Equity as an asset class, when compared to other asset classes, tends to be more volatile, scaring away many investors. Investors who are new to equity markets are thrown off balance after their first encounter with a major correction. Sharp and rapid corrections due to black swan events such as Covid-19 (March 2020) is the most recent example where many investors saw their portfolio value plunge deep in red.
Gripped by the fear of facing further losses, many investors even ended up stopping/pausing their SIPs (Systematic invest Plan). But equity markets staged a sharp turnaround recovering all of their lost ground and rallied to new highs, taking both the novice and the experienced investors by surprise. This is what volatility can look like in equity as an asset class.
Seek lesser volatility in investment journey
Various studies have proven time and again that equity investing is one of the optimal ways to beat inflation and create wealth over the long term. However, this journey is not linear in nature but is fraught with various lows and highs, akin to a roller coaster ride. Equity is one asset class where the chances of losing money, in the short term, are very high. Also, risk-taking capabilities varies from person to person, depending on one’s financial abilities and psychological aptitude. During my stint at a leading marketplace for financial products, an internal research showed that an investor has to keep up with SIP for at least seven years such that the investment makes money in all market conditions. So, in order to create wealth, it is clear that one has to stay invested in equities with a long-term view.
Behavioural science shows that the lower the volatility in one’s chosen investment product, the higher are the chances of an investor braving times of correction and remaining invested in the product. Also, with lower volatility, the minimum period to ensure that you do not incur losses on SIP investment also comes down. Therefore, it is imperative to look for options where one can invest with lower volatility.
Ways to reduce volatility impact
When it comes to equity investing, volatility cannot be eliminated altogether but can surely be moderated with certain measures. The first measure is to refrain from direct investing. Instead opt for SIP in an equity mutual fund. This is because individual stocks are more volatile as compared to overall fluctuations in NAV of any equity mutual funds. The second measure is to invest in large cap companies only, and the third and final measure is to invest in a scheme which is designed to offer lower volatility.
Making peace with equity market volatility
Though the broader indices such as S&P BSE Sensex, Nifty 50 or Nifty 100 comprise of companies across sectors, the index itself tends to be lesser volatile than any specific sector. Here also, the shares of certain companies inherently tend to be lesser volatile than others. Taking cognizance of this fact the National Stock Exchange introduced an index (July 2016) comprising of 30 least volatile shares from Nifty 100 universe. This index is known as “Nifty100 Low Volatility 30 Index”. Since an investor cannot directly invest in an index, mutual fund houses have launched Exchange Traded Funds (ETF) which have such indices as their underlying universe. Since ETFs are listed on stock exchanges, the NAV of these ETFs fluctuates on real-time basis to reflect movement in the prices of the underlying shares/asset. In July 2017, ICICI Prudential, one of the largest mutual fund houses in the country launched ICICI Prudential Nifty Low Vol30 ETF. This ETF was set to mimic the Nifty100 Low Volatility 30 Index.
However, the catch here is that an investor needs a demat and a trading account to buy/sell ETFs, which can be a limiting factor for several investors. So, as a means to make the product accessible to one and all, ICICI Prudential has announced the launch of Nifty Low Vol 30 ETF Fund of Fund (FOF). The NFO of this FOF is open from March 23, 2021 to April 6, 2021. This FOF will be investing a minimum of 95% of its corpus in the underlying ETF which is the ICICI Prudential Nifty Low Vol30 ETF. By tracking the 30 least volatile stocks in the Nifty 100 Index, the scheme offers wealth creation opportunities with a lower level of volatility. As this is an existing scheme with well-established performance track record, I believe, there is not much risk in applying for this NFO.
Does lower volatility mean lesser returns?
It is important to understand that higher volatility does not translate to higher returns. In fact, data shows that over one and three years, Nifty 100 Low Volatility 30 Index has generated better risk adjusted return than Nifty 100 index. So, the return profile of such a product is in no way inferior to a broader index which comes with higher volatility. The question now is: why should one invest in funds with higher volatility carrying higher risk of losing money?
Taxation of Equity ETF Fund of Funds
Since this FOF will invest at least 95% of its corpus in an equity-oriented ETF, the FOF will be treated as an equity fund for income tax purpose. Short-term capital gain tax will be 15% while long-term capital gains will be taxed at 10%, post the initial exemption of Rs. 1 lakh.
To conclude, low volatility ETF/ FOF is an optimal investment tool for investors who find market volatility unnerving.
(The writer is a tax and investment expert and can be reached at firstname.lastname@example.org)
Disclaimer: This is the personal view of the author. Please consult your financial planner before making any investment.