Beating volatility

Written by fe Bureau | Updated: Jun 1 2012, 08:45am hrs
While the markets have been volatile for the past few months, a smart investor would seek investment opportunities and continue with tactical asset allocation. In a volatile market, analysts say, one should never panic into taking wrong investment calls. And during volatile times, one should also build a portfolio for long-term gains.

It is common for retail investors to opt out of their systematic investment plans when the markets are down. Instead, one should invest a fixed sum regularly and gain on the averaging opportunities during a market crash.

Moreover, investors should look at the option of SIPs in stocks, which gives the flexibility of investing in fundamentally strong stocks that would have the potential to bounce back during the recovery. The advantage of equity SIP is that you can pick up your stocks, unlike in mutual fund, where the fund manager will do it for you. But you have to understand the various parameters to select the stocks.

At times, some of the blue-chip stocks could be highly priced, making it difficult for retail investors to buy in bulk. Many wont want to block a large part of their investible surplus in one go. In such a case, investors should look at more trigger dates to invest when the markets are down.

Diversify portfolio

It is never advisable to keep all your eggs in one basket; asset allocation pays healthy dividends. Asset allocation gives you the framework on which investments are structured and built. In the current scenario, it is advisable that you carry out a portfolio rebalancing exercise in line with the current market scenario, says Brijesh Damodaran, founder of Zeus WealthWays.

Analysts say one way to diversify the portfolio when the markets are down is to look at commodities, especially gold. They say, ideally, one should invest around 10% of the total portfolio in the precious metal to hedge against inflation.

The current economic scenario is grim and this has affected sentiments in the global financial markets. Risk appetite has taken a beating as investors are keeping away from riskier investment assets. But gold, which is the most favoured asset class, has retained its charm as investors cling to the metal amid the rising economic risk. Analysts also say the falling gold price is a good buying opportunity.

In a volatile equity market, exposure to debt products makes sense and especially at a time when the rates are at the higher end of the curve. As interest rates are likely to fall, it is a good time to invest in bank fixed deposits for a long maturity, say, 3-5 years. A five-year bank fixed deposit will also get tax benefits under Section 80C of the Income Tax Act, 1961.

Fixed Maturity Plans

For risk-averse investors, fixed maturity plans offered by mutual funds have been very popular for the last one year. Investors prefer close-ended debt funds because of the high interest rate and the double indexation benefit that fixed maturity plans give.

Since mutual fund cannot provide assured returns scheme, FMPs only indicate the likely returns that the scheme will give to investors. Moreover, FMPs score better than bank deposits because of their tax efficiency. With the main objective to generate returns and protect the capital invested, FMPs invest in debt products with a fixed maturity. Analysts say FMPs in the short term score better with dividend distribution tax applicable at 14.16% and, in the long term, they have the benefit of indexation, which gives the option of paying taxes 20% with indexation and 10% without indexation benefit. Since inflation was high last year, investors whose scheme will mature this year will benefit the most from indexation.

Most mutual funds come out with a spate of FMPs in March with a 12-month lock-in period because of the benefits of double indexation for those who stay invested in these products for over a year. FMPs have very negligible interest rate risk for the investor as these products invest broadly in assets maturing on or before the scheme maturity. Moreover, fixed income investments offer opportunities both in rising and declining interest rate regimes and one has to maximise gains.

Investors in FMPs have an option to pay tax on long-term capital gains at 10% without applying indexation, or 20% after applying indexation. One should consider investing in FMPs only if he is willing to take some risk for tax-efficient returns. Analysts say investors with a fixed-term horizon, who seek certainty of returns, should invest in fixed maturity plans. As the current short-term rates are at an elevated levels, investing in FMPs makes sense for higher returns.

Systematic withdrawal

At a time when volatility in the stock markets has become quite regular, planning for a regular flow of income after retirement is tough. And the job gets even tougher as annuities are tax-inefficient. One can look at investments in mutual funds and a systematic withdrawal plan (SWP) will help you automatically redeem a predefined amount of your investment at regular intervals. SWP lets you take money out of a fund account according to a regular schedule that you choose and is a convenient way to draw down your holdings over time.

In SWP, if one has invested for less than a year, short-term capital gains tax would be applicable. SWP also helps an investor, especially a pensioner, to work out the cash flow as per ones requirement. The problem, however, arises when the equity fund suffers sharp decline in net asset value. The investor would then be withdrawing more capital and getting less capital appreciation. Though, most often, SWP is a no-charge service, mutual fund houses charge an exit load if the investment is redeemed before six months to one year.

Analysts say SWP of mutual funds is useful for individuals as it allows investors to withdraw money from a mutual fund scheme at pre-determined intervals. Such a facility is more relevant at post-retirement stages where there may not be a regular source of income and this facility serves as a source of regular income to meet expenses.

Asset management companies cater to two types of investor needs one, where an investor withdraws a fixed amount every month and, the other, where an investor withdraws only the appreciated capital and not the initial capital.

In fact, SWP investors are able to secure higher unit prices than those who withdraw the whole amount at once. In an SWP, an investor instructs the mutual fund company to withdraw a certain amount at regular intervals. Fund houses have a different option for SWP. A fixed amount can be withdrawn either on the 15th or the last business day of every month/quarter; in the capital appreciation option, the capital appreciation as on the last business day of the month can be withdrawn. Each withdrawal is processed automatically according to the details of your plan. The other advantage of SWP is that it scores over dividends in case of debt mutual funds because they incur lower tax.

Also, since the income you get through SWPs is by way of redemptions and not dividend, there is no dividend distribution tax. Technically, though both dividends and systematic withdrawals mean partial liquidation of the fund capital for tax purposes, these are treated differently. To avoid short-term capital gains tax, one should not redeem anything within a year of investing.

Another popular mode is Systematic Transfer Plan, which is a disciplined way of shifting part of your current investments into other schemes that helps you diversify your investments. This scheme from mutual fund houses enables the investor to switch or transfer a fixed amount of money at regular intervals from the fixed income scheme investments to designated equity and balanced schemes.