WF: Conventional wisdom suggests that staying invested over a market cycle is a great way to create long term wealth. Your data seems to suggest that a regular profit booking and re-balancing discipline may actually generate substantially more wealth. Can you please explain this?
Naren: While it is true that staying invested over a market cycle creates wealth over the longer term, from the below data it is evident that a general tendency of Indian investors is to invest in equity when the markets are surging high, while pull out money when the markets are underperforming- which may not necessarily lead to a good investment experience. Also, more often than not, in times of market volatility, some investors either stay put or panic-sell their investments.
This lack of confidence could arise out of their lack of understanding of equity as an asset class. It is apt to mention here that equity is a suitable investment avenue for long term wealth creation. One should ride the short-term volatility with patience with an aim to benefit from the potential capital appreciation in the long-term.
To eliminate this psychological barrier while investing, it may be a prudent strategy for investors to add funds in asset allocation funds in their portfolio. Such funds allow "Buying low and selling high" while keeping human emotions aside. They invest in equities, when markets are cheap and book profits when markets are high, completely reverse of what retail investors normally tend to do.
WF: Why do you believe a Price/Book Value model is a better model to use for asset allocation over the more popular P/E model?
Naren: Price-to-book value ratio (P/BV) which is calculated by dividing the stock price to its book value per share, is less volatile as compared to price to earnings ratio, and the reason we switched to P/BV model is because 2008 showed us that markets could be very volatile. As markets went up in 2007, earnings went up and when markets fell in 2008, so did earnings; earnings turned out to be very pro-cyclical. In general we have observed that Book value being a balance sheet item, is more reliable than Earning Ratio to gauge the intrinsic value of a company.
WF: How has your model shifted allocations between equity and debt over the last 5 years and how has this actually helped deliver superior risk adjusted returns?
Naren: ICICI Prudential Balanced Advantage Fund and ICICI Prudential Dynamic Plan are being run on P/BV Model since 2010. This has helped the funds to consistently outperform their benchmark index and deliver reasonable alpha over the last five years.
Essentially, the model eliminates human emotion and decision making with its model; and, the rebalancing strategy helps the fund achieve the goal of buying equity at low valuations and selling at high valuations.
WF: There is a belief that model based asset allocation products do better in range bound markets but tend to underperform in bull markets. Is this a valid comment?
Naren: Such funds usually tend to do well across market cycles when one holds for the long term. In a bull market, it has the potential to reasonably capture the upside, while in a falling market, it could have less downside as compared to market.
WF: Which are the products that use the P/BV model and how do you define suitability of each product?
Naren: It is important for an investor to understand investment risk profile based on which one could decide the asset allocation (i.e. how much of one's wealth should be invested in which asset class). At ICICI Prudential AMC, suitable investment solutions in this category are - ICICI Prudential Equity Income Fund, ICICI Prudential Balanced Advantage Fund, & ICICI Prudential Dynamic Plan.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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