Ever seen a lion eating grass? No right?

No lion eats grass.

Likewise, there are no equity funds that are NOT volatile (risky). All holdings are volatile. That is the nature of equity investments.

Just as a Leo can’t stop being a carnivore, so stock investing won’t stop being volatile.

You can tame a lion but still not make it eat grass. Similarly, you can use various strategies to reduce losses in the portfolio (at least in the case of back tests), but not exclude the risk of loss in equity products.

I usually come across questions about a safe or less risky stock fund. Believe me there aren’t any.

You can say that the small cap funds are volatile (risky). More volatile than large-cap funds. So if you’re looking for less risky (less volatile) equity, you’ll need to stick with large-cap or multicap funds. However, the large-cap funds are also volatile. And you can lose a lot of money if the markets correct sharply.

In fact, there are low volatility indices that include the least volatile stocks (Index Nifty 100 Low Volatility 30 and Nifty Low Volatility 50). You would expect these indices to be less volatile. Yes, low volatility indices are less volatile, but that is relative. Nifty lost 38% in March 2020. The low volatility indices lost 30%.

What about hybrid funds?

Yes, there are hybrid funds, asset allocation funds and balanced advantage funds (dynamic asset allocation funds). And such funds are marketed as a less risky alternative to equity funds. Typically marketed as “Better than FD returns, but less risky than equity funds”.

I have to say that many such funds have done well.

We discussed some popular hybrid funds and a popular balanced benefits fund and the results were positive.

However, these funds do not reduce volatility by choosing a different type of stock. Such funds simply invest less in stocks.

Let’s say large-cap stocks fall 30% in a week. One fund only invests 60% in large-cap stocks and holds the rest in government bonds. Since the fund only had 60% of the stocks it will obviously only fall 18%.

OR

These funds bring in different types of lower correlated assets (Diversification). If Indian stocks are not doing well, international stocks may be doing well. Or gold is fine. Or the other assets aren’t falling as much as Indian stocks.

Expect this to happen with Asset Allocation Funds and Hybrid Funds.

We discussed this approach to reducing portfolio losses in this post. However, even with diversification, you can only reduce the amount of cases. The drawdowns will continue to take place.

I reproduce the performance of a portfolio with a mix of Nifty, Nasdaq 100, Gold ETF and a liquid fund. Low correlations. Low drawdowns compared to Nifty 50 but significant drawdowns nonetheless. Data from March 30, 2011 to December 31, 2020 taken into account.

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Safe volatility of the portfolio of equity funds less risky diversification of equity funds international equity gold

OR

Take an active call about asset allocation. Active calls are usually managed through proprietary models. The intention is increase Exposure to stocks when markets are expected AND expected to do well reduce Exposure to stocks when markets are not expected to do well.

Here, too, such funds do not rule out the risk of loss. The ICICI Prudential Balanced Advantage Fund lost over 25% in March 2020. While the non-equity portion was less affected, the equity portion must have performed just as badly.

Maximum Drawdown ICICI Prudential Balanced Advantage Fund HDFC Hybrid Equity Fund Asset Allocation Fund

How can we reduce the volatility (risk) in the portfolio?

There are basically 3 approaches.

  1. Do not take any risks. Stick to the convenience of bank deposits, PPF, EPF, etc. This is a good approach for the very risk averse investor. Nothing wrong. Just that you may have to settle for low expected returns. Be ready to invest more.
  2. Bring in different assets with lower correlation: Bring in domestic equity, international equity, gold, fixed income securities, REITs, and more. The premise is that NOT all of the assets in the portfolio will have problems at the same time. Essentially, diversify your portfolio.
  3. Take control of a fund that manages the asset allocation for you: Balanced Advantage, Hybrid Funds, Asset Allocation Funds.

Only approach (1) completely eliminates volatility. You will never see the value of your portfolio drop by a small amount.

Approaches (2) and (3) can cause you discomfort in bad market phases. While diversification and active investment strategies can reduce volatility to some extent, they cannot eliminate volatility.

Select your asset allocation accordingly

When I structure portfolios for my investors, the choice of funds is almost the same for all types of investors.

Therefore, the same fund is proposed to both aggressive and conservative investors. Say, the same equity funds E1 and E2. And the same debt funds D1 and D2.

The difference lies in the asset allocation. And the asset allocation depends on your risk appetite.

For an aggressive investorThe equity allocation (E1 + E2) is 60% of the portfolio. D1 + D2 is 40%.

For a conservative (or risk averse) investorThe equity allocation (E1 + E2) is 30% of the portfolio. D1 + D2 is 70%.

So focus more on things like asset allocation that you can control. The asset allocation must match your risk appetite.

Don’t follow the illusion of safe equity funds. Such equity funds do not exist.





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