Yuvaraja, Director, Boho Finserv Pvt Ltd
With posting nearly 40% returns in the last twelve months, Indian equities has been one of the best performing equities among the major economies in the world; outpacing France to become sixth largest nation by market value. Despite all that, the bedrock of equity market performance in the long-term, i.e. earnings growth, is not very encouraging, and is rather seen moderating in the earnings upgrades. Furthermore, hordes of new and amateur investors are propelling cash volume in the equities market, driving the screaming stock rallies, stoking concerns of a massive ‘overheating’ of the equity market, something that has not been witnessed in the last 15 years. Indian markets have not seen a correction of more than 10% for more than 280 days, which is the third longest rally ever.
Indian Equities Overstretched
There are several indicators suggesting that the Indian equities valuation has overstretched territory. The gap between earning yield, an inverse of P/E and bond yield, has risen to around 200 basis points, which is nearly double the historical average. Higher gap of earnings yield and bond yields suggests that the equity valuation is swelling. Meanwhile, the historical data suggests that if the gap between earnings yield and bond yield crosses more than 170 basis points, the probability of a negative return in the next 12 months shoots up. In absolute terms, the Nifty 50 is trading at 22 times one year forward earnings, a 45% premium to long-term average.
Navigating The Elevated Valuations
So, what is an ideal product for investors to navigate in times when the assets are undergoing an extended period of elevated valuation, propelled by ultra-low cost showered by central bankers? The answer is ‘Balance Advantage Funds’ (BAF), where equity allocation is hinged on the valuation of the market, if the valuation is stretched the equity allocation drops to 30-40%, while if valuations are appealing equity allocation can be increased to 70-80%. Thereby, addressing the biggest dilemma of investors “when to enter and when to exit”. However, the challenge here is there are several variants within the BAF universe.
The oldest fund in the category is the ICICI Prudential balanced Advantage Fund which is over a decade old. The most comforting part of a BAF investor in this fund is that the equity allocation is based on the reading of the model, which is based on several market dependent indicators thus limiting human discretion when the cycle reverses.
Why ICICI Balanced Advantage Fund?
Before we start with the ICICI Prudential offering, it is important to understand the universe in which the fund is placed. In the balanced advantage category, based on the equity allocation of the fund over the past 3 years, one can see three distinct type of funds. In the first category the equity allocation is elevated between 70% to 80%, while in the second category the equity allocation is between 10% to 15% and in the third category the allocation can range between 40% to 50%.
In an up trending market higher equity allocation funds tends to do well. But the basic premise of a balanced advantage fund is one where assets are dynamically managed such that investment remains protected even during volatile times. So, funds with higher equity allocation could prove to be in a challenging phase if markets were to change course. This is where ICICI Prudential offering tends to do better. The offering takes a counter cyclical approach to investing thereby aiding investors to buy low and sell high. As a result, the fund will increase equity allocation when equity valuation becomes cheap and as markets becomes expensive, profits are booked and the same is allocated to debt. As of October 2021, the equity allocation is down to 35.3% from 74% seen during the height of market correction in March 2020. Owing to this feature, the fund has outperformed in a falling as well as a range-bound market since 2010; while it has posted a decent absolute return in the rising market. Over the last decade, the fund has delivered 12.8% annualized return since 2010, which is 20 basis points higher than the Nifty 50 total return index with average net equity exposure of 54.6%, which shows superior risk adjusted return.
