Friday, October 16, 2009

Mutual Funds: Value averaging to be new investment strategy

A new investment theory is gaining favour with wealth managers and mutual funds, something that could soon replace the conventional systematic investment plans (SIP) strategy. Termed value averaging investment (VAI), the technique allows investors to determine the size of investment needed (at the time of investing) to get desired returns. Value averaging works much like rupee cost averaging, which forms the basis of systematic investment plans.

“While SIP investments are made on fixed dates, irrespective of market conditions, VA investments are made on dates when the markets look investible. The best aspect of VAI is that it enables investors to buy stocks at dips — a facility that is not really possible in SIPs,” said Nipun Mehta, head of Societe Generale Private Banking India.

In value averaging, the investor sets a target growth rate or amount for his portfolio each month, and then adjusts the next month’s contribution, according to the relative gain or shortfall made on the original asset base. To cite an example, investor A needs to invest Rs 1,000 (calculated using statistical formulae) every month to get 15% return (on his investments) over a time-frame of 10 years. A invests Rs 1,000 in the beginning of the month (usually when the market is trading lower); at the end of first month A’s investment has declined to Rs 800 as a result of the further fall in market. To correct the course to target growth rate, A invests Rs 1,200, marking net term investments to Rs 2,000. Conversely, had the markets gained and A’s investment surged in value by Rs 200 (taking the total value to Rs 1,200 at the end of the first month), he would only have to pay Rs 800 in the second month.

“Under VAI, investors contribute to their portfolios in such a way that the portfolio balance increases by an amount calculated by a formula-based technique, regardless of market fluctuations. As a result, when the market declines, the investor contributes more and when the market goes up, the investor contributes less,” said Anil Rego, CEO of Right Horizons — a wealth management firm.

Though VAI has no historical references, returns (asset growth) could well be very close (or a bit high) to those offered by investments through SIPs. While VAI enables flexible investing, there is a good possibility that the fund manager may not be holding cash at the time of a sudden dip in market value. Another negative aspect to VAI is the fact that as the investor’s asset base grows, shortfalls (in case of market slumps) become too large to replace (especially for retail investors). While several fund houses are planning to introduce VAI plans on existing MF schemes, the benchmark MF has attached value averaging transfer plan (VTP) in its derivative fund, equity fund and derivatives opportunities fund.

Source: The Economic Times (This article is written by Shailesh Menon)

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