Volatility is a double edged sword. The recent crash of March 2020 and subsequent faster recovery has amplified this fact. Those who had taken the risk of investing during the crash are now reaping the benefits. However, the reality is that the risk of volatility deters many individuals with low risk appetite from investing into equities. It is often believed that lower volatility comes at the cost of lower returns. However, this is not true. There is a method to invest in equity which is not only less volatile but also helps you get higher returns (popularly known as Alpha in equity terminology).
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Understanding Alpha
As per Investopedia.com “Alpha (α) is a term used in investing to describe an investment strategy’s ability to beat the market. Alpha is thus also often referred to as “excess return” or “abnormal rate of return.” Alpha is mainly used in relation with active investing and since passive investing generally tracks an index, the misnomer is that passive investing do not generate alpha.
What is volatility and why we seek less volatility while investing?
The rise in equity market is never linear but is marred by many small and big ups and downs. As a result, it is very likely that in the short term the chances of losing money are higher in equities as compared to any other asset class. However, the truth is that when it comes to wealth creation, no other asset class holds the potential of long term growth like equities. So, if one wishes to create wealth that is inflation adjusted, equity as an asset class cannot be ignored. The only way ahead is to come to terms with market volatility.
Given the risk associated with volatility, an investor always endeavours to avoid or minimise it. One can achieve reduced risk through opting for investment vehicles like mutual fund or by investing in large cap companies or broad based index funds like the Nifty 50. Lower the volatility in your investment product, higher are your chances of remaining invested in the product even during correction times.
Can Alpha be made while investing passively?
The excess return of an investment relative to its benchmark index return is an investment’s alpha. Alpha may be positive or negative and is largely the result of active investing. In order to help investors, generate Alpha returns through passive investing, an investor can consider opting for offerings like the Nifty Alpha Low-Volatility 30 Index. This index comprises of 30 shares with high alpha and low volatility out of Nifty 100 Index and Nifty Midcap 50 Index companies.
Since an investor cannot invest in such an index directly, mutual fund houses introduce Exchange Traded Funds (ETF) to replicate such indexes. These ETFs are also traded on the stock exchanges. Therefore, in order to help an investor, invest in the Nifty Alpha Low-Volatility 30 Index, ICICI Prudential Mutual Fund launched ICICI Prudential Alpha Low Vol 30 ETF in August 2020. The catch point here is that an investor needs to have a demat account and a trading account to buy and sell ETFs which is a stumbling block for a large segment of investors. Moreover, one cannot reap the benefits of rupee cost averaging under ETF as very few platforms offer the option of SIPing in ETFs. As a means to address these challenges, ICICI Prudential has now launched the NFO of ICICI Prudential Alpha Low Vol 30 ETF Fund of Fund (FOF). This FOF invests in ICICI Prudential Alpha Low Vol 30 ETF.
Performance history of Nifty Alpha Low-Volatility 30 Index
Taking August 2011 as the base year for Nifty 100 Index, Nifty 50 Index and Nifty Alpha Low-Volatility 30 Index, their value as on 18th August 2021 are 352, 340 and 590 respectively. The outperformance of Nifty Alpha Low-Volatility 30 Index is glaringly evident. Also, the index has outperformed Nifty 50 and Nifty 100 for periods over three years on an annualised basis. If one were to consider a 10-year timeframe, the index has generated an annualised return of 20.2% as against 14.2% and 14.6% generated by Nifty 50 and Nifty 100 indices respectively. These superlative returns are backed by better return- risk ratios as well. So from an investor’s perspective, investing in a fund which replicates Nifty Alpha Low Volatility 30 index is akin to having your cake and eating it too.
To conclude, by investing in Nifty Alpha Low-Volatility 30 index, you can not only reap Alpha in a passive fund but also gain from the lower volatility and reduced fund management charges.
Balwant Jain is is a tax and investment expert. He can be reached at jainbalwant@gmail.com and @jainbalwant on twitter
Author Bio
Very useful,educative and a new method of safe investing.