must buy equities to bring the ratio up to 60%. The width of the band clearly determines
the extent of trading that takes place. If we set too narrow a band, we will be buying and
selling at almost every fall or rise in the market index and we will make money only for
our broker. If we set too large a band, we can stray too far away from the desired ratio.
The constant value plan on the other hand demands that a constant value be invested in
equities. We might start with a portfolio of Rs.100 with Rs.60 in equities and Rs.40 in
bonds. The constant value may say that we must have rs.60 in equities with a band of
Rs.5 to bring it up to Rs.60. this is more stringent than the earlier example of the
constant ratio plan; if equities have dropped to Rs.55 and bonds are unchanged at Rs.40,
then the total portfolio is only Rs.95 and the ratio is 55/95 = 58%. This is higher than
55% and the constant ratio plan will not be triggered.
Several modifications and combinations of these two plans are also available for those
who seek to make tactical asset allocation almost automatic. The better way of looking at
these plans is as aids to our judgment. Rather than blindly follow these plans, we should
treat the recommendation of these plans as buy and sell signals which we evaluate using
our judgment and view of the market.
Portfolio Insurance
In western capital markets, there is an alternative to defensive portfolios if one wants
protection against market slumps. Known as portfolio insurance, this technique lets the
investor protect himself against downward movements in prices while continuing to
benefit from upward movements. There are two routes to portfolio insurance:
- In developed economies, there are options markets where the investor can
buy put options. The put option allows the investor the right but not the
obligation to sell a security at a prespecified price at a prespecified date. If the
market goes down, the investor exercises the put option to get out of the scrip
without much loss. If the price goes up, the option is not exercised, and the
investor can obtain the benefit of the higher price. In India, organized options
markets do not exist as of now, but there is a distinct possibility of their being
permitted in the next few years. What is available in India is an informal teji-
mandi market in which a narrow range of very short term options are traded. This
market is unlikely to be of much use for portfolio insurance purposes. - The second route to portfolio insurance does not use options markets, but
relies on a dynamic hedging strategy implemented using program trading.
This method typically involves using a computer program to generate
trades designed to artificially replicate the effect of a put option. Program
trading has come under a cloud in the United States after the crash of
October 1987. In any case, its practicability and efficacy in Indian
conditions has never been demonstrated.