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PE Ratio Fund - Invest or Ignore?

A unique offering - Pioneer ITI PE Ratio Fund attempts to time asset allocation with discipline, guided by the PE Ratio of the Nifty Index. The fund will change with changing valuations and will look like an index, balanced or a bond fund. This all in one fund sounds interesting. But it's just possible that it may not be what you expect.

A unique offering -- Pioneer ITI PE Ratio Fund attempts to time asset allocation with discipline, guided by the PE Ratio of the Nifty Index. The fund seeks superior risk-adjusted return from a portfolio of stocks and bonds whose equity allocation would be dynamically adjusted in accordance with the PE Ratio level of the NSE Nifty Index. At its core, a disciplined asset allocation fund with automatic sell-buy mechanism to be triggered by the P/E levels of the NSE Nifty.

How does it work: Asset allocation (i.e. equity and debt split) of the PE Ratio Fund is determined by the weighted average PE Ratio of the stocks of NSE Nifty Index. By its design, higher the PE Ratio, lower will be the funds equity exposure and vice versa. And the realignment of allocation will be done every month. The equity component of the portfolio will be managed as an Index Fund tracking the Nifty, while debt portfolio will be a discretionary selection of bonds.

The Allocation Mechanics
PE below 12: 90-100% in equities and upto 10% in bonds
PE between 12-16: 70-90% in equities and 10-30% in bonds
PE between 16-20: 50-70% in equities and 30-50% in bonds
PE between 20-24: 30-50% in equities and 50-70% in bonds
PE between 24-28: 10-30% in equities and 70-90% in bonds
PE above 28: upto 10% in equities and 90-100% in bonds

The fund will change with the PE Ratio of the Index. Today, with the weighted PE of the Index at around 22, the fund will have 30-50 per cent investment in equity and the rest 50-70 per cent in fixed income. But the fund will look like a bond fund if the PE of the Index is above 28 and it can also become an Index Fund tracking Nifty if PE is below 12.

Back to Basics -- PE Ratio

The P/E (price to earnings) ratio is the most fundamental piece of information you need to know about a stock, mostly because it helps you determine if the share price is too high, too low, or just right. The P/E ratio, which is also called the "earnings multiple" or just "multiple," tells you what it costs to buy a rupee's worth of earnings in a particular company.

Generally, the higher the P/E, the higher the growth expectations. And a low P/E doesn't always mean a better value, for two reasons. P/E is a backward-looking measure. Because it uses last year's earnings, its usefulness in predicting future earnings growth is limited.

Some companies deserve a low P/E. They may look like bargains because they're selling their earnings for cheap. But if the market thinks the company will be hard pressed to grow those earnings, or even tread water, the stock price will probably stay low. Similar for the market as whole too, based on weak economic fundamentals.

While investing in equities, the goal is to find companies whose future earnings will cost you less today than those of other companies. There are only two ways to do that. One can either buy companies whose current price is lower than "it should be" or buy those whose future earnings will be higher than expected. That makes PE Ratio of limited use.

Pros and cons

1. The fund attempts timing the market, i.e. buy low and sell high, based on PE of the market. But timing doesn't work. Investing in equity can be a test of patience. Equities make a comeback when least expected or slip in a prolonged bear phase. The fund will be unable to capture from significant surprise gains. But no one can successfully time the market -- that is, predict its next move. Not even the best fund managers. The validity of a timing model based on PE Ratio is debatable.

2. I am generally skeptical about validity of Indexing in India. My concerns are based on the fact that India is an emerging market -- under researched and an active manager's paradise. Proved by the limited but solid performance of Pioneer ITI Bluechip, an active fund. Besides, Index constituents have to be diversified across sectors. And all representative sectors may not necessarily be competitive businesses.

3. A peep into the likely fund performance in various market's phases.

Prolonged bear phase. When market pessimism lingers, the fund will be in equities for low PE of the index and will gain nothing or could well lose.

Growth lead bull market. The phase of the market and economy for which equity investors painfully wait for year's. This PE ratio fund will be a key loser, as it will ignore equity for its high PE. And the PE may remain high for a long time, to get discounted by higher earnings.

Range bound market: The fund can deliver high returns from its allocation moves in a range bound market. And could thrive in wild oscillatory market.

4. The fund will have a much higher hidden expenses for its high turnover.

5. On the plus – the fund is innovative, disciplined and can have limited downside by design. Could be well suited for an investor seeking growth from investment with limited downside.

Fund Details
Initial Issue Closing February 25, 2002
Issue re-opens March 18, 2002
Minimum Investment Rs 5,000
Initial issue expense 2 %