In terms of portfolio building, investors tend to focus on the core portfolio holdings which mainly comprise active strategies. However, there is an opportunity to make use of passive strategies in a tactical manner from time-to-time to boost overall portfolio return.
Understanding passive strategies
Passive strategy makes use of index funds and ETFs. These offerings are designed to replicate an underlying index in terms of constituents and proportion of weights, with minimal deviation. The units of ETFs are listed on an exchange and can be bought or sold just like a stock during the trading hours of the exchange. In general, the costs associated with passive offerings tend to be on the lower side since there is no active management and research involved.
Passives for tactical allocation
Tactical allocation is a dynamic investment strategy that actively adjusts a certain portion of a portfolio to improve the overall risk-adjusted returns. For example: If one believes that value style has been underperforming and is available at an attractive valuation, then an investor may consider allocating a small portion of the portfolio to a value based smart beta offering. Similarly, for a sectoral or thematic or a commodity allocation as well, one may consider a tactical allocation.
Following are the reasons why passive products are better-suited for tactical allocation
- Passive products track markets efficiently. Since indices get rebalanced at defined intervals, based on certain parameters, there is no time lost in tweaking a portfolio.
- Typically, the window of opportunity for tactical allocation tends to be a short one when it comes to specific themes and sectors. Hence, investing before the trend reverses is of importance. For instance, in the year 2018 and 2019, auto as a sector was a laggard. If an investor was of the view that the auto sector could revive in the future, one of the easiest ways to invest in this story would be through an auto index fund or an auto ETF. In this manner, an investor could have successfully tapped into the gains the sector has registered over the past three years. In effect, by using passives, one can go overweight on a sector basis one’s conviction.
- For allocation to commodities, ETFs route is a simple option available. For example, if an investor is of the view that silver can see a sharp upward movement due to global rise in demand for solar panels and other industrial uses for the metal, a tactical allocation to silver can be considered via silver ETF, instead of buying and storing silver bars (in physical form). By investing in ETF form, one can exit the position at ease as and when required.
- One can use smart beta funds to play on a market trend or a particular factor. For instance, if an investor is averse to market volatility but wishes for a measured exposure to equities, then such an investor may consider a factor based or smart beta investing based on low volatility as a factor. Here, one can opt for an offering based on Nifty 100 Low Volatility 30 TRI. Similarly, based on the market condition, a savvy investor can choose to take exposure to a variety of factor based offerings.
- Investing through passive offerings is a cost-effective way to tactically allocate and diversify the portfolio while gaining exposure to a broad range of market segment. In effect, passives emerge as an easy and efficient way to fire-power the portfolio to boost return.
(Chintan Haria is Head Investment Strategy at ICICI Prudential AMC)
