AFTER A ROARING bull market over the past year, equity markets in the recent months have gone into a correction mode as FIIs go on a selling spree. Volatility has risen and investment returns are hurt.
A low-variance portfolio―where the returns over a long period of time do not move too much away from the expected mean―is critical for goals such as retirement where we project long-term corpus requirements.
Averages often do not convey the full picture on several aspects, more so in the case of investments. Thus, the journey in delivering an average return of, say, 12 per cent over 10 years, has several periods when returns significantly deviate from the expected mean, both on the upside and downside. This variance indicates portfolio volatility.
Heightened risk-taking brings variance to the fore
Investor exuberance: Pre-Covid, investors typically had allocations to equity, debt, hybrid and gold funds so as to ensure a balanced portfolio. In the past few years, investor portfolios have gone heavily (almost entirely) in favour of equities with huge weightages to mid and small caps. This has skewed the risk-reward equation.
US-China trade wars and geopolitical tensions persist
The India growth story seems to be intact due to strong government finances (record direct and indirect tax collections, low fiscal deficit of 5.6 per cent in FY24) and robust corporate balance sheet. Premiumisation of household has also helped growth.
These factors point to a possibility of unrealistic investor return expectations, which necessitate greater focus on volatility (variance).
Large cap driven low-variance portfolio
In general, large-cap companies tend to experience much less volatility in their prices―thanks to stable earnings prospects, liquidity, etc―compared to mid and small caps. On the valuation front, the Nifty 100 TRI with a P/E multiple of 23.1 and P/B ratio of 3.66 as of October 31, 2024, is cheaper than the Nifty Midcap 150 TRI (P/E: 43; P/B: 5.44) and Nifty Small Cap 250 TRI (P/E: 32.4; P/B:4.25), according to data from NSE.
Adding an element of active management to a plainly passive rule-based low volatility portfolio can help realise better outcomes. Macro parameters, investment indicators, business sentiments and global factors can be used in addition to low variance filters for better judgement. Interest rates, US dollar dynamics and oil prices are some factors used to better gauge the best beneficiaries within a low-variance universe rather than just a passive rule-based method.
A low variance approach ensures that a portfolio falls less than the broader indices, while attempting to capture a reasonable portion of rallies.
Investors may consider the new fund offer (NFO) from ICICI Prudential Mutual Fund, the ICICI Prudential Equity Minimum Variance Fund, which is open from November 18 to December 2, 2024. This scheme is ideal for those seeking long-term capital appreciation and equity exposure with reduced market volatility. It focuses on large-cap companies with strong corporate governance and robust cash flows. The strategy emphasises large-cap stocks with low volatility, assigning them higher weightage. Through in-depth analysis, weight management, and view-based allocation, the fund aims to build a diversified portfolio that minimises volatility while fostering stable, long-term growth.
The writer is director, Intelli360 Asset Pvt Ltd.