The Mutual Fund Show: How Multi-Asset Funds Help In Portfolio Diversification

Kalpen Parekh: Actually, I think we say that over a very long period of time, equity has been proven to be the best asset class, but only for a few countries. In fact, a couple of days back we published one data point for all the emerging market countries since the beginning of 2000. In their local currency accounts their equity markets actually underperformed in gold and this is actually a bit startling.

Now this has some start point and end point bias because 2000, was in a way a bubble peak for emerging markets and then they had sharp currency drawdowns. India has been one of the very few countries where there has been policy stability, there has been macro stability barring few years here and there because of which our currency has remained stable, and we have had good entrepreneurship where profits pools go back to shareholders.

In many emerging market countries, first of all, profit pools are shallow, or not consistently growing and they do not go back to shareholders. So, India has been in a way, an outlier, apart from U.S., where for long periods of time, equities have actually delivered 6 to 7% or rather 5 to 6% extra return over inflation. There's no point in looking at returns only in macro terms like 15% or 20%, ultimately how much more do we want over inflation is what matters.

So, India and U.S. have delivered very good long-term secular returns for their equity shareholders. But in this journey, this journey is laced with periods of 20 to 40% price falls in between. Every two-three-years there is a 20% price fall. Every seven to eight years, there is a 30 to 40% price fall, the reasons would be different. The reason could be international prices. It could be local prices; it could be currency net corrections. We don't know and I cannot forecast what the next reason also would be or when the next correction would be.

Now there are two types of investors, one who don't get affected whatsoever by these corrections, who in fact, enjoy these corrections, who rejoice in these corrections and were able to take advantage of this correction by actually investing more or looking through them. So that's the first group of investors for whom equity is the best asset class.

There is another group of investors who panic from corrections, who think that when prices are falling, I should get out of the market and actually they end up distracting or hurting their asset allocation or skewing it away from being in equity when prices actually have become cheaper.

So, asset allocation strategies, multi-asset allocation funds are suitable for the second group of investors and if we were to look at the entire universe of investors that we see investing in any asset class or in mutual funds, most of us tend to be the second group where we chase past performance.

There are very few investors who have the temperament or the resilience to live to equity fluctuation and valuations and which is why we feel for people at large asset allocation funds, multi-asset funds, offer a very disciplined way of investing in tomorrow's winning asset classes and not just in yesterday's winning asset classes. That is exactly the reason why we believe that till you do not become a pro at equity investing on your own, till you cannot digest fluctuation and volatility on your own, take advantage of multi-asset allocation funds.

Now what does multi-asset mean here, we also are introducing asset class like gold and global stocks in the portfolio and these two asset classes in the long-term have again given returns closer to what Nifty would have given over a full cycle, but they behave many times in opposite direction, they have low or negative correlation.

So, without compromising on the long term, accurate/absolute returns that each of these asset classes give, when you mix them, they actually increase the ability to withstand fluctuations, because they fall much lesser when markets go through sharp drawdowns, but they don't compromise too much and that is what I do multi-asset funds.

Kalpen Parekh: That is not diversification in the first place. Remember, when you are buying stocks, you are buying stocks period, whether they are large-cap, mid-cap, small-cap, that's not true diversification.

In fact, they give you the same risk of equities. When in 2008, the markets crashed, Nifty fell by 57%, small-cap index fell by 70%. So where is the diversification? So, when you are buying stocks, there is no diversification and when you are buying bonds, all bonds will fall more or less in the same pattern.

So, diversification truly means diversifying into asset classes which are actually friends of each other, which means they go in opposite direction at different points in time. So, the period from 2003 to 2007, equities, had a blockbuster move, Nifty went up seven times, small-cap went up 15 times but in those four years, interest rates actually rose back in India and bonds did not deliver and gold was just marginally going up.

From 2008 peak till 2013, Nifty first fell by 50% then doubled back, so it came back to the same value and in the next four years went nowhere. Six years of zero return, gold went up 350%. So, that's diversification and low correlation, when one asset class zigs, the other zags, they don't move in the same direction.

Yesterday, after the great victory that we had and when Mohd. Siraj took six wickets, I asked my son if you were to build a team, how many Mohd. Siraj, will you have and thankfully he did not say I want all 11 because that is not diversification in different types of scenarios. So, good diversification means that you will never own the best performing asset class only but it also means you will never end up owning the worst performing asset class completely.

So, it always will give you a middle of the pack returns and in some patches, it will give you the best return also, but the benefit of diversification is what Morgan House says beautifully, that it creates a design which allows you to stay invested for long periods of time and if you keep/retain assets for long periods of time compounding is taken care of and automatically the wealth creation happens.

The challenge with single asset class investing is we always change the asset class which has done well yesterday, but my money was not invested yesterday, I am getting invested today. So, when Nasdaq did very well in 2020, a lot of money went to global stocks and global funds but the next one year it underperformed, when small-cap and mid-cap is doing well today and money is coming today, it should have come one year back, two years back, only then will you want those returns.

I think these are not easy nuances for consumers to understand and which is why even mixing these asset classes in a certain proportion. 

Kalpen Parekh: So, the first thing that you said so even for me today let's say, my equity exposure has got tilted to 73 right now, ideally, I could rebalance it, if I had been disciplined. I may end up rebalancing it either out of laziness, out of you know being busy with a lot of other things or out of greed.

Right now, there is a greedy element inside me saying that run with the market, stocks are rising, flows are coming in, so I am justifying to my own self rationally or irrationally saying that let this asset allocation continue. So, I may not even do the right thing as I am supposed to do.

Whereas in a fund where there is a structure well defined, it says that whenever certain thresholds are crossed, rebalancing will have to happen without informing and that is the beauty of discipline that the structure will keep rebalancing whenever any asset class causes certain outlier returns in a current cycle.

Secondly, when I do it on my own or when we as investors on our own, we end up incurring transaction charges or tax cost and the loss of compounding on the amount of tax that gets calculated in every rebalancing. In the last few years what has happened is asset class cycles have also become very fast and short. So, a lot of times you may want to rebalance faster than in prior regimes.

So, all these rebalances, if you want to make them tax efficient, a mutual fund constructor allows you to do that, and gives you the benefit of scientific disciplinary rebalancing with reasonably low cost and superior tax efficiency.

Kalpen Parekh: Let me explain, in our design we created leeway to go to certain extreme points or only in extreme situations, but at large, we believe in discipline. We believe in structure, we believe in emphasising things upfront because we believe that discipline is superior to all of us as individuals while we are talented, we hope to always do better, but we are always learnt that discipline works better.

But portfolio stocks for example, let's say today to deploy the portfolio would have around 40 to 50% in Indian stocks, around 25% in global stocks, so collectively give around 70% weight to equities overall. But there are two types of equities, global as well as domestic and why does equity demand a better tilt, or a higher tilt is because generally in the long-term equities beat inflation or they give you real rate of return.

So, all points in time equities will be closer to around 60 to 70%. Only then because it is multi-asset it should do justice to other asset classes. So, gold minimum will be 10, bonds minimum will be 10. But at this point in time, we also believe that stocks generally are richer than what we would have loved them to be, valuations are higher than you know what gives us significant comfort from our safety point of view.

Instead of 80% stocks, you will be 60% stocks or maybe 65% stocks, the balance gap will get filled up by bonds and gold and why so because bonds yields have also risen in the last 18 months very sharply. We are very comfortable with Indian bond yields at 7.5% with a very balanced macro, bond yields are now giving us a reasonable cushion over inflation.

We have real rates of almost 2.5%, highest ever probably in this regime in across any country we have a reasonably high amount of real weight. Gold again as an asset class over the last 10 years has gone nowhere to go. The last one or two years it has done well but 10-year return of gold compared to equity is half, very low at 25 the equity has given very similar returns. So, in a way gold has delivered lesser than its potential and we would like to invest in asset class, which is currently earning lower returns so that when future returns come it is meaningful to be there in our portfolio.

So, it is comfortable right now to add 65-70 stocks, 15 bonds and gold. Let's say something like Covid happened and the market scratched by 40%, valuation are at 14-15 times or even cheaper at times is when you say that okay now there is more of safety in equities because margin of safety is there, valuations have come down of course at that time headlines will be very negative, a new flow will be very clear, we may not even know how the economy is going to be but that's when you get cheap prices. So only at such extreme price we will increase equity.

Likewise, if equities go into a bubble zone let's say the valuation go to 30 times, we are at 22-23 right now. If that were to happen, the 65 or 70 in equity to go down to around 40-45 and we would balance the balance amount to bonds and gold.

Lastly, why would we think one of these things, if you remember every time markets fall, we are inundated with interesting quotes from Warren Buffett or your experts saying that buy more when there is blood on the street. But to buy more when there is blood, you need some cash flow from some other asset class which has not fallen and that's where gold and bonds can create that liquidity, which is very precious on days when markets are sharply correcting.

Kalpen Parekh: The reason I didn't mention it is actually these are very recent/nascent asset classes still in India. There are a handful of instruments which are just come in the last three-four years, and many times very theoretically we say that when there is inflation, REITs will do well, or InvITs will do well but at least the data or evidence does not yet suggest because there are many other variables which play a role in the performance of either InvITs or REITS.

In the last 18 months, inflation has risen everywhere in the world but in the same period stocks have delivered better returns than InvITs and REITs, everywhere else in the world as well in India. So, it's a new asset class, we will want to spend some time seeing it season and seeing more options. becoming available.

We have an enabling option to invest in them. In some of our funds we do have 2-3% in InvITs, their yields are very high because in the last cycle some of these InvITs had seen significant price correction because one part of their retail shareholding they were actually selling it after the earlier hyping this thing. So, we just took advantage of those lower prices.

So, to some extent, we had a small component, but at this point, I would say that's not a dominant part of our strategy, we will see and wait and watch for more such instruments to get listed and once we get more confidence and comfort, when we also come our learning curve, we will evaluate these strategies.

Nikhil Kothari: See, as an investor, you can primarily invest in five places only, which is your Indian equities, international equities, you can invest in debt fixed income, you can invest in gold, and you can invest in real estate.

Now if you have a very large corpus, you can divide your money in different asset classes depending on your risk appetite, your time horizon, and your investment outlook. But if you are routine investors and do not have such a large corpus will divide across different asset classes and your risk appetite is moderate then this asset class works perfectly for you because you can invest your money in one place and depend on the fund manager's outlook, depends on your risk appetite.

Broadly, the fund manager can allocate money in different asset classes and as is seen that all asset classes do not work in tandem. Sometimes gold may perform, sometimes equity may perform. So overall, this portfolio brings down the risk quite substantially and, on an average, it gives you better than if I take an average return.

They give you better than two or three asset classes, they may not be the best performing asset class, but then up in terms of return there, the average returns are better than other quality components and classes.

Nikhil Kothari: So, every fund house has a different strategy of managing a multi-asset fund. So, you need to understand the strategy of the fund house itself. There are fund houses financing which have a static of 60%. You fund houses have a range from 30 to 80% as asset allocation.

Now how the fund manager manages the money. The fund manager, if he believes that the equities are overvalued, then he will reduce equity allocation and invest in arbitrage and invest in other asset classes more and if you believe that the markets are fairly valued or undervalued, then he will increase equity allocation for more.

So, this fund gives you exposure that if markets are overvalued the equity exposure reduces, and if the fund is underlying equity exposure increases. So, the fund manager does this work for you which you will not have done on your own. Now when you are investing in this fund, since this fund invests in equities, you need to have a minimum horizon of three to five years.

If you have a horizon of one or two years, then it may not be a great strategy because equity markets may underperform and because as sizable amount of money is in equities so your fund may underperform the fixed income asset allocation.

But if you have a three-to-five-year horizon, and you are not able to manage in terms of changing equity allocation based on market outlook, and you want exposure across different asset classes, then this fund is the right fund for you.

Nikhil Kothari: See, over a longer timeframe, we know that most of time, equities as an asset class will outperform most of other asset classes. So, if you have a 10-year plus horizon, then you can invest in equities and stay invested for the long term.

But what we need to understand is that markets are not linear, markets will always be volatile. So, there may be a period when one equity may not perform for two or three years. So, if you are an investor, which you get panic, those timeframes, then multi-asset funds work perfectly for you because in here you will have different asset classes and even if equities are not performing, either gold will outperform, or fixed income may outperform.

So, your overall risk may come down, and you still get an average return on your overall portfolio. Just to give a perspective, in 2020, during the year of Covid, gold was the best asset class and if you look at year '21, U.S. equities were one of the best asset class. If you look at '23, today we are talking to U.S., equities again outperforming, if you look at tech index, but if you look at the last six months Indian equities have outperformed. So, what we have seen is that at any point in time, it's not that one asset class will perform always every year. So, you will have different asset classes performing at different points in time.

So, multi-asset overall reduces the risk because of low correlation between asset classes, and your volatility comes down. But if you are looking at something purely from a long-term perspective, of 10 years and I want to get the best return, then I think equities may be the option for you. But if you are looking at reducing your overall risk, then multi-asset funds make sense for you.

How we look at from client's perspective that you will have always have equity exposure, you will have some amount of fixed income exposure which is the money that you need for one to two years, but if you have money which you require for four to five years, then multi–asset fund works better for him because here you may get slightly better than that in fixed income and not as volatile as it is. So, it works in terms of increasing your return slightly and reducing your own risk as compared to equities.

Now if we look at today's environment, when markets are slightly expensive because you have seen the markets have run up quite a bit in the last six months and if someone wants to invest in lump sum money right now. In that case, multi-asset fund may be a slightly better option as compared to investing in pure equity fund, because in short-term, it will be volatile and multi–asset fund may be less volatile as compared to pure equity fund.

Nikhil Kothari: So first, when you are looking at a multi-asset fund, your primary objective is consistency. You are not very, very comfortable with too much volatility. 

You need to look at a fund which has been consistent over a period of time, whose stand initially is slightly lower than most of asset other asset class because if you are willing to take a non-linear payoffs and willing to work and you are able to adjust the volatility and you are able to digest the volatility, and if you have a long-term horizon then you be in equity fund.  

But you invest in multi-asset fund because you want to reduce overall risk and you don't have that much risk appetite. So, you should look at a fund which is consistent across timeframes. So, look at it longer track record and who has been doing good over a period of time.

Secondly, you have to look at whether the investment across asset classes, so you shouldn't look at only a multi-asset fund which only investing in debt and a very small portion in commodities and a very small portion in fixed income and is primarily a long-term equity fund only, because in that case, your objective is not met, it is not a pure multi-asset fund.

So, you should look at a fund which can change equity allocation based on the valuation of the market, who will invest in international equities also, who will invest in gold also, who will invest in debt also, and who can also invest in REITs up to a small portion. So, then it's a pure multi-asset fund and will be based on the fund manager's outlook so he can invest in different asset classes.

So, I will say that look at a fund which has a very long history, who is consistent, who has an objective invest across asset classes, and they are not only biased towards one asset class, but they also have investment across asset class. If from a taxation perspective, if you get a fund which falls into the taxation, say for example, where it's not a pure debt fund, which is tax as per the tax bracket, but if it's a fund which gives you a 20% with indexation benefit, where they invest up to 35% in Indian equities, that fund from the taxation perspective also maybe a feasible option for you.

Last and most important, should be very broadly expenses ratio, it should not be very high on expense ratio because here are your overall return is slightly subdue as compared to pure equities because it is invested across asset classes. So, look at expense ratio, look at consistency, look at whether the investing across asset classes and they are not only biased with one asset class, and if we have a taxation which is debt taxation, which gives you 20% with indexation, then that fund is the right choice for you.

Nikhil Kothari: So, there are few funds, like UTI multi-asset fund which has got a long history and they have done a reasonable work. There is also the Nippon multi-asset fund which also invests in different asset classes, with gold, commodities, real estate, some amount of REITs, Indian equities, international equities, you can look at Nippon multi-asset fund.

So, these are primarily two funds which you can go ahead and invest apart from any other fund which falls broadly in your criteria, in terms of the five points which I mentioned.