Tactical Allocation

Can you have your cake and it eat it too?

“You've got to know when to hold 'em
Know when to fold 'em
Know when to walk away
And know when to run.” - ‘Gambler’ by Kenny Rogers

Assume you started investing in 2004 with 100 Rupees in stocks. Instead of picking stocks, you just invested in the front-line Index, Nifty 50, which comprises of the top 50 companies In India.

This is how you would have done:

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Nifty Performance From March 1 2004 to Today

• Total Return: 549.85%

• Annualized Return: 12.68%

• Largest Drawdown: -58.45% (2008)

• Second Drawdown: -34.34% (2020)

• Third Drawdown: -25.92% (2011)

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That 100 rupees you invested in 2004 would have become 649 rupees today, translates to 12.68% annualized return, which is not bad. However, you would have had to stomach very high volatility and experience losing as much as 58% of your portfolio, which can lead to many to lose asleep and that’s no way to live.

So last week we prescribed, a 50% Allocation to Equity and 50% allocation to Debt portfolio to help cushion the volatility in markets.

The cost of being able to sleep more peacefully is trading away potential to earn more returns. Can there be a better way to capture more of the upside?

Tactical Investing

A tactical approach would mean structuring your portfolio in a way to increase or reduce exposure to riskier markets i.e equities in this instance, based on perceived market conditions.

Today, we will explore two easy strategies to see if this approach makes sense.

200 Day Simple Moving Average (200 SMA)

A 200 SMA is average price of last 200 days of an asset. 200 days is nearly a year and therefore can be a useful indiactor to determine the long term trend of an asset. If price of an asset is above the 200 SMA it is believed to indicate that the asset is experiencing an uptrend.

So what would happen if we only invested in equities i.e Nifty when it was above the 200 SMA and we exited it when it fell below the 200 SMA indicator to invest in bonds.

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• Total Return 726.43%

• Annualized Return 14.26%

• Largest Drawdown -28.68%

• Second Drawdown -24.50% '

• Third Drawdown -15.38%

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So that 100 rupees would have become 826 rupees with an annualized return of 14.26% by just using a simple and easy to calculate indicator. The higher return also comes with a maximum loss of -28.68%, which is much lower than -58% of just investing in Nifty.

So this makes more sense whichever way you look at it.

50 Day simple moving Average (50 SMA)

The 50 SMA is used to determine the short-term trend of an asset . The reason why this might be useful is that it might provide a better cushion from falls in the market.

Let’s see

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• Total Return 844.01%

• Annualized Return 14.81%

• Largest Drawdown: -26.92%

• Second largest Drawdown -17.19% '

• Third largest Drawdown -16.93%

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Investing based on the 50 SMA trend did very well. A 100 rupees invested in 2004 in this strategy would be worth 944 today versus 826 in 200 SMA and 649 in just buying and holding Nifty. With much less volatility than the other two

So why is this not more popular? It’s easy to implement but hard to follow a strategy that requires discipline. To be not swayed by CNBC and our own emotional biases.