A surge in Covid-19 infection in India and the renewed mini-lockdowns have intimidated the stock markets. The daily volatility (as measured by the standard deviation) of the Nifty 50 returns is up 1.33% for the 3 months ending March 2021 as opposed to 0.89% in the December quarter.
While the local markets cautiously watch the developments from the Covid-19 pandemic, globally, fire sale by a US hedge fund (Archegos Capital) after defaulting on margin calls made investors wonder if there could be more such instances.
At this juncture, what sort of investments will help reduce a potential damage to your portfolio, if a correction happens? Staying entirely out of equity may not help as there has been returns despite heightened volatility. The last 3 months’ Nifty 50 performance has shown this.
Reducing portfolio volatility would be an option for those wishing to stay invested in equities. In this regard, we had already recommended ICICI Pru Nifty Low Vol 30 ETF in January 2021 as we felt that there was volatility ahead. The ETF is also part of Prime ETFs. We now reiterate this call through the NFO of ICICI Pru Nifty Low Vol 30 ETF FOF. This fund of fund (FOF) will simply invest in the ICICI Pru Nifty Low Vol 30 ETF. While The ETF had poor turnover earlier, it has significantly improved now. Yet, it is erratic with turnover of just Rs 3-7 lakh on some days. With the FOF, you need not worry about the liquidity and your ability to buy and sell this ETF (something we have mentioned as a limitation in our ETF call) in the market. It does not need a brokerage account and is also convenient for executing SIPs. The current market condition also makes ‘Low Vol’ as a theme more conducive, despite its underperformance in the last 1 year of bull market.
About the index
The Nifty Low Volatility 30 index (Nifty Low Vol) is built on the acknowledged theory that containing volatility is key to portfolio returns. The Nifty Low Vol is built from the Nifty 100, drawing the 30 least volatile stocks in the 100. Volatility is measured by the deviation in daily price movements for the preceding 1 year. Stocks are scored and ranked based on this metric.
The weight of each stock to the index is based on its volatility score and not its market capitalization. However, weights to some stocks with lower liquidity are capped at 3%.
Given that the index is built on the premise of low volatility, the standard deviation (a measure of volatility) of this index is lower at 12.2% (when 1-year returns were rolled daily for 3-year periods) compared with the 13.7% deviation seen in the Nifty 100 and Nifty 50. The above holds the index in good stead during market falls and as a result helps overall performance as given below:
- For the above-mentioned period, the worst 1-year performance for the Low Vol index was -26% as opposed to -32.4% for the Nifty 100 and -33% for the Nifty 50.
- The above difference may not sound material, until you translate it in terms of how much return is needed to break-even the losses. For example, from the above fall, the Low Vol should have climbed up by 37.7% while the Nifty 50 and Nifty 100 would have needed a steep 49% jump to break even. This is exactly what makes the performance of this index superior, over the long term. Simply put, you don’t have to work hard at generating returns if you did not fall hard in the first place!
- And the return differential of this index can be significant. When 3-year returns were rolled daily over a 5-year period, Low Vol index’s (TRI) average returns came to 13.2% annualized, as opposed to 11.3% for the Nifty 100 TRI while it was 9.5% for the Nifty 50 TRI.
- The index has beaten active large-cap funds (category average) 99% of the times when 3-year returns were rolled daily. This massive outperformance is not surprising as active large-cap funds have been underperforming their indices – Nifty 50 and Nifty 100 – in the past few years.
The Low Vol index though, is not infallible. During prolonged bull rallies, it can underperform. For example, at present, the index’s 1-year returns at 62.4% is a good 6.7 percentage points lower than the Nifty 100 TRI return of 69.1% In other words, Low Vol can underperform in prolonged bull markets.
The Low Vol index is a far more diversified portfolio as it is not market-cap driven. The top 5 stocks at present account for less than 20% of the total weight. Compare this with the Nifty 50’s top 5 stock-weight of 42.6% or the Nifty 100’s 37% weight. The lack of concentration itself ensures lower falls for Low Vol, albeit lower returns in rallies. Given that consumer goods, IT, automobile, financial services, and power are the top 5 sectors, the PE (according to index factsheet) is at a far lower 24.45 times than the Nifty (standalone, as per factsheet) PE of 39.6 times.
How to use ICICI Pru Nifty Low Vol 30 ETF FoF
This FOF can be used instead of the ETF if your investment runs to several lakhs (no liquidity issue through fund route) or you want to use SIPs. Do not be too fixated on costs as you will know that ETFs have their cost structure as well. Read our article on this. You can use this FOF in the following ways:
- Allocate the index for long-term investment horizons of 5 years and above. This longer period is needed for the benefit of the low volatility to kick in.
- Use SIPs given that the current market levels are not the best for large lumpsum investments. Or follow a lumpsum with SIPs.
- You can use this as a substitute for large-cap funds, especially if you want a low-risk large cap.
- If you already hold this as an ETF, you need not invest again, unless you want to do SIPs and your broker does not provide SIPs on ETFs.
- Combine it with other active funds to build a balanced portfolio. Consider mid/small-cap active or passive options if you have a higher risk appetite.
- You need to note that the Low Vol index has just 8.6% allocation to financial services as opposed to Nifty 100’s 37% exposure. This is inevitable as banking stocks are volatile and would therefore not appear in the Low Vol index’s top ranks. To this extent, you need to ensure you have banking and financial exposure through other funds (which you will mostly).
The NFO will close on April 6, 2021. But the fund will reopen for subscriptions. You can start SIPs then.