I have observed over the years that particular class of funds and products become popular with investors at given points of time. This has been observed in the Fund industry over the last several years where products become fancied due to prevailing sentiments. One such product which is getting fancied at this point of time is TARGET RETURN products. However these products in the end turn out to be sub optimal investments for investments going into the future. The reason for this is simple – most investors tend to extrapolate what is today into the future in order to make their investment decisions, whereas the future is very different from today. What is consensus at any given point of time typically does not turn out to be the right investment.
Let’s see this through some examples of the kind of products which have come in the past. There was a time in the bear market of the period 2000-2003 when dividend yield funds and P/E funds became very popular with investors. The story there was that these funds will invest in good dividend yielding companies and as such give good returns. However the reality is that when we talk about dividend yield it is typically on past dividends and future dividends cannot be really judged from past dividends. As an example let’s say that there was one commodity having an up cycle in the previous year and as such gave out a good dividend. However subsequently the cycle turned down and along with that the stock price of the company crashed as we saw in the second half of 2008. Under the circumstances the dividend yield and P/E on past earnings will look very good, however on future earnings and dividends it might not be attractive at all. Similarly my experience of low P/E is that if some company has got a low P/E then there could either be lot of value in the company or there might be issues related to management quality, business outlook, balance sheet concerns, growth etc. etc. with the company. In any case my view always has been that such products are the worst in a growing economy like India where money will be made out of growth rather than dividend yield.
Subsequently Capital guaranteed products became popular, which were actually nothing but balanced funds under the guise of Capital guaranteed products. Such product played on the investment psychology of investors in the years just after the bear market where most investors were looking to protect downside rather than play for upside. Such investors would have missed the big bull phase of 2003-2007.
Similarly in the year 2008 Gold funds and FMP’s became popular. I have already written on these products in my previous articles. Where FMP’s resulted in lot of money being locked in by investors and these investors typically did not realize that locking in money for a couple of points higher interest for periods excess of one year or so carry a big reinvestment risk. Now as the investors are starting to get their money back the stock markets are already up more than 85% from their bottom. Similarly I have written in my article about Gold that I do not believe that it will create big value for Indian investors in the long run given the facts related to strong growth in the economy and rupee appreciation.
In between there were some hedging products which came out which also performed sub optimally as I believe that the philosophy of P/E ratio based shorting or hedging is fundamentally flawed. The reason is that in bull markets P/E ratios expand and in bear markets they contract. As such a strategy which is not focused on fundamental and technicals based shorting but just on P/E ratio will remain under invested in bull markets and over invested in bear markets and as such under perform in both scenarios.
The current FAD is for target return funds. I believe that these products will again turn out to be suboptimal investments for investors. These products are playing on the psychology of investors where most of them feel that they could not encash after the bull move of 2003-2007 and remained invested when they should have redeemed. As such they believe that redemption at target returns and shift to debt oriented products will make them book profits periodically. So what happens after you book profits, there is again a reinvestment risk. Given the fact that Capital Guaranteed Products failed to deliver as per investor expectations today these kinds of products are likely to become popular. Given my view on the long term direction of the stock markets in India investors who invest in such kind of products will miss out the big bull move in India. Similarly if investors had invested in target return funds in February 2009 then they would have achieved most of their targets in the first few weeks of the current upmove and would have got into debt when it was time to ride the equity wave.
The key for investors in my view is to have a proper asset allocation between different asset classes and after having done that the portion allocated to equities can be reallocated to diversified, mid cap, thematic etc. mandates in pure equity. For example, if out of Rs 100 with investors if they want an allocation of Rs 25 into equity then it should go to mandates which are not hedged but will play out the equity cycle in which ever direction it moves. Reallocation of the total investment pool can be done at periodic intervals so that this 25% allocation is maintained in the long run. This will deliver proper return from that asset class for the investors. In case the allocation to equity goes into products which will cut out returns in a sub optimal manner then the overall asset allocation will also deliver suboptimal returns. Remember
A PUBLIC OPINION POLL ON THE WAY INVESTMETS SHOULD BE MADE IS NO SUBSTITUTE FOR A LONG TERM INVESTMENT STRATEGY