. Rents, bills, and debt payments
2. Food
3. Medicine costs
4. Transportation costs
5. Savings or employee pension contributions
6. Money given to dependents

What necessary monthly expenditure does not include:

1. Vacations
2. Expensive clothes, electronics, bags, etc.

Once you have a clear idea about your total monthly expenses, you can multiply it by 6 (or whatever number of months you choose) to determine your emergency fund target amount.

How to build your emergency fund? 

Once you have determined the amount you want to set aside for emergencies, you need to plan how you’ll save that much because there’s a good chance that you do not have that amount readily available. You can use the following formula as a guide towards efficient savings:

For example – Suppose your Emergency Fund Target is Rs. 1,80,000, and the amount you already have towards the target is Rs. 60,000. You aim to get the emergency fund ready in 6 months. This means the amount that you will need to save per month = (1,80,000 – 60,000)/6 = 1,20,000/6 = Rs. 20,000.

The most confusing part of this process is where to keep the emergency funds. 

As discussed previously, the foremost requirement from an emergency fund is liquidity. So, should you keep the entire amount in your cash or bank account? No, you would want to earn decent returns on your funds, but you would also like to be careful of market volatility and its risks. Thus, the ideal thing would be to spread this money across liquid funds, short-term Recurring Deposits (RDs) and debt mutual funds.

For example – Suppose you have successfully accumulated Rs. 1,80,000 as stated above. Now, you may decide to keep Rs. 30,000 in cash at home and Rs. 50,000 in your savings bank account and invest the remaining Rs. 1,00,000 in a liquid mutual fund.

What are liquid funds? 

A liquid fund is a class of debt funds that invests in debt instruments with a maturity of less than 91 days. These are high-rate papers which are not affected by fluctuations in interest rates. Hence, they successfully earn decent returns without being volatile.

The final question we will address is how to redeem these funds in emergencies and what to do after the emergency fund has been used. 

Most liquid funds allow instant redemption of up to Rs. 50,000 or 90% of the invested amount. Thus, you can redeem the money whenever needed, and it will be directly credited to your linked bank account. Make sure to check whether the facility of instant redemption is available before investing in any fund.

Once you have utilized the firm for an emergency, it is time to restart the process of fund accumulation all over again. Obviously, this will require you to make certain lifestyle changes to accommodate those extra savings, but till now, you would have realized that it is totally worth it. Emergencies do not occur with an invitation, so it is necessary always to be prepared.

If you need any help setting up your emergency fund or are confused about where to invest, you can contact us at Daulat because we are always here for you!

Retirement is the second inning of a person’s life, and the idea of a significant change like it might seem daunting to some people, especially when it comes to managing money. If you do not know how much you need to save for retirement, a good initiation point can be referring to the 4% retirement rule.

The roots of the 4% rule lie in the historical data of stock and bond returns from 1926 to 1976, covering 50 years. Until the 1990s, many believed that the 5% rule was more effective; however, real-life experiences led people to think that 4% was sufficient. Thus, to resolve this issue, William Bengen, a financial advisor, conducted extensive research in 1994 covering returns from 1930 to 1970, including periods of serious economic downfalls. He concluded that the 4% rule is ideal even in recessionary times and can provide funds to retirees for up to 30 years.

So, what exactly does the 4% retirement rule say? 

The idea is that retirees can withdraw 4% of their investments in the first year of their retirement. Then in the subsequent years, they can increase this amount by adjusting for inflation. This rule typically applies to an investment portfolio consisting of 50% stock and 50% debt.

We must remember that the ideal withdrawal amount also hugely depends on the retiree’s life expectancy. It also depends on the environment you live in and the future inflationary trends. Also, this rule assumes that the person is retiring at age 65, so if someone plans to retire earlier or later, their financial plan changes.

How to implement the 4% rule?

The investment portfolio, once you reach your retirement age, looks very different from when you were young and just getting started. Ideally, you should have a majority of your investments in debt with a small allocation towards low-cost passive index funds. Such an asset allocation provides an optimal balance between capital growth and protection. For e.g. you can have approximately 70-80% of your portfolio in debt mutual funds with the balance in equity. This ensures that you are able to steadily withdraw the 4% out of the growth of the debt fund without dipping into your capital.

Pros 

1. The rule is fairly simple to follow.
2. It provides the retiree with a predictable income stream.
3. It prevents retirees from running out of money post-retirement, thus providing protection.

Cons

1. There exists a need to comply with the rule strictly. Moreover, the response to lifestyle changes is negligible.
2. In the current market conditions of 2023, there is soaring inflation and low yields on equity and bonds compared to when this rule was formulated.
3. It is outdated and does not guarantee protection in the long term.

Tweaks to the 4% Retirement Rule

This rule should not be written in stone and may just be a beginning guideline for financial planners and retirees. Sometimes it can be too rigid, and thus, there is a need to include a degree of flexibility. With changing times, there emerge changing needs and varying market conditions; thus, the withdrawal plan should be failproof to these changes.

Debates over the 4% rule have been going on for decades. While some financial planners believe that the 4% rule is too conservative and it should be increased to 5%, others believe that it is too liberal and may lead to running out of savings quickly, thus suggesting a reduction to 3.3%. There is no correct answer, so another plausible solution is to revisit the withdrawal rate yearly.

Nonetheless, the 4% rule is a good start to estimate how much money you require after retirement. But how? 

Make a list of all the essential costs, including:

1. Annual medicine costs
2. Rent or mortgage
3. Annual grocery costs
4. Annual transportation and travel costs
5. Health emergencies and long-term care costs

Of course, this list is not exhaustive and varies individually, but these categories apply to almost everyone. It is also recommended to consult professional financial planners and advisors who can help you navigate saving schemes and investments. You can reach out to experts at Daulat because we are always here for you!

Multi Asset Allocation Funds are back in fashion. Fund managers are busily recommending these schemes to their investors who want to proceed cautiously in this turbulent market. Many mutual fund advisors are also promoting these schemes saying they can offer better returns than debt and other available schemes. Reflecting the newfound enthusiasm for multi asset schemes, these schemes also attracted whopping inflows in December.

What are Multi Asset Allocation Funds

A combination of asset classes that are used as an investment is known as Multi Asset Allocation Mutual Funds. Multi asset allocation funds invest in three asset classes- equity, debt and one more asset class like gold, real estate etc. These are hybrid schemes that are mandated to have a minimum of 10% in each of the three asset classes. The distribution of assets and their composition tends to vary depending on an individual investor and stick to a particular pattern once decided.

Why should one invest in these?

The recent couple of years has witnessed magnified volatility with regard to the financial markets in India. Apart from the pandemic, Russia’s invasion of Ukraine, the steep rise in crude oil prices, the weakening of the Indian rupee and the second wave of COVID-19 could be seen as a few contributors to this market upheaval. Many financial experts are of the opinion that this intense market volatility, especially in the equity markets may continue for a considerable time period. With such times of uncertainty looming over the horizon, it may seem to increase their allocation to fixed income securities. However, the bull run of 2020 and 2021 provided a good opportunity to reduce fixed-income allocation and increase their exposyre to equities. It is there prudent for investors to spread their investments across multiple asset classes. This is where it might make sense to opt for a multi asset investment owing to the market volatility.

Choosing this type of scheme could help investors get the required exposure to multiple asset classes such as equity, debt, gold and so on. So, in case one of the asset classes faces a downward trend, there are other asset classes that might help an investor with capital protection and more or less stable returns over time.

Taxation

Multi asset mutual funds usually do not follow a strict allocation between equity and fixed income. These funds change their allocation dynamically on several factors, like the market condition, etc. Here we take the annual average of the monthly average allocations to equity to derive whether at least 65 per cent of the fund is invested in equities or not. They are then taxed accordingly.

Equity-oriented funds are taxed just like any other equity fund. If they are held for more than one year, it qualifies as a long-term capital gain. But if the gain is above Rs 1 lakh, it is taxed at the rate of 10 per cent. If the holding period is one year or less, it is termed a short-term capital gain and is taxed at the rate of 15 per cent.

In the non-equity-oriented fund, the holding period is less than three years, the gain is termed a short-term capital gain and is added to the income and it is taxed as per the investor’s income slab. But if the holding period is more than three years, it is counted as a long-term capital gain and is taxable at 20 per cent after indexation.

Ideal Investors

Fund managers and mutual fund advisors agree that this product is best suited for those investors who do not or can not manage their asset allocation mix. Investors starting with a small amount and seeking diversification in one product can start with these funds. Additionally, it ensures a steady flow of income for the investors even at a time when some asset classes are underperforming than usual.

However, an informed investor or someone with help of a financial planner or an investor with a decent-sized portfolio should look at diversifying according to her risk profile and investment strategy.

Periodic Rebalancing

Rebalancing a portfolio is quite important to ensure that investments are well-distributed in those asset classes that are generating more returns than others. Usually, multi asset allocation Mutual Funds come with the option of automatic portfolio rebalancing that helps investors in all sorts of ways. Since the market tends to be a volatile place, rebalancing portfolios and reallocating assets is the key to tide through the ups and downs.

Bottom Line

Even though the multi asset allocation fund has not been through a full market cycle, significant returns can be earned in a short period. Investors with experience in asset allocation and portfolio rebalancing may be able to earn the full benefit from such funds.

In this blog post, we will talk about the 7 investing lessons for 2023. But before that, let’s quickly recap what happened in the markets over the past 3 years.

2020 – 2021 was a dream run for investors; interest rates were at an all-time low, employment was high and the stock market was booming. However, things began to change in 2022 with an unprecedented geopolitical crisis. With persistently high inflation, central banks all across the world started to rapidly increase interest rates causing both the equity and bond markets to fall drastically.

As we enter 2023, we observe ever-increasing interest rates, inflation, shortage of raw materials, geopolitical crisis, and global economic instability. The present investing environment needs to be treated with caution.

Here are 8 investing lessons that you should be aware of for a more informed investing journey

7 investing lessons:

1. Diversify your Portfolio

Diversification is the process of spreading your investments across different asset classes to reduce your portfolio’s overall risk profile. These different assets work together in a manner that ensures that they are not affected similarly by the same event. E.g. The COVID-19 crash of March 2020 led to huge losses in the equity/bond markets but was a good time to invest in Gold due to its perceived value as a haven during turbulent times. Investing randomly in many asset classes will not lead to diversification. Portfolio construction is a systematic and disciplined process which must be done correctly to reap the full benefits of diversification.

2. Utilize Tax Strategies

Use tax strategies to your advantage by combining investments and tax savings. For instance, you can save up to INR 46,800 in taxes by making use of the deduction u/s 80C of the Income Tax Act. Investing in ELSS funds is a great way to both save on taxes and earn long-term returns.

3. Research before buying

The ace investor Warren Buffet states, “Risk comes from not knowing what you’re doing.” Before making any investments, research the potential risks. Due diligence should be done to determine whether the investment is a good fit for your portfolio or not.

4. Have a high margin of safety

The difference between an investor’s purchase price for a company and its real or fundamental value is known as the margin of safety. Investments with a market price below their intrinsic value are given priority. Therefore, the difference between the investment’s actual value and market price increases with the size of the margin of safety. A higher margin of safety has the main advantage of reducing the investor’s overall risk.

5. Know your risks

Understanding the risks involved with each type of investment and how they might impact your portfolio is crucial. You can choose your assets more wisely if you know the risks. Another risk is receiving wrong advice from supposedly influential people. As a result, one should seek financial advice from SEBI-registered professionals rather than from people on social media.

6. Start early and invest for the long-term

Think about the long-term trajectory when making investments. The power of compounding is greatest the earlier you start. Instead of focusing on short-term price fluctuations, strive for fundamental long-term growth. An investor’s best friend is time, so get started early and benefit from cumulative returns for long-term gains.

7. Focus on what you understand.

Investors must always fully understand an asset class before they decide to invest in it. Not knowing it will expose them to unintended risks which they may not be fully capable of taking. For e.g. A lot of youngsters got attracted to Crypto over the last few years without understanding its nature and how it functions. As a result, the steep crash in 2022 caused a lot of them to re-evaluate their exposure to this asset class. Just because something is done by everyone around you doesn’t mean it’s relevant to you. Understand before investing.

FAQs

1. Why is it important to know these 7 investing lessons?

It is said that history doesn’t repeat itself but it often rhymes. The same is true for investing in the markets. We should learn from what has occurred in the past so that we do not make the same mistakes again.

2. How can we apply these 7 investing lessons to our own investing journey?

By making yourself well aware of these important investing lessons, you will be able to invest more confidently for your future. Most importantly, you will invest based on your own risk appetite and in things that you completely understand.

3. What to invest in right now?

This depends on your risk appetite and your time horizon. If you want to invest for the short-term i.e 1-3 years, then invest approximately 70-80% of your money in bond/debt funds with the balance 20-30% invested in 2-3 diversified equity funds. However, if you want to invest for the long-term i.e 5-7 years, then allocate a majority of your money to domestic and international mutual funds with the balance 15-20% invested in debt.

A mutual fund scheme that adjusts its asset allocations (equity or debt) based on current market conditions and trends is known as a dynamic asset allocation fund or balanced advantage fund. These funds employ an asset allocation strategy where they tweak the investments in securities depending on the conditions of the market. Dynamic mutual funds act as a shield against downswings in the market and they usually lose substantially less amount of money during a time when the markets are down. Hence, these funds are believed to be an ideal investment avenue in the volatile market that seems to be on a bull run.

Purpose of Dynamic asset allocation

It is perhaps the best and most well-suited investment vehicle in an irregular market. As opposed to static allocation funds, the dynamic funding mechanism is a better option because the investments are widely spread out and can be altered as and when needed.

A dynamic asset allocation perspective means that whenever an investment class is underperforming, the money can be shifted to other assets that stand to gain the most from the given market conditions.

The built-in dynamic nature of these funds is their primary advantage. It is a mechanism to beat off the market slumps and adapt according to the situation.

The balanced funding option is highly recommended for those who are looking for assured returns after the end of their tenure. It is also a valuable asset to those who have limited funds to invest in multiple sectors. Above all, dynamic asset allocation Mutual Funds are preferred for their steady and recurring returns.

Dynamic Asset Allocation funds vs Balanced mutual funds

Many investors tend to confuse dynamic asset allocation or balanced advantage funds with balanced hybrid funds which also invest in a combination of debt and equity securities. However, both of these funds differ in many aspects and the differences are as follows :

• A balanced hybrid fund invests in a mix of debt and equity securities where the proportion is usually 35% in debt and 65% in equity. In a dynamic fund, the exposure to equity and debt can go up to 100%, depending on how the market plays out.
• Unlike balanced hybrid funds, dynamic asset allocation funds can switch their asset allocation which aids in riding out the market volatility and can minimize losses.
• Dynamic asset allocation funds are much more flexible as they can juggle between asset classes as compared to balanced funds which have a fixed asset allocation ratio with which they have to invest capital.
• Balanced hybrid funds carry a relatively higher risk than dynamic asset allocation funds.

Taxability

Since these funds usually have an average equity exposure of 65% or more, they are taxed as equity mutual funds. This means that while short-term (less than 1 year) gains are taxed at 15%, long-term gains (investments sold after 1 year) are taxed at a mere 10%. More importantly, only long-term gains in excess of Rs. 1 lakh are taxed at a rate of 10%. Thus, if you sell your investment in 2 years and make a profit of Rs 1,10,000, you would only pay 10% tax on Rs 10,000.

Extremely safe in nature

One of the best things about this fund is the way in which these investments are designed. Equity investments are made based on the fund manager’s equity outlook and other pre-determined investment criteria and analysis. Thus, when markets are going up, the equity investments increase so that you can reap the maximum benefit of rising equity prices and make huge gains. Now, if the markets start falling, the fund manager has the ability to pare down the equity investments in the portfolio and start buying debt investments. This way, the portfolio downside is very well-protected and you don’t need to worry about finding the right time to invest in equity markets.

Focuses on Asset Allocation

The main reason for the success of this fund is its focus on asset allocation as an investor you don’t know which asset class is going to perform better in the coming years. Having an asset-allocation-defined portfolio ensures that the fund manager can oscillate between different asset classes. The below table makes it amply clear that different asset classes outperform in different years. For e.g. Gold beat equity and debt over the past 2 years due to the volatility in the markets.  Hence, having a mix of multiple asset classes in your investment portfolio is essential. As a result, there can be a considerable variation in the number of returns by two different asset classes in the same year.

Investors have historically had the option of allocating their money between active and passive management strategies when investing in public markets. A broad-based, cap-weighted, passive exposure to stocks, bonds, or commodities is available at a low cost (total expense ratio), or you can choose from several active managers at a greater price who offer a variety of styles, strategies, and market segments. After the introduction of smart beta funds in 2003, this changed.

The meaning of Smart Beta Funds 

Similar to passive investments like standard exchange-traded funds (ETFs) and index funds, smart beta funds—also known as strategic-beta funds or factor-based funds—track the benchmark indexes. The distinction is that smart-beta funds choose equities using factors rather than weighting assets according to market capitalization.

What is a Smart Beta Strategy?

Smart beta funds choose their underlying investments based on a variety of criteria, including low volatility (lower variation in price movement), momentum (following the trend), quality (buying businesses with sustainable earnings and little or no debt), size (smaller businesses), dividend growth, share buyback, cash flow, book value, etc. Given that value plays a significant role in smart beta strategies, even though everything sounds exotic, we can trace this so-called factor investing back to Benjamin Graham.

The goal is to raise the return offered by traditionally constructed stock indices based on market capitalization. It tries to introduce active rule-based management while eliminating the role of emotions in choosing investments. These tactics are sought after by investors looking to outperform the market.

How do smart beta funds work?

Smart beta funds purchase an index like the Sensex, but money is distributed among the index’s stocks according to the abovementioned factors.

These investment funds vary in how they base their decisions—some are driven by just one element, while others by two or more. The latter are frequently known as multi-factor funds. Before being implemented in the real world for investment purposes, the index built on these parameters is back-tested for return. Given the pitifully low-interest rates in the developed world, investors have been paying close attention to a smart beta fund focused on dividend yield.

Smart Beta funds in India

Due to increased flows from the National Pension Fund (NPF) and Employee’s Provident Funds (EPF), which have been using ETFs to direct their funds in stocks, passive investing has gained popularity among investors over the past three years. According to data from the Association of Mutual Funds of India (AMFI), as of the end of August 2020, passive funds, including exchange-traded funds (ETFs) and index funds, had assets under management (AUM) of 2.19 lakh crores and had received inflows of INR 70,773 crores during the previous year.

The main determining factor for smart beta funds in India is style. Taking the value-based smart-beta funds as an example. Over the past year, these value-based Smart beta ETFs have beaten their large-cap counterparts by an average of more than 2.5%. Despite having the same benchmark index, tracking mistakes, liquidity issues, and various expense ratios can cause smart beta ETF returns to diverge.

Issues with Smart Beta Funds

• The trading volumes in these smart-beta funds may be low because this investing approach is still relatively new, which impacts liquidity and, in turn, the ability of investors to sell their portfolios at the current market value.
• While investing in these complex investment vehicles, investors must consider several factors. Investors may need clarification as a result of this.
• Smart beta ETFs are more expensive, hazardous, and prone to protracted periods of underperformance than conventional ETFs. Additionally, they have a higher cost of rebalancing, expense ratio, and portfolio turnover.

Should you make a smart beta fund investment?

As indicated above, these funds weigh equities according to objective variables rather than the market cap. In essence, these are made to outperform the benchmark while maintaining costs below those of actively managed alternatives.

Smart-beta funds can diversify your entire portfolio and reduce some of the stock market’s volatility. An investor must realize that a fund ceases to be passive if it departs from the market capitalization theory.

In addition, compared to conventional ETFs and index funds, they are more expensive and frequently display a prolonged period of underperformance. Investors who are considering investing in these funds should exercise care.

Market participants who participate in actively managed funds may designate a limited portion of their investable surplus to this category.

Conclusion

Smart beta is just a marketing term. There is no smart beta or dumb beta. In contrast to the Nifty 50, market capitalization-weighted, smart beta funds are nothing more than factor funds or funds with alternatively weighted indexes. Factor fund performance in real-time may vary from index performance. Factors can be very cyclical and underperform index funds or simple diversified funds for decades. The importance of factor diversity is a key issue to consider if you wish to invest in factor funds. It is extremely dangerous to base investments on a factor’s prior performance.