/How to shift between debt & equity to ride volatility, avoid emotional bias

How to shift between debt & equity to ride volatility, avoid emotional bias

By Radhika Gupta

Ask any investor about the things she would like to filter out of her investments, and it won’t be a surprise if volatility tops the list in her answers. Often touted as the bugbear of investments, volatility can make even the most seasoned investor unnerved and reckless.

Unfortunately, while volatility is not easy to handle, it’s also a reality of the investment world that cannot be eliminated, but only embraced and navigated.

Volatility stems from various factors. To be honest, most of them are beyond one’s control. Having said that, a successful investor is the one who, instead of trying to predict volatility, prepares his portfolio in a manner that can withstand volatility, if not benefit from it.

There are several ways to achieve this practically, but balanced advantage funds (BAFs) stand out among the rest because of several advantages they bring to the table.

What is a balanced advantage fund?
BAF is a category of mutual funds that dynamically manages equity levels based on a pre-determined model as per market condition. Holding equity and debt, BAFs shift allocation between the two based on a specific model depending on various parameters. Typically, these models tend to use either trend or valuation-based metrics.

In a trend-based model, equity exposure is cut sharply during a market fall to protect the gains, while a valuation-based model holds lower equity at peak valuations.

Whatever approach is followed, the dynamic management of equity exposure enhances gains during a bull run and cuts losses during sharp downslides. To put it otherwise, it adds to investors’ wealth when the market is performing well, i.e., rising, and prevents a dip in the corpus when is nosedives.

This dynamic strategy of BAF is akin to a game of kabaddi, where teams frequently adopt aggressive and defensive ploys to score points and avoid getting ‘out’. When a raider finds opponent players surrounding him and see thin chances of survival, he retreats. On the other hand, when there’s the slightest of opportunities, he makes an aggressive move to score points.

Switching between these two modes judiciously ensures safety and helps one get the points required for victory. This art, deployed by BAFs, can help in rebalance a portfolio and maintain an equilibrium between risk and reward.

Other Benefits
BAF’s dynamic asset allocation strategy helps an investor gain across market cycles. However, the benefits aren’t limited to this. BAF also mitigates the risk of emotions clouding ones judgement.

An emotion-driven investment strategy more often than not results in failure, and is a roadblock to financial independence. Investors adopting this strategy often fail to see the big picture and end up getting caught off guard, especially when they lose large amounts of money.

During volatile times in particular, investors display their worst behaviours like exiting an investment, thereby converting notional losses into actual ones, or adopt herd mentality and get into investments that everyone else may be chasing.

It has also been found that due to prevailing volatility, investors end up investing at peaks and suffering losses. Such sour experience often turns them away from equities, an asset class that holds the potential to generate inflation-beating returns in the long run.

The automatic and dynamic asset allocation strategy in BAFs can act as a hedge against such emotions and ensure that an investor remains invested across market cycles.

Summing it up
Calendar 2020 has shown once again how unpredictable markets can be. When they crashed in March after coronavirus was declared a pandemic by the World Health Organization, even the most optimistic investor wouldn’t have expected them to gain lost ground so early.

As the race towards the elusive vaccine continues and as we adapt to several ‘new normals’, markets will be on tenterhooks in the coming days. Investing in BAFs in such times can help one ride these choppy waters, bring discipline into investments, and help them in the very important objective of staying invested!

(Radhika Gupta is the MD & CEO of Edelweiss Asset Management (EAML). The views expressed above are her own.)

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