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Automated Profit Bookings

ICICI's new fund, which allows investors to book profits automatically, does look like an attractive proposition

One of the more frequent laments of investors is that they failed to protect the profits they had made in their investments. They bought at the right time but they didn't sell at the right time. Booking profits and putting them away in a safe place is what investors should be doing, but rarely do. Taking money out of investments that are making money is an extraordinarily hard thing to do systematically. It works against the basic human instinct of greed. When the markets are roaring and the returns are flowing in, it's hard to believe that selling out is anything but stupid.

Now, ICICI Prudential Mutual Fund has launched a fund which tries to tackle this problem in a systematic manner. The AMC's Target Return Fund has a facility by which investors can make their profits safe automatically. In this fund, gains made above a certain trigger percentage automatically get redeemed from the fund and switched to a fixed income fund. The investor can choose trigger percentages of 10, 12, 20, 50 or 100. Whenever the gains since the initial investment or since the last trigger cross this percentage the money gets switched.

Effectively, the fund seeks to automatically emulate an investor who regularly books profits and shifts those profits to a safer investment. The various percentages that one can choose between are intended to be control the risk and the rewards. In theory, the higher the percentage, the greater the risk and the greater the reward.

Does this kind of automated profit-booking work? To find that out, Value Research carried out a simulation to test the hypothesis. Since this fund is benchmarked to the BSE 100 index, we based our simulation on the same benchmark. We assumed that an investor put in Rs 1 lakh on January 1, 2000 in a fund that precisely tracks the BSE 100 index. This hypothetical fund had the same trigger rules which were tested at the various percentages available to the investor. We also assumed that the triggered switches would transfer the gains to ICICI Prudential Income Fund, which is one of the choices available.

In our simulation, we found that at the trigger level of 10 per cent, the investors' Rs 1 lakh would have grown to a total of Rs 2.73 lakh. The equity portion (the amount that stayed in the BSE 100 fund) was at about Rs 48,000, while the booked profits in the income fund had grown to about Rs 2.26 lakh. In the BSE 100 fund itself, the money would have grown to Rs 1.94 lakh. However, the real story is in how the money grew and was saved from reducing. In the BSE 100 itself, the Rs 1 lakh would have grown to about Rs 4.05 lakh at the January 2008 peak of the markets and then collapsed to a trough of Rs 1.63 lakh. In the profit-booking mode, the early-2008 peak was just Rs 2.9 lakh from which the value fell no lower than about Rs 2.4 lakh at the worst time.

This underlines the conservatism of this approach. This is an emphatically low-risk approach which does not hold the promise of huge gains. It will get you reasonable gains and then protect your returns. The best part of the story is the automated approach. Most of us would lack the attention and the self-discipline needed to do this. Having it done for you really expands the usability of booking profits regularly.

Of course, these triggers are really not part of the fund itself, but an additional facility. There's no reason why it shouldn't be routinely offered as an option with every equity fund.