Amongst equity analysts, there’s a great deal of talk nowadays about the markets’ valuation levels and what they say about investment prospects. Broadly, lower valuation levels (indicated by a lower PE ratio) are supposed to be provide an indication that compared to their profit levels, the price levels of stocks are cheap enough to invest in.
While all investors and fund managers keep an eye on valuations, there are a couple of mutual funds that are based on the interesting idea of implementing this idea algorithmically. These two funds (Franklin Templeton’s FT India Dynamic PE Ratio fund and Principal’s SMART Equity Fund) are both asset allocator funds. That means that they are balanced funds but unlike conventional balanced funds, their debt-equity balance is not fixed within a narrow range. Instead, it can vary widely, depending on the market’s valuation levels.
It’s interesting to note that currently, both funds’ algorithms indicate that its time for equity. The Franklin fund has an algorithm that varies the equity exposure based on the Nifty’s PE level while Principal SMART Equity is based on the Sensex. Since January this year, its equity allocation has been stepped up from 25 per cent to 60 per cent. In the case of Principal SMART Equity, the equity allocation has been stepped from 38 per cent to 81 per cent.
These numbers pretty much reflect the fact that the valuation of the large cap benchmarks have plunged during 2011. By any kind of numbers-driven criteria, stocks valuations are really low and this is the time to load up on equity. The only possible problem is that even though stocks are cheap right now, there’s no telling whether they could get stay cheap for a long time. Or indeed, get even cheaper!