By Srikanth Meenakshi, Shankar Bhatt/FundsIndia.com

A RELATIVELY new method of making periodic investments for regular investors has caught the interest of financial advisors and the investing public. This new method, called Value-averaging investment plan (VIP) is a close cousin of the Systematic Investment Plan (SIP).

Difference between SIP and VIP
The main difference between the approaches is that in VIP the monthly amount of money invested varies according to a formula as opposed to SIP wherein the invested amount remains constant.

Internationally, the VIP method has been implemented successfully using, primarily, mutual funds. It has out-performed comparable SIPs yielding, according to published results, 1 per cent better IRR.

We set out to test the premise of VIP out-performance in the context of Indian mutual funds. One mutual fund – Benchmark funds – has already implemented this method with one of their funds (an index fund), with promising results.

Here, we present our results with a broader set of managed equity funds and suggest a couple of ways an investor can implement the protocol themselves for their portfolio.

About Value-averaging investment plan
This basic premise of this method - designed in 1988 by Michael Edelson, a professor at the Harvard University - is that money is invested in periodic intervals in a portfolio in such a manner that the portfolio value keeps tending towards a pre-determined value based on a target rate of return. Since a portfolio might grow in a particular month, and shrink another month, the targeted value for the portfolio might come nearer to or recede farther from the actual value. The subsequent investment tries to compensate for this movement by investing less or more in the portfolio. The idea is to keep the value of the portfolio at an average value during the tenure of the investments, and hence the name.

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An example: To establish a VIP, we need to decide on a few parameters:
1. An investment vehicle, say, a mutual fund scheme
2. A starting amount to invest
3. A minimum amount for the periodic investments, could be zero
4. A maximum amount for the periodic investments
5. An expected rate of return.

Let’s assume that we choose to invest in mutual fund scheme A with a starting amount of Rs 5000. We intend to invest a minimum amount of Rs. 1000, and a maximum of Rs 10,000 every month. Let’s fix the expected rate of return is a healthy 15 per cent annually.

Now after making the first month’s investment of Rs. 5000, we wait a month and come back the next month to see how much to invest. Suppose the investment has grown by 2 per cent over the course of the last month. The value of the portfolio is now Rs. 5100. The expected value at the one-month point, however, is (given the target return of 15 per cent), Rs. 5063. Hence, the value of the investment is Rs 37 more than the targeted value. Consequently, the current month’s investment would be Rs 5000 – Rs 37 = Rs 4963.

Similarly, if the investment had decreased in value by say, 10 per cent, in the past month. The value of the portfolio is now Rs 4500. The expected value remains the same, at Rs 5063. The current month’s investment would try to compensate for the loss of value by investing Rs 5563.

We would do this continuously month after month taking into account the growth target for the portfolio, and the actual value of the portfolio at that time point. If the investment vehicle chosen for implementing this method is a well-diversified equity fund (as we do later in this article), the growth of the portfolio value will co-relate to the movement of the broader stock market. Hence, essentially, the investor ends up investing more when in a sliding market and less in a growing market. Over the long run, assuming the equity markets generally trends upwards, this process holds the promise of better return over an equivalent SIP.

Illustration: Vaibhav Shirke


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