The glide path for your equity allocation

Previously in this column, we discussed asset allocation funds. One of the main features of such funds is the glide path. In this article, we discuss the importance of glide path in the professional management of such funds.

Slide rule

Picture a slide in a play area. Next, imagine a child climbing the steps and reaching the top of the slide only to gently slide down to reach the ground. Now, think of your equity allocation. When you start working, you gradually increase your equity allocation, just like the child climbing the stairs to reach the top of the slide.

You typically reach the top of the slide (maximum equity allocation) at age 45. That is when you should have an equity allocation of not more than 70% in your retirement portfolio. From then on, you must reduce your equity allocation (slide down) till you reach age 55 and then maintain the allocation till your retirement, presumably at 60. This process of reducing your equity allocation as you approach retirement is referred to as the glide path. Target date funds in the US adopted the glide path to reduce portfolio risk for investors approaching their retirement. Your retirement portfolio will have a large value as you approach retirement. Therefore, even a 15% price decline can be harmful for your portfolio. The glide path is a way to reduce this risk by cutting equity exposure and moving the sale proceeds to bonds.

Conclusion

The NPS applies the glide path for the auto allocation option. More recently, SEBI has allowed asset management companies (AMCs) to offer lifecycle funds that also adopt a glide path. According to the SEBI regulation, lifecycle funds that have 15 years to target date can have between 65 and 95% in equity. This allocation should drop to between 50 and 65% when the target date is between 5 and 10 years, and to 20% or less when the target date is less than one year.

The range of glide path enables product differentiation among AMCs. A more aggressive fund will have higher equity allocation, dropping from 95% with 15 years to target date to 65% when the target date is 5 years away. A conservative fund may have a lower allocation, say, 65% 15 years to target date to 50% when the target date is 5 years away.

(The author offers training programmes for individuals to manage their personal investments)