A few readers of my previous post have said that I was wrong in suggesting that all funds are equally suitable for a SIP. According to them, if an investor who is proposing to start a SIP, had to choose between two funds, he/she would be better off choosing the fund that is likely to be more volatile (i.e. the fund that is likely to see greater fluctuations in its NAV).
This is not the first time that I have heard this argument. Over the years, I have heard many advisors voice a similar view. Unfortunately, this is a flawed perspective that is, paradoxically, the result of intelligent thinking. In this post, I propose to clear the air on this. But since this may not be easy to explain or even follow, let me first cut to the chase, and state my position:
a. There is no conclusive or compelling evidence that supports this argument.
b. Pursuing such a strategy can potentially have disastrous consequences if one is forced to redeem one’s investment in a bear phase.
If you’d like some elaboration on this, do read on.
Let me start by questioning the mathematical validity of the volatility argument, if I may call it that. Imagine, if you can, two equity funds that, over a certain period, start with an identical NAV, and end with an identical NAV. Let’s further assume that, over this period, these funds have an identical average NAV. This may be a hypothetical scenario but it is one that immensely favors the volatility argument. If the argument truly has merit, then in such a scenario, an investor opting for a SIP in both funds, should always gain more in the more volatile of the two funds. Yet the fact is that even in such a favorable scenario, there is no certainty that that will happen.
For those who prefer empirical evidence, I’d like to present some data on three of the oldest equity schemes in the country. The table below gives the data for the period from April 2012 through March 2015. All the data has been taken from the fund factsheets.
| Apr 2012 - Mar 2015 | Fund A | Fund B | Fund C |
| Standard Deviation* | 14.2 | 16.5 | 15.8 |
| Fund Return (p.a.) | 18.6% | 17.1% | 34.9% |
| SIP Return (p.a.) | 24.9% | 25.2% | 35.2% |
*Standard Deviation (SD) is a measure of volatility. The higher the SD, the more volatile a fund.
Over this period, Fund B was more volatile than Fund A, and despite its lower return, an investor opting for a SIP would have gained more in this fund than in Fund A. One may say that this data supports the volatility argument. However, when we compare Fund B with Fund C, the picture appears to be somewhat different. Fund B was also more volatile than Fund C but an investor opting for a SIP would have gained less in this fund than in Fund C. One may think that this was because of the much higher return of Fund C over the period. But before drawing any conclusions, let’s look at the data for the preceding 3 year period.
| Apr 2009 - Mar 2012 | Fund A | Fund B | Fund C |
| Standard Deviation | 22.5 | 27.9 | 28.3 |
| Fund Return (p.a.) | 27.9% | 26.7% | 34.6% |
| SIP Return (p.a.) | 8.8% | 4.5% | 9.3% |
This period was marked by a significantly higher level of volatility across all funds. Yet when you look at Funds A & B, despite a much higher return over this period (compared to Apr 2012 – Mar 2015), an investor who opted for a SIP in these funds over this period would have gained much less than a similar investor in these funds over the subsequent 3 year period. Fund C had almost the same return across both periods but here, too, an investor who opted for a SIP over this period would have gained much less than a similar investor in this fund over the subsequent 3 year period. Clearly, the volatility argument does not hold good.
You may also note that during this period, Fund C was more volatile than Fund B. However, in the subsequent period, Fund B was more volatile than Fund C. Thus, even if volatility were to matter, to whatever extent, historical volatility of a fund (absolute or relative) can be no indicator of future volatility. Just to be clear, the investment objectives of these funds did not change over these years. In fact, these are among the most consistently well-managed funds in the industry.
Let me now flip back another three years to a period that highlights some of the risks of investing in highly volatile funds.
| Apr 2006 - Mar 2009 | Fund A | Fund B | Fund C |
| Standard Deviation | 28.4 | 31.5 | 33.2 |
| Fund Return (% p.a.) | -3.1% | -2.7% | -17.5% |
| SIP Return (% p.a.) | -13.9% | -13.7% | -30.2% |
To put these numbers into context, the value of a SIP over this period in Fund A or Fund B would have been almost 20% below the amount invested, by the end of the period. The value of a similar SIP in Fund C would have been almost 40% below the amount invested. So much for the volatility argument.
