Comparison between the performance of Dynamic Asset Allocation and Strategic Asset Allocation Model in Indian market

Comparison between the performance of Dynamic Asset Allocation and Strategic Asset Allocation Model in Indian market

By INDHUPRIYA P (1^st year MBA, VIT BUSINESS SCHOOL)

YASWANTH KUMAR S (1^st year MBA, VIT BUSINESS SCHOOL)

ABSTRACT: Investment intends to utilize your cash to get more cash-flow. Anything that generates a return is an “investment”. This means even your savings account generating 3.5% interest is an “investment”. We as individuals, invest to meet our financial or retirement goals. The first and foremost requirement from our investment avenue should be such that, the return from our investments should at least meet or exceeds the inflation rate. The inflation rate specific to the goals.

The next consideration should be of proper asset class diversification, where the saying goes, “don’t put all your eggs in one basket”. This is very true for investments as well, a prudent investor, would need to diversify the investment avenues and have a proper asset allocation model. An important choice, before the investors are what should be the asset allocation strategy, should it be based on market timing, which involves buying the market is cheap and selling when the market is at high. The alternate to this method, is the asset allocation based, life stage of the investors. The former method is referred as Dynamic Asset Allocation model (DAA) and the later Strategic Asset Allocation model (SAA).

In our paper, we cover the performance of DAA model vs SAA model, in Indian context.

ASSET CLASS DIVERSIFICATION- An introduction

An Asset Class is a process of grouping of investments which has similar characteristics and behaviours in the market place. The practice of spreading money among different investments to reduce risk is known as Diversification.  

Asset allocation and diversification go hand in hand that diversification reduces the fluctuations of investment returns. Asset allocation is important because it has major impact on meeting financial goal, if you don’t take enough risk no return.

Asset class is important because it helps in risk minimization like investing as fixed deposits this involves zero risk (market risk or fluctuations in prices). It also helps investments align as per Time horizon, longer your time horizon, the more you can tilt your asset allocation such as equity works well when you invest for the long run as they have historically delivered high returns and rising above inflation.

Purchasing gold or commodities-the price can rise or fall as per the demand, buy when the prices decrease and sell when the prices increases. It helps in optimal return like real estates and cash and cash equivalents.

Strategic Asset Allocation (SAA):

This involves setting target allocation for various asset classes, based on the life stage of the individuals and it also rebalances periodically. It moves funds from over-performing asset classes to under performing asset classes. It helps to achieve long term targets and it is mostly used in mutual funds, index funds and hedge funds. In our study, we had adopted for the SAA model based on investors age.

Strategic Asset Allocation depends on 3 important factors such as

Ø Investor’s risk tolerance

Ø Time horizon

Ø Investment objectives

Dynamic Asset Allocation (DAA):

Dynamic asset allocation is a portfolio management strategy that frequently adjusts the mix of asset classes to suit market conditions. And the adjustment involves reducing the positions in the worst performing asset classes adding to best performing asset classes. The main premise of DAA is to respond to the current risks and downturns and take advantage of trends to achieve returns that exceed a targeted benchmark. There is no target asset mix.

Dynamic Asset Allocation ensures the following:

Ø Highest exposure to momentum.

Ø Exposes portfolio to multiple asset classes to manage risk.

Among these two models, Dynamic Asset Allocation (DAA) model can be adopted to asset allocation as for investors wanting marginally lower risk and stable risk-adjusted returns. The allocation ratio will be varied between the asset classes, based on the risk associated with them.

In our study, we looked at NIFTY 50, price earnings multiple, as a proxy, if the market is cheaper, defined an asset allocation model, based on the NIFTY 50 P/E multiple.

PROCEDURE:

SCENARIO 1:

In scenario 1, an individual invests an amount of INR 1,00,000 based on both SAA and DAA on January 1999 to till now (2020). There is no periodical inflows and outflows. The asset classes which are used: Equity, corporate Bonds, government Securities and gold.

The rebalancing model of SAA, is based on the age of the individual. At January 1999, the age of the individual was 24. The strategic asset allocation model of SAA is given below: 

Age	Allocation in Equity	Allocation in Corporate Bonds	Allocation in Government Securities	Allocation in Gold
18 years – 36 years	50%	30%	10%	10%
From age 37 – 45 years	30%	20%	40%	10%
From 45 years to 50 years	20%	15%	55%	10%
From 50 years to 55 years	10%	10%	70%	10%

The rebalancing model of DAA, is based on the price to earnings multiple (or PE level). The dynamic asset allocation is given below:

Nifty Index PE Level	Allocation in Equity	Allocation in Corporate Bonds	Allocation in Government Securities	Allocation in Gold
Less than 16	80%	10%	0%	10%
From 16 to 19	60%	20%	10%	10%
More than 19	20%	40%	30%	10%

Based on the individual's age and P/E multiples, the investment amount is allocated to each asset at certain proportions. At the end of each year, the return on investment are rebalanced and this process is continued till 2020. Thus, the overall return on investment is calculated, under the SAA model and DAA model.

SCENARIO 2:

In scenario 1, the amount of INR 1,00,000/- is invested in the starting stage and there is no cash inflow and outflow between the period. In scenario 2, the amount of INR 10,000/- is invested monthly at the first year (1st January 1999). Then the investment value is increased by 10% of the amount i.e., at 1st January 2000, the investment amount will be INR 11,000/-. There is no lump sum in this scenario. The rebalancing will happen only at the end of the year.

The distribution of the fund between NIFTY 50 (Equity), Fixed deposits, government securities and gold, are based on the individual’s age for Strategic asset allocation model and P/E multiple (performance) for dynamic asset allocation model. The rebalancing of asset allocation for both the models (SAA & DAA) is same as the scenario 1.

FINDINGS:

Scenario-1:

For SAA, the allocation is done based on the age of the investor. At the end of age 45 (2020), the total amount of return is INR 7,02,643.44/-. The overall return in terms of percentage is 7.026 times more than the initial investment.

For DAA, the allocation is done based on the performance of the assets. At the end of February 2020, the total amount of return is INR 18,35,569.12/-. The overall return in terms of percentage is 18.35 times more than the initial investment.

END OF THE YEAR	RETURN IN SAA (INR)	RETURN IN DAA (INR)
1999	136667.687	154147.52
2000	126417.9464	153715.94
2001	122081.05	162013.29
2002	130263.14	170423.08
2003	180173.53	269192.53
2004	190324.92	272889.37
2005	227617	352222.49
2006	284540.44	452058.44
2007	369286.79	517402.95
2008	302930.29	532635.76
2009	419510	853117.47
2010	472529.15	917020.02
2011	440031.58	921434.31
2012	495472.66	1107499.21
2013	494496.69	1153728.04
2014	558144.24	1391582.44
2015	556968.55	1416819.86
2016	591591.02	1511566.72
2017	633418.69	1606468.8
2018	650859.99	1668778.27
2019	707737.2	1815059.21
FEB, 2020	702643.44	1835569.12

Scenario-2:

For SAA, the allocation is done by the age. The investment amount is increased by every year. The total return is INR 1,64,01,893.5/-.

For DAA, the allocation is based on the P/E multiple. The total return from the investment is INR 2,09,81,936.92/-.

END OF THE YEAR	RETURN IN SAA (INR)	RETURN IN DAA (INR)
1999	140744.97	150125.62
2000	257423.52	258860.41
2001	393882.7	380246.35
2002	589452.6	568737.98
2003	1047565.9	1160911.94
2004	1301434.81	1440111.49
2005	1802433.05	2121279.73
2006	2521029.54	3155169.21
2007	3585333.59	4834257.51
2008	3176926.27	3310167.75
2009	4776721.94	5712945.57
2010	5757803.47	7031524.82
2011	5728017.6	6315002.97
2012	7220189.65	8319412.45
2013	8052599.09	9239706.01
2014	9721212.33	12088699.22
2015	9366901.12	12289796.08
2016	10505384.92	13429309.9
2017	12827197.85	17275503.4
2018	14176325.56	18829590.35
2019	16593379.79	22089951.61
FEB, 2020	16401893.5	20981936.92

CONCLUSION:

SCENARIO-1:

Since the total return in DAA is greater than return in SAA, we would recommend to use the Dynamic asset allocation model. In DAA, people will look upon the previous year performance of an asset data, instead of seeing the age of the investor and they will frame their distribution of funds. So, DAA will give us more return and low risk than SAA.

SCENARIO-2

The total return in DAA is greater than the total return in SAA. Thus, we would suggest to use the dynamic asset allocation model, if we are investing in annuity format. In DAA model, the allocation of funds is based on the market price and performance of the asset.

ASSUMPTION:

   v The Taxes are excluded.

   v We are considering only 4 asset classes.

   v There is no cash inflow and outflow in scenario-1.

   v Debts are not included.

  DATA USED:

    1.   NIFTY 50 P/E multiples from 1^st Jan 1999,

    https://www1.nseindia.com/products/content/equities/indices/historical_pepb.htm

    2.   Corporate Bonds - SBI Historical fixed deposits rates. (Source from SBI Website)

     3.   Government Securities – NIFTY 10 Year Benchmark G-Securities (Clean Price) data.

   https://www1.nseindia.com/products/content/equities/indices/historical_index_data.htm

4. Gold rates source from RBI Website.