There are two key ingredients to successful mutual fund investing –

1. Investing in the best mutual funds, and
2. Investing according to an effective strategy that balances return and risk

This blog is geared towards the second point. We shall compare some of the most popular Investment strategies and find out which one of them wins the crown of the best mutual fund investment strategy!

For those interested in the first point – the best Mutual Funds to invest, here’s the perfect resource –

Best Mutual Funds to Invest in 2019

But to be very honest, the second ingredient has far more importance than the first which is why you should keep reading…

So how do we decide what strategies should be compared?

When we talk of an investment strategy, we don’t mean to refer to SIP. SIP is not an investment strategy it is merely a mode of investing that is, more than anything else, convenient.

An investment strategy (especially when it comes to mutual funds) should broadly focus on two pointers –

1. Asset allocation strategy – could be passive, active or somewhere in between
2. Mutual fund selection – investing the best mutual funds in the chosen asset (equity and debt)

We have shared one resource pertaining to the second point already. Here’s another one –

How to choose the best mutual funds according to the Finpeg CRAFT Framework

Let’s forget about mutual fund selection for some time. It is, in most cases, not something that will always be under your control – when investing according to a proprietary strategy of Motilal Oswal AMC – MOVI Pack Plan, they impose the funds on you. The same goes for FundsIndia’s SmartSIP.

Finpeg’s AlphaSIP doesn’t impose funds on you – merely recommends them. It is an investment strategy that works well with any diversified mutual fund!

Since point 2 has less importance and will seldom be under your control, for the sake of this blog we can make it an external factor and focus solely on the very core of the strategy – Asset Allocation. Let’s go!

One final note – The investment tenure of one cycle is 5 years in all the further discussions unless mentioned otherwise. The proxy for equity is the NIFTY50 index and the assumed returns for equity is 12% and that for debt is 6%.

Investment Goal based Passive Asset Allocation

By far the most commonly deployed investment strategy, passive asset allocation is something that you will be recommended by most advisors – sophisticated and otherwise.

Here’s how the process goes –

1. You are asked a few questions that will assess your risk appetite and identify your investment goals
2. Basis assumptions like equity will return 12% and debt will return 6%, an asset allocation is decided basis the investment amount you can spare
3. A bunch of funds are recommended in the equity and debt categories and you are asked to invest in them either one-time or at regular intervals (read SIP’s) depending up on the capital at hand
4. The investments start and are never tinkered with until the end – the investment goal achievement

A few advisors might be vigilant and recommend changes in the specific mutual fund schemes but no other aspect like rebalancing the equity and debt portions or changing the allocation to each asset shall be tinkered with.

Sounds simple but the whole idea is built on a concept called Modern Portfolio Theory whose proponent Harry Markowitz won the Nobel Prize for it.

So, there is some science and math to it but most advisors are clueless about it.

Investment Goal based Asset Allocation with Periodic Rebalancing

This approach introduces an aspect that cancels out a negative of the first approach. Here’s an example –

Let’s say you have started out with an asset allocation in the ratio of 50:50.

The markets behave perfectly normally and in one year the equity portion earns 12% and the debt portion earns 6%. A quick calculation tells us that now the portfolio has 51.3% equity component and 48.7% debt component.

Another year passes and the markets continue to behave normally. The equity component now has a weight of about 52.7% and the debt component about 47.3%.

See what happens when you have an extremely passive investment strategy? The weights of the assets in your portfolio change over time and as time passes are likely to be completely different from what you had intended them to be.

To avoid this, we can introduce the idea of rebalancing your portfolio – intervening when the assets change by x% or at regular intervals.

For example – you can take an approach that you will intervene to rebalance your portfolio when the equity component increases by 5 percentage points (which also means that the debt component has decreased by 5 percentage points) and bring it back to the intended level.

Another way you can rebalance is without caring for the increase/decrease in asset weights in the portfolio, just intervene every 6 months or 12 months and correct the asset allocation.

Here’s a table that captures the effectiveness of rebalancing – at different frequencies and different thresholds…

As we can see, this approach (no matter what the rebalancing trigger) works better than an approach that doesn’t include rebalancing at all!

Since there is practically nothing to differentiate among the rebalancing triggers, we can look at this from one other perspective – which of the rebalancing triggers has won the greatest number of times.

Here’s a pictorial representation –

As we can see S3 – Rebalancing every 6 months – is the best rebalancing trigger by far.

However, there is no concrete reasoning behind this or even any intuition. It just is and may or may not be continue to be as time passes.

Dynamic Asset Allocation

There are fund schemes based on this investment approach – a number of hybrid mutual funds!

The idea is simple – bias your portfolio toward the asset that looks more likely to perform.

Sounds simple? The execution is much harder and probably can never be perfected!

This approach requires a lot of intelligence in the development of the strategy itself and immense work on the execution tools. All this while being restricted by fund house rules like exit loads and taxation!

Here’s one aspect that can be a part of a strategy like this –

PE ratio (Price-to-earnings ratio) is a commonly used parameter when it comes to investing equity assets – direct equity or mutual funds.

A low PE ratio indicates that there is value in the equity market – so a good idea is to invest or enter equity market.

A high PE ratio indicates that the equity market is expensive – so a good idea is to stay away from equity market or exit.

This can be further verified from the chart below –

Whenever the PE ratio has breached the level of 28ish from below, it has always triggered a market correction ranging from 15% to almost 60%!

So, a 28 PE level asks us to stay cautious of the equity market. A good dynamic asset allocation strategy would bias your portfolio towards debt during such times.

Just like PE ratio, you can include a number of indicators that give you a pretty good sense of the market outlook, direction or valuation and recommend optimum asset allocation.

Dynamic or Tactical Asset Allocation is at the crux of the investment strategies we offer at Finpeg.

The Finpeg Lumpsum Strategy which introduces the concept of tactical asset allocation has comprehensively outperformed a simple lump-sum in equity mutual funds and even STP’s.

Here’s a quick shot of how the Finpeg Lumpsum Strategy has performed when directly compared with simple lump-sum –

In Conclusion…

There’s no right or wrong strategy of investing in mutual funds – choose the strategy that you are most comfortable with and which will help you sleep well at night.

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