Index Alpha – “Core” portfolio for the Long Run

“There are three kinds of investment risk. Two can be virtually eliminated. The third, market risk, must be managed.” – Charles D. Ellis

2001 – Winning the Loser’s Game, 3rd edition

Executive Summary

Index Alpha is a managed portfolio solution of index funds/etfs that aims to deliver equity like returns with bond like volatility and drawdowns over the long term i.e. provide improved risk-adjusted returns[i]. This can therefore be a low risk “Core” portfolio for most investors looking to build wealth over the long run with lesser volatility and drawdowns.

The three pillars on which this portfolio solution is built is:

  1. Bridge investor ‘Behavior Gap’ which costs investors approximately 4% p.a.[
  2. Build investment discipline by process driven systematic investing and risk management
  3. Use low cost, transparent and easy to understand passive investment products like index funds

Index Funds have been advocated by Nobel Laureates like Paul Samuelson to renowned investors like Warren Buffett and Ed Thorpe as the best vehicle for investors to capture long term equity returns. It is well documented now by S&P’s research that majority of mutual funds, globally and in India, are unable to beat their benchmarks. Hence, odds of choosing an out performing mutual fund are worse than a coin toss. You can also read our study on this here

What does Index Alpha portfolio solution do?

Sometimes during a match, the weather turns bad and play is called off by umpires. IndexAlpha portfolio solution is like that umpire who keeps an eye on match conditions like the pitch, light, weather conditions etc. and they impose certain restrictions or stop play when the weather is bad or for other reasons, play cannot take place. Similarly, when financial markets start showing signs of turbulence and downtrend, Index Alpha’s portfolio solution which is based on a tactical asset allocation system starts reducing equity allocation and takes cover until good conditions or an uptrend resume. As you can see in the table below in times of high market turbulence, Index Alpha portfolio solution has had much lower drawdowns than the market and consequently has also recovered faster.

Peak to trough drawdowns during severe market downtrend and turbulence

This is because of the tactical asset allocation model over a portfolio of Nifty 50 and Nifty Next 50 which will give index like returns with lower bond like volatility and lower drawdown than a buy and hold Nifty 50 strategy

*Summary Statistics from 2003-2009 (March)
Equity Curve from 2003 to 2009 (March)

How do I use Index Alpha?

  1. It is a tool to manage portfolio risk. It will protect the portfolio from extreme drawdowns and from tail risk events. However, in sideways markets there will be whipsaws, or false positives. It is not a tool to enhance returns by timing the market.
  2. Over a cycle, protecting downside risk will help in enhancing returns if one sticks to the process. It is not a technique that will lead to outperformance in. In fact, it may underperform during roaring bull markets or sharp V-shaped recoveries.
  3. It is a simple to understand but tough to follow, over long periods, portfolio solution driven by tactical asset allocation.

(Written by Anish Teli, Portfolio Manager with contributions by Aayushi Shah, Quantitative Analyst)

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Source: Nifty 50 TRI Data. Past performance is no guarantee of future results. Chart is provided for illustrative purpose and reflects hypothetical historical performance. Please note that there are inherent limitations associated with back-tested performance.

[i] 2014 – A Quantitative Approach to Tactical Asset Allocation by Mebane T Faber