I bought units of FT India PE Ratio Fund in February 2002. The performance of this fund has been disappointing thus far. Since this is a new class of fund, I really have no benchmarks. Should I hold on to this fund?
Prasanth, via e-mail
An ideal situation for an equity investor is to buy low and sell high, ie buy in a bearish market and sell when markets are at a peak. But no one tells investors when the markets are high or low. Thus, investors do not know when to enter and exit an equity fund. The FT India PE Ratio Fund aims to solve this dilemma by mechanically investing in stocks when the markets are low and exiting stocks when the markets are high. The fund uses the PE ratio or the price-earnings ratio as the measure to judge whether the market is high or low.
The PE ratio is a measure that indicates the price the market is willing to pay for one rupee of earnings. It is calculated as the ratio of a stock's market price and its earnings per share. A high PE ratio indicates that investors value the stock and are willing to pay more for it. The PE ratio of the market as a whole, as represented by a particular index is used as a proxy to determine whether the market is at a 'high' or 'low' level.
By tracking the PE of the Nifty, the fund decides on equity and debt allocations. The equity component of the portfolio is managed as an index fund tracking the Nifty, while the debt portfolio is a discretionary selection of bonds. When the PE ratio is high, the fund will reduce its equity allocation to minimise downside risk. When the PE ratio is low, the fund will move into equities to capitalise on a possible upside.
Hence, the equity component of the portfolio is passively managed as it moves in line with the PE band of the Nifty. This rebalancing of the portfolio is done on the basis of the fund's PE band and is carried out during the first week of the following month. The fund by following this strategy will mechanically follow a buy-low and sell-high approach. By virtue of its debt allocation, the fund should underperform in a rising market and outperform in a falling market.
FT India PE Ratio Fund is the only PE fund in the country. As on January 29, 2002, the fund has lost 7.60 per cent since its inception vs the Nifty's 9.36 per cent decline in the same period, thus outperforming it. In each quarter when the market has fallen, the fund has done better. In the last quarter of 2002 when the market rallied, the fund generated lower returns. This is, however, true to its character. So you have no reason to be unhappy with the fund. It is doing its job of allocating between equity and debt. While appreciating this you must not forget that in spite of a disciplined approach, risks attached to equity investing cannot be ruled out.
This article was originally published on April 01, 2003.
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