The ups and downs of the stock market are a source of anxiety for many investors. It is more difficult to hold on when the market is down than to make good profits in good times. This emotional challenge is what keeps many people away from investing in stocks. But for those who want the growth potential of stocks but don’t want those dramatic swings, there is a category of funds. That is low-volatility funds .
These funds are once again attracting the attention of investors due to the recent market uncertainties. But does ‘low volatility’ mean ‘no risk of loss’? When do these funds actually help? Who are they suitable for? Let’s take a closer look.
What are low volatility funds?
As the name suggests, these are mutual funds that invest in stocks that fluctuate less than the general movements of the market. They may not rise as much when the market rises sharply. But they may be able to protect investors from a large fall to some extent when the market collapses. This is their main attraction.
Many low volatility funds in India are based on indices like the Nifty Low Volatility 30. This index consists of 30 companies that have historically recorded low volatility. Through this, fund managers try to provide a smoother investment ride.
But investors should be clear about one thing. Although these are less volatile, they are still equity funds. That is, the fundamental risks of the stock market apply to them as well. During a severe recession, the value of these funds may also decline significantly.
Why are these being discussed again?
Low volatility strategies are coming back into play as investors start to value stability along with growth. There are three main reasons why these funds are currently gaining attention.
1. Drama-free stock investing
Investors who entered the market after 2020 have seen extraordinary conditions. Lightning-fast rises and just as fast crashes. The emotional stress caused by these extreme fluctuations is as great as the financial losses. A stable investment approach can help investors continue to invest without faltering in such situations.
2. The relevance of stability in uncertainty
Low volatility portfolios typically include companies with stable earnings, strong balance sheets, and predictable business models. Stocks in sectors such as FMCG, healthcare, and utilities tend to be favored. Such ‘defensive’ stocks naturally gain traction during times of economic uncertainty.
3. Investor behavior is more important than numbers
This is one of the greatest truths in investing. It is better to invest in a fund that promises high returns and then panic and sell when the market falls, than to invest in a fund that may give a slightly lower return but allows the investor to continue with confidence. It is important to choose an investment that suits your psychology.
Some things to consider before investing
Before asking which low volatility fund is best, you should ask yourself whether this investment style is suitable for your portfolio and expectations. To do so, you can evaluate the following things.
- Costs: These funds rebalance their portfolio more frequently than regular index funds. This may result in a higher expense ratio and turnover. Check this before investing.
- Approach: Not all funds follow the same approach. While some select stocks with low volatility, others use a ‘minimum variance’ model that reduces the volatility of the overall portfolio.
- Limits of Protection: Low volatility does not guarantee that losses will not occur. It is important to understand that losses can also occur in deep bear markets.
- Sector Tilt: These funds often have a greater focus on one or two sectors, such as FMCG and healthcare. While this can be beneficial, it can also hurt the fund if a particular sector performs poorly.
- Market Regime Fit: These may perform well in choppy markets, but they may also underperform in strong bull markets where small-cap stocks are rallying.
- Return is not the only metric: Apart from looking at the past year’s performance, you should also consider things like rolling return, Sharpe Ratio (which shows how much return was given in proportion to the risk taken), and Drawdown (what percentage it fell from the highest value).
Who are these funds suitable for?
The following categories of investors may consider low volatility funds :
- Those who want to gradually move from debt investments like bank FDs and bonds to the stock market.
- Those who want to participate in the growth of the stock market without major shocks after retirement.
- Those who invest for medium-term goals like children’s education and buying a house and value stability in the market.
Who should avoid?
- These may be disappointing for those who invest only aiming for the highest return when the market is booming.
- This may be an added advantage for those who currently have a portfolio that is stabilized through conservative hybrid funds.
- If you’re looking for a magic wand that’s completely crash-proof, this isn’t for you.
The final word: Structure, not armor
Low volatility funds are not a new invention in the market. They do not provide a shield for investments, but rather provide a structure. They are a means of coping with market volatility, not a way to completely eliminate the risk of loss. Depending on your investment objectives and risk-taking ability, you can decide whether to include them in your portfolio. These may be a relief for those who lose sleep over the volatility of the stock market.
