Let’s begin with some maths. If a stock falls by 25% from ₹100 to ₹75, how much do you think it will need to grow to get back to ₹100, the cost price? The answer is the stock will need to go up by 33.33% to get back to ₹100… Similarly, if ₹100 stock falls by 50% to ₹50, it has to go up by 100% to reach its original value. If the same stock falls by 75% to ₹25, it will need to gain 300% to recover to its original price and if it falls by 90%, it needs to go up by 900% to recover.
These numbers make it very clear that the more you lose, the harder it becomes to recover your original price. This explains the importance of protecting downside in your investment portfolio.
Equity inflow numbers and SIP additions for the past two months have suffered to record lows due to negative returns in the investors’ portfolios. Such low inflows might not hurt asset management companies as much as the pause in regular investments can hurt an individual’s plan to achieve long term or short term goals.
“People get very worried by looking at the negative returns in the portfolio. Despite experts advising not to stop and capture the benefits of volatility with your regular investments, investors tend to stop their SIPs during such times. Thus the good habit which was formed gets negated due to the downside in investments,” says Vishal Kapor, CEO, IDFC AMC.
Investment strategy to protect downside
IDFC Mutual Fund believes sticking to your asset allocation can provide stability to your portfolio. “SIP has formed a good habit among investors to invest in equity funds in a disciplined manner but most investors keep debt investment to be done later on a periodic basis as lumpsum. This can change asset allocation of an investor. But had the investor divided his SIP in equity and debt as per his asset allocation, the fixed income investment would have cushioned the fall in equity,” says Vishal Kapoor of IDFC AMC.
“Fixed income cushion could have blunted or toned down the negative returns of equities during the volatile markets,” Kapoor adds.
IDFC AMC conducted a study comparing SIP returns in pure equity fund an a combo SIP in equity + debt. The results were quite interesting as given below:
3-year SIP in BSE 200 : A pure equity SIP
Worst returns: -18%
Best returns: 26%
Average Returns: 10%
3-year SIP in Crisil Short Term Bond Index : A pure debt SIP
Worst returns: 6%
Best returns: 10%
Average Returns: 8%
3-year Combo SIP : Equity+ Debt SIP in 60:40 allocation
Worst returns: -8%
Best returns: 19%
Average Returns: 9%
Note here that asset allocation of 60:40 in equity and debt has been taken as an example for a moderate investor. It simply means that if an investor invests ₹10,000 monthly via SIP, he can distribute the money as — ₹6,000 in equity fund and ₹4,000 in debt fund in line with his asset allocation.
Look at the worst returns, the negative returns in the combo SIP has far more blunted than in a pure equity SIP portfolio. The returns from 40% allocation to debt have cushioned the total SIP returns and the fall is -8% as compared to -18% in a pure equity SIP investment.
Comparison: SIP in pure equity or SIP in pure debt or Combo SIP
Average returns in the pure equity SIP is 10% and in the combo SIP, it stands at 9%.
This explains the importance of SIP in fixed income. A small behavioral change of sticking to your asset allocation by way of regular investment in debt funds via SIP, the way you do it in equities can make a lot of difference to your portfolio returns.
Some may argue that extra return of 1% on an annualised basis matter a lot. Yes it does but the stable returns will prevent panic reactions and the overall long term benefits of continuing your investments without any pause will help you to achieve your goals timely.
Downside protection will also keep an investor calm during the times of volatility to continue with his investments.