Ultimately, all the questions relating to whether you should take a cash call, move to large-cap stocks or buy a hedge, boil down to just one factor - timing. If markets are at overheated levels with an impending crash it makes sense to put any or all of the above risk controls in place for your portfolio. If you believe the market's got plenty of steam left, it would be better to just sit back and enjoy the ride.
However, calling market tops and bottoms is no easier for professional investors than it is for amateur ones. Therefore, AMCs have tried to crack the problem by applying quantitative measures to decide on timing. In recent years, they have launched a bunch of dynamic equity, balanced advantage and asset allocation funds that juggle tactically between stocks, debt/cash and sometimes gold to deliver a good long-term return amid the ups and downs of the stock market. Some of these schemes are directly invested in stocks, bonds, cash and gold while others take the fund-of-funds route to achieve their targeted allocations.
For instance, ICICI Prudential Dynamic Fund and ICICI Prudential Balanced Advantage Fund, both rely on a tactical-allocation model to increase or reduce their equity allocations based on market valuations. The fund house uses the market's P/B multiple with other indicators to take this call, deeming a P/B of five-six times for the market as expensive and two-three times as moderate. Franklin Dynamic PE Ratio Fund maintains a 90 to 100 per cent equity exposure when the Nifty 50 PE ratio is below 12 times, cuts it back to 70-90 at 12-16 times and prunes it further to 50 to 70 per cent at 16--20 times. The fund moves to a 70 to 90 per cent debt weight if the Nifty PE is 24 times or higher.
DSP BlackRock Dynamic Asset Allocation Fund decides on its equity-debt mix based on the 'yield gap' model, which uses the 10-year gilt yield, one-year gilt yield and the Nifty's PE ratio to arrive at the optimal allocation.
While some dynamic-equity and balanced-advantage funds have proved adept at smoothing out market volatility, they do carry two disadvantages. One, given the divergent models they use, it is quite difficult for the investor to figure out which of the myriad asset-allocation funds has a model that really works over the long term. Two, fund-of-funds schemes in this category restrict themselves to equity or debt schemes from the same AMC, which may not be the best choices for the investor. The FOF model is also inefficient from a tax perspective.