How conservative investors can take a low-volatility route to invest in stocks

Since equity inherently is a volatile asset class and the volatility cannot be eliminated altogether (Bloomberg)

Equity as an asset class is more volatile as compared to other asset classes and therefore scares away many investors. Even it throws out many of the novice investors after their first encounter with major correction. Huge correction, due to the black swan event of Covid-19, of March 2020 is recent example where many investors lost their money or stopped their SIPs (Systematic invest Plan) out of fear. And then it recovered faster than anyone had expected. This is volatility of equity as an asset class.

Why should we need to seek less volatility while investing

The equity investing is the only way out to create wealth by beating the inflation by huge margin is agreed to by all and sundries. However, the ascent in valuation of equity is not like a straight line but is pawed with many small and big ups and downs. sometimes the experience of volatility in the equity market is no lesser than that of a roller coaster ride. In the short term the chances of you losing money are higher in equity than any other asset class. Each one of us have different risk taking capabilities depending on our financial abilities and psychological aptitude. As per a research carried out during my previous employment we had arrived at a conclusion that a person has to continue his SIP for a minimum period of seven years so as to ensure that he does not incur any loss under any circumstances on his investment. So in order to create wealth one has no option but to invest in equity for a longer time frame.

Lower the volatility in your investment product, higher are your chances of remaining invested in the product even during correction times. Moreover, with lower volatility, the minimum period to ensure that you do not incur loss on your SIP investment also comes down. Everyone generally likes smooth ride unless you are in an entertainment park. This explains the need to find out the ways to invest with lower volatility.

How the volatility of equity investing can be reduced?

Since equity inherently is a volatile asset class and the volatility cannot be eliminated altogether. However, it can certainly be moderated with certain measures. The first measure to meet the challenge is to avoid direct investing in shares and instead invest in equity through mutual funds periodically in systematic manner only as individual stocks are more volatile as compared to overall fluctuations in NAV of any equity mutual funds. The second measure to reduce volatility risk is to invest in large cap companies and the third measure is to choose the equity mutual fund product which offer lower volatility.

Is there is a way out to meet the challenge of volatility of the equity market?

Though the broader indexes like Sensex, Nifty 50 and Nifty 100 comprise of shares of companies from different sectors, the index itself is less volatile than any specific sector. Out of the shares included in such index, shares of some companies are inherently less volatile than others. The National Stock Exchange had introduced an index comprised of 30 least volatile shares from Nifty 100 on 08, July, 2016 . This index is called “Nifty100 Low Volatility 30 Index”. Since you cannot invest in any index directly, from time to time, mutual fund houses introduce schemes which are traded in the stock exchanges. These are called Exchange Traded Funds (ETF). The price of ETFs fluctuates on real-time basis to reflect movement in the prices of the underlying shares/asset. ICICI Prudential had launched “ICICI Prudential Nifty Low Vol 30 ETF” on 3rd July 2017 imitating the “Nifty100 Low Volatility 30 Index”.

One needs to have a demat account and a trading account to trade in ETFs which is out of bound of many investors who do not directly deal in shares. Moreover, the benefit of systematic investing either through SIP or STP (Systematic Transfer Plan) is also not available in the case of ETFs. In order to cater to the needs of the investors who do not have a demat account as well as to those who wish to invest in such low volatility index periodically through SIP, ICICI Prudential is coming out with “Nifty Low Vol 30 ETF Fund of Fund” which will open on 23rd March, 2021 and will remain open through 6th April 2021. This is a fund of Fund investing minimum 95% of its corpus in the “ICICI Prudential Nifty Low Vol 30 ETF” an existing scheme, performance of which is already established, there is not much risk in applying for this fund offer in my opinion.

This is has all the three measures reduce the volatility as discussed in earlier para. With strict regulations in place, the days of generation of extra ordinary returns by active fund houses are a thing of past and looking at the fact that the fund management charges are minimal in the case of passive fund investing in ETF, there is high probability of you getting market returns.

Are return generated by low volatility fund also significantly lower than the broader category?

Since the shares comprised in the underlying index are less volatile, the fund is less risky, You might be wondering whether choosing the shares of low volatility adversely impacts the returns generated. The fact is that such the low volatility index has generated better risk adjusted return as compared to main indices of NSE like NSE Nifty 50 and Nifty top 100. The absolute returns on “NIFTY100 Low Volatility 30 Index” are higher than “Nifty 100″ index for last one year and three year periods as on 28th February, 2021. So in term of returns low volatility index is in no way inferior than the broader index with higher volatility. If the returns are not lower, why should we invest in funds with higher volatility carrying higher risk of losing money.

Taxation of Fund of Funds of equity ETFs

Since this Fund of Fund will invest at least 95% of its corpus in the “ICICI Prudential Nifty Low Vol30 ETF” this will qualify as equity oriented scheme under income tax laws and will enjoy the same tax treatment as is available to other equity scheme like concessional rate of 15% on short term capital gain tax and 10% tax on long term capital gains after initial exemption of one lakh.

In my opinion low volatility index fund offers safer and better opportunity for conservative investors.

The writer is a tax and investment expert and can be reached at [email protected]

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