Analysis: Index PE based Mutual Fund SIP Investing

Here is an analysis of a mutual fund SIP investment in which purchases are systematically 'timed' using an index PE.

I made this analysis following the suggestion of ET Wealth analyst/columnist Dr. Narendra Nathan (@drnarendranET) after (or amidst!) some fierce discussion over the usefulness of the SIP.

The SIP is a useful way to invest (something I have been doing for close to 8 years and intend to continue). However, we must recognise that there is a conflict of interest when a salesman says 'do not stop your SIPs' and 'do not time the market'! For the AMC and the distributor, the SIP is a way to obtain constant income.

Dr. Narendra Narthan's point is that the investor could do better if the Index PE is used as a guideline to 'time' investing. I had earlier written about this: Are Mutual Fund SIPs Suitable for Disciplined Long-Term Investors? where I refer to systematic PE based investing as SI-PE.

I write this post with a huge amount of trepidation. Running a backtest is quite easy. All it requires is interest and some Excel skills. Is it however, responsible? I am inclined to say no, especially because I tend to get emails that go,'you wrote XYZ on abc date and I started to invest like that'. I  do not have the health to emotionally handle that!

That said, it is also incorrect to not publish an analysis and present it as an 'alternative' with an open mind. That is all the following is.

THIS POST IS NOT A RECOMMENDATION TO STOP YOUR SIPS. I will not be held responsible if your investing habits are influenced by it.

Index PE based Mutual Fund SIP Investing

While the debate on SIPs was unfolding on twitter (my handle is @freefincal), Balaji Swaminathan was conducting an independent analysis on the Sensex PE. Therefore, I used his insights for the following study:

Franklin Prima Plus fund was chosen as the example of a diversified equity fund (across caps and sectors).

Franklin Dynamic Accrual fund was chosen as an example of a diversified debt fund (it has recently become more of a credit opportunities fund with only corporate bonds)

Analysis period: April 1997 to Feb 2016.

Monthly investment: Rs. 1000

Sensex PE rules: 

PE >20, invest 100% in debt fund

PE <15, invest 100% in equity fund

15<PE<20, invest as per asset allocation (60% in equity fund and 40% in debt fund).

No fund switching or rebalancing was considered to avoid tax and exit load issues.

SIPE-3
Sensex PE is wrt right axis

SIPE-2 SIPE-1

Here the 'timing value' represents the results of SI-PE  and 'AA value' represents SIP with asset allocation: AA-SIP

It is not surprising that SI-PE has resulted in a larger corpus

SI-PE (Equity corpus): 17.76 Lakhs XIRR: 23.1%

AA-PE (Equity corpus):  15.2 Lakhs XIRR: 22.1%

Considering the amount invested, that is a significant different in corpus.

SI-PE (Debt corpus):  2.24Lakhs XIRR: (cannot be calculated*)

AA-PE (Debt corpus): 2.02 Lakhs XIRR: 7.93% (before tax)

If you think that is a big difference so be it. The way I see it, the extra corpus did not come free. You had to work for it. Easy to claim that PE is easy to track etc. but it is still non-zero time and effort.

Therefore, considering the completely automated way of investing, SIP has done quite well.

* XIRR sometimes cannot be calculated! Read more: IRR/XIRR – Excel – Limitations of Calculating Complex Cash Flow Returns

Wait just a minute!

The SIP duration above was 19 years! We don't have enough data to perform a rolling SIP return analysis. So how about a 10-year SIP.

Franklin India Prima Plus
That looks like it is heading south fast!
Franklin-Dynamic-accrual-fund
SIP returns vary even for a debt fund!

Rolling AA-SIP vs SI-PE analysis (10 years)

SIPE-5

SIPE-4

For some intervals, the SI-PE XIRR could not be computed. So clearly SI-PE is superior to AA-SIP. It is worth the effort though?

At least for the assumptions made here, SI-PE returns are as volatile as AA-SIP returns. So timing the market (in this instance) does not reduce rolling SIP volatility.

There is a clear and definite benefit of investing based on the index PE values (you can choose index you like - perhaps BSE or NSE 500 to get a broader market perspective). However, there is also an effort and discipline involved. Quite easy to backtest. Not so easy to implement in real life.

To be fair, the good old SIP does not fair too poorly at all.

Wait a minute, how about

PE >22, invest 100% in debt fund

PE <15, invest 100% in equity fund

15<PE<20, invest as per asset allocation (70% in equity fund and 30% in debt fund).

No fund switching or rebalancing to avoid tax and exit load issues.

SIPE-6

Results are not too different!

We must recognise that these PE limits are based on limited hindsight and we could be wrong.

In this study I changed the asset allocation of the amount invested alone. Perhaps I should have changed the asset allocation of holdings. Perhaps I should not have invested in the debt fund and waited for PE to correct and then invested as a lump sum. Perhaps, perhaps, perhaps ....

Can I make significantly reduce return volatility associated with  the SIP by 'some timing method'? I won't bet on it.

I still think that a SIP done with asset allocation in mind, with periodic reviews and de-risking prior to a goal will work. 'Timing' is likely to provide a higher corpus and better returns, but at a price.

At the end of the day it is 'personal' finance. However, it should not be 'clouded' by conflict of interest in the name of behavioural finance, if can catch my drift...

My key takeaway: If I want to reduce portfolio volatility, I must change the asset allocation of existing holdings. I want only higher returns but with same volatility, change only asset allocation of future investments, and do not touch existing holdings.

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14 thoughts on “Analysis: Index PE based Mutual Fund SIP Investing

  1. Kamal Garg

    Normally an active review of any portfolio whether comprising of direct equity or MF, should give a better return, of course at a cost of time and money at that particular point of time.
    Have seen few people who do not have any SIP, but continue to invest total roughly same amount in different tranches whenever market tanks by , say, more than 1000 points (sensex). Their return has been better.
    Of course it requires active participation and management of your portfolio.

    Reply
  2. Raj

    By viewing the charts and corpus accumulated it is easy to say that SI-PE works great and is in favor of investors but as you said it right it doesn't come without time and most importantly one needs to be disciplined to invest the right amounts as planned.

    Many people fail in execution if he/she is doing manual investments, automated way will help us in inculcating the discipline.

    #this is what my experience with investments have taught me.

    Reply
  3. nitin

    PE<15 is a bit more. Can you share the excel you used to calculate? How about PE<16.5 or 17? It is important to be in the market for significant time too and PE<15 takes away that by a significant margin. Another thing would be, using 100% allocation to either debt and equity when PE remains in between its low and high trigger.

    Reply
    1. freefincal

      come one man! We can always fine tune past data! There is no telling which would be better for the future - 15 or 16.5! That is all that matter. I have this Excel will spurce it up and bit and post it.

      Reply
  4. Jagan

    Pattu, thanks for the analysis. I too have though abt this strategy and it might not be so much time consuming since PE 22 has happened only about 6-7 times in last 15 or 20 yrs(dont remember exact figures but can help u with such analysis link if required)

    But my question is this:
    In PE based MF investing we generally say that, for instance,
    if PE 22
    move all ur money in debt --My question is with this
    else if PE >15 but 22 and I move my money into safe debt instruments(say debt MF), then wont Tax(debt inst. have LTCG taxes 🙁 ) hurt me in terms of eating into my returns when I redeem my Debt MF and move 100% into equity when PE 22 and investing back into equity when PE < 15 and even with debt taxes(inflation indexed) is win win then I think it shud nt be a hassle since such PEs happen so rarely.

    Reply
      1. Jagan

        So you are saying that the strategy that move all your money into debt funds when PE is more than 22 and invest money from debt into equity when pe is less than 15 will be a useless strategy after all since LTCG even if inflation indexed will give me negligible returns since LTGC will eat away the gains I make on equity. If so then this is exactly what I thought also. I dont know why many financial blogs/sites suggest such a strategy.
        But then a corollary question is why we ask people to move their investments into debt when they are nearing their retirement from equity to safeguard the profits made? When they try to withdraw from those debt funds post retirement to fund their living, wont the same loss happen since a) debt funds have 3 yrs lock in b) post lock in returns are also taxed. So what should one do according to you?

        Reply
  5. Satish

    This whole SIP logic is based upon the statement "past performance IS an indicator for future performance". Pattuji can u pls see if it possible to do this same analysis for a young japaneae student inveating in the Nikkei at 40000. The interest rate too is a bit low as compared to india. But this analysis would be nice. And who is to say that we r not at 40000 nikkei.

    Reply
  6. Senthil

    Thanks for the nice article.
    Principal Smart equity fund is based on the same principle of investing based on PE. Since monitoring and tracking are complex can we do SIP in Direct Plan of this fund? Please suggest.

    Reply
  7. Pradeep A Gowda

    What if we exit the equity market at PE 22 and sell all the funds.
    Then move that money into into 3-4 different arbitrage funds instead of Debt funds?
    Move back when the PE comes down to like 15.

    The discipline to save money should still be there though.

    There are also these Dynamic PE funds too.

    Reply

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