Use this simple rule to reduce your risk with Mutual Funds Investment

Personal finance
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People usually diversify their portfolio or allocate their capital to different asset classes. One of the subscriber from our telegram channel asked us, if there is a way to reduce his risk exposure to mutual funds without using hedging techniques.

But so far, people haven’t tried a quantitative approach to reduce the risk with mutual fund investments.

We have tried various parameters with quantitative techniques, ran many complex simulations to come up with a risk management model. None of them worked, later I figured that a simple parameter can reduce the risk considerably.

Its what we call it as MA10,which is nothing but a 10 month moving average. 10 Month moving average is almost equal to 200 days moving average, but why not 200 day MA? Why should we use 10 month MA?

Because, the daily moving average contains so much of noise due to daily fluctuations that we see in the market, using 10 month moving average will remove these noise.

Let’s see how it can help us in reducing the risk.

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The above chart shows the chart of NAV of HDFC TOP 200 fund since inception.

Rs. 1 lakh Invested in 2002 at the time of inception has grown to Rs.25.9 lakhs by 2018.

That’s a CAGR of about 22.5%.

Sound great! What about the risk involved? Remember the period 2008? When market collapsed, 50% of your capital would have wiped out, whatever you gained prior to that would have been lost in the financial crisis?

How many investors can tolerate such downside fluctuation?

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We tried implementing the MA10 rule.

Whenever NAV of a mutual fund goes below 10 month moving average, just exit from it. Re invest again in it,only when the NAV goes above 10 month moving average.

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The above chart shows the NAV of HDFC TOP 200 fund. The red line is the 10 month moving average value plotted.

Rs. 1 lakh Invested in 2002 at the time of inception has grown to Rs.20 lakhs by 2018.

That’s a CAGR of about 20.5%.

Our CAGR dropped by 2%, how about the risk?

Risk reduced drastically.

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As you can see, the maximum drawdown was just 20% in 2008, when the whole world markets were crashing more than -55% in that year, your investments would have been down only by -20%.

During the other years, the average downside was just -5%.

We are able to reduce the risk in mutual fund investments by more than 60% by simply implementing a moving average with NAV of a fund.

Simple but very effective! try it out.

4 Likes
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No, not really. For last 16 years, only 6 times you need to exit and enter. It doesn’t affect much on transaction cost

4

Why do so much circus ,when you can simplify so much more when it comes to MF

Find MF which are low volatile(only large caps) or say having sharp ratio of 1 or above.

Also , you can calculate the volatility and understand your risk much better. This can also help you add more to your existing positions.

You don’t have to sell to make profits , you just average better.

Besides risk appetite is subjective.

if i had to sell MF units ,what the hell am i paying the expense ratio to the fund for? I would rather buy/sell the stock myself.

The whole point of buying MF is so that you don;t have to do all this work, only understand volatility to understand the risk better.

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That’s cool, is there any Mutual Fund that you know which had better sharp ratio that has delivered good returns with lesser than 30% draw down in 2008? I would love to invest in it.

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@kirubakaran,

I wish i had the historical data pre 2008 , but sadly hard to find.

Major indices fell by 50% or more during that time, but normally the fund managers will do something during high volatile times, either reduce exposure or invest in debt.

So if you have invested in good MFs now and say we have a 2008 like scenario, the fund managers will act to reduce their exposure which means they will sell off stocks, this is why markets fall so sharply. Majority of institutions will be de-risking. so you don’t have to. This is why we pay them.

your money however will be managed better if you just sit tight until the storm settles, then buying starts again. but sadly this is exactly the point many many will sell their units and markets rally like crazy.

This is why its very very essential to understand volatility. without this understand no one should invest in markets.

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There are 20,000 plus mutual funds schemes in India presently, I have analysed almost all of the equity mutual funds in India, and i can be sure that none of the Mutual funds able to reduce the risk in 2008 when index itself lost more than 56%.

Even though we think that our funds are in safe hands by investing in mutual funds, when you literally see your money wipe out in few months of time, majority of people panic and withdraw their funds at the most crucial time. So the main motive behind this 10 MA rule to avoid that scenario by managing the risk by ourselves.

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@kirubakaran,

Then why pay the fund manager.

Maintain your own portfolio.

TA and risk management on MF is meaningless.

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Time is money, those who do not have time & knowledge for all these, go for it.

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It doesn’t fit in for MFs, which is primarily an investment vehicle. Avoid technical analysis in investing

1 Like
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Well, nobody could predict whats going to happen next in stock market, anybody who tried that failed miserably. A successful trader/investor never predicts, he just reacts to market movements. And this thread doesn’t help anyway in predicting or increasing one’s returns to 100s of %. Its just a research work done to find a way to control the risk through quantitative way.

Analysis based on past return cannot predict future,true. But the funds/stocks that have performed well in the past has higher probability to continue to perform well. I did not say this, many researches back in 1990’s Jagdeesh & Titman already said that and even Nobel Laureate Eugene Fama & Kenneth French have confirmed the same.

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2 Likes
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@KirubaKaran The strategy of using 10 month moving average sounds like a good way to reduce risk. Is that any website where we can see the moving average of mutual funds?

1 Like
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@KirubaKaran Where can we plots the chart for MF? I don’t see it in coin or kite.

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You cannot plot charts but you can compare the schemes on Coin and plot it as per the NAV or the Equity curve. This feature is only available on coin web. Go to the scheme name, and use the compare option.

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@Neelesh thanks for your response. Need not be just tools from Zerodha, but any other site will also help. Let’s say I want to exit a MF if it moves below 50 days SMA. I can’t do that on Coin, so looking for some tool. I know it might be madness to do technical analysis on MF, but I don’t want to see a draw down like 2020 and instead withdraw funds when the market starts correcting.

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Not aware about charting tools/service that supports MF data. However, I use 20, 50, 200 DMA in Portfolio Tracker (Google Sheet) using Google Finance formula.

I have extracted that Stock, ETF, and MF price tracker in a separate Google Sheet for everyone where one can track 5, 20, 50, 200, and 10 months SMAs. Check this out if that sounds useful Stock & MF Tracker by Manaday Mavani v20230919-01 - Google Sheets.

You need to make a copy from the “File” menu to your Google Drive to make any changes to it. :grinning:

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In this example its assumed that its one-time investment. The benefit is evident … drawdown is neatly managed for this investment.

Practically, investment is not one time event.
Typically, We invest during our “earning” phase continuously and start withdraw during “post-earning” (retirement) phase. In “post-earning” phase drawdowns hurt us very badly. So, the benefit of technique mentioned by you in “post-earning” phase is clearly visible.

However, let us focus on “earning” phase. Since we are accumulating wealth, we can (in principle) weather down drawdowns for better returns. Also, we have some money to invest every month, so we will need technique which allows periodic investment.

From post it appears that you have setup where simulation/back testing can be done easily. Can we take contrarian view and analyse results.

Proposed approach will be… Say X is max amount I can invest. Every month, see how much fund NAV is down from 52 week high. Invest in proportion difference from 52 week high. (Say if today’s drawdown is 2%, will invest 20% of X, if drawdown is 5%, will invest 50% of X). This way more the drawdown you see, more you will invest in that month. Effectively In case today’s value is equal 52 week high, do not invest .

@KirubaKaran
If you can run simulation on HDFC TOP 200 fund, what will be in max drawdown and what will be XIRR (since CAGR may be meaningless) for the same study period where you applied MA10 technique. It will be good insight about how to invest during “earning” phase.

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Instinctively i would expect this appraoch to not have done well over the last decade.

In a bull market,
someone following this strategy,
would inevitably end-up sitting on a huge pile of cash without investing it.

Right? :thinking:

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spot on :slight_smile:
The original post has only one time investment so was thinking how it can be improved further, when we are in earning phase. Still point you made is valid.

Currently we are discussing backtesting of a strategy. once we understand average cash pile left unutilized, it can be used for SIP of that amount. I believe ICICI Direct “smart SIP” uses similar strategy to ensure there is no cash pileup.

Anyhow lets wait for backtesting results from @KirubaKaran

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You tweak the rule by adding only on Nifty red day even if it is in 52W high zone.

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why take all the pain monitoring everyday the index, than periodic SIP for over a decade or so? Invest in dips may be gives 3-4% gains above the periodic SIP set and leave for a decade, isnt it ?