The Mutual Fund Show: The Pros And Cons Of Multi-Asset Funds

Aashish Somaiyaa: The genesis of creating this kind of fund was the regulatory definition of multi-asset allocation. It says that any fund that has a minimum of 10% exposure to at least three different asset classes will be called a multi-asset fund. Now, if you look at asset allocation, it's more like chemistry. Even if you look at this definition, it means that you can mix any number of asset classes (with) regulation allowing you.

Why did I say it's chemistry? It is because when you mix these asset classes, you can mix them in varying proportions. The other important thing is that if you look at different asset classes and their return profiles, they will have varying degrees of correlation. So, for example, if you take large cap and mid cap and small cap, as they are all within equity, they will move in tandem.

Sometimes, if you see equity and oil, they both are indicators of economic progress—oil prices going up and stock markets booming. So, they are sometimes positively correlated.

But if you take Indian equity and gold, or if you take Indian debt and global equity, for instance, you will find that there is low correlation. The returns are random and they are not correlated at all. So, what happens is that when you mix different asset classes together, you can arrive at a combination which can ultimately dampen the volatility and still allow the returns to play out.

So, for us, it is entirely this chemistry at play. We are trying to combine multiple asset classes in such a way that over any three-year return rolling period, you should get the volatility like a short-term debt fund. On a three-year rolling basis, the return profile should be positive, much higher than fixed income hopefully; may not be as much as equity, but at least higher or comparable to fixed income or hybrid kind of categories.

So, we set out to create this product to achieve this combination. Then, we took the return profiles of one year, three years, five years of different asset classes and then regressed them over multiple time frames. Then, we looked at how the return and volatility profile of such a combination would play out when they are combined in various prostheses. And then, on that, we added another layer of complexity, saying that at different bends on the road, how we would re-balance these combinations.

So, we have done all that homework. Of course, Chirag is responsible for it. We have done all that back-testing, homework, and arrived at a combination, which will give us volatility comparable to a debt fund, but with potential for much higher return than debt fund. And, that's what we are trying to achieve with this.

Aashish Somaiyaa: So, eventually when it comes to many walks of life or in almost every walk of life, you eventually realise that simplicity is the highest form of sophistication.

Ultimately, when people invest, what are they trying to achieve? See, we tell people that depending on your risk profile and your goals, you should invest in assets. If you are in equity, you should need a long-time horizon. If you are in fixed income or short-term, gold is for a hedge against volatility and global equities are for capturing other growth opportunities, etc.

So, you always tell people to allocate assets as per their goals and return-risk tolerance. With all of that, ultimately, on any asset-allocated portfolio, if you try to achieve all your goals and you set out a proper diversified portfolio, what are you trying to do? You are trying to have low volatility with some 10%-12% return. You will realise very quickly in life that if you try to go for a 20% return, then none of your short-term goals will be met and if you try to keep your capital intact, then you will never get growth.

So ultimately, everybody's trying to achieve a reasonable return with low volatility. So, that is why what Chirag does for these kind of products at the back-end is very complex. But, at the front end, it is not supposed to be as complex. It's just supposed to give you a ready-made asset allocation.

Globally, this is the fastest growing category, according to the BCG Asset Management report. There's a global asset management report published by Boston Consulting. If you take the reports of the past two or three years, you will find this category called solutions-based products is the fastest growing category globally.

Chirag Patel: Typically, a product is devised to target an expected return and the volatility is the outcome. But here, we consider that the tax benefit has been taken away from a fixed income investor or a debt mutual fund investor now. His first priority or primary goal is to have lower volatility and the secondary goal is return.

So, while designing this product, we have targeted volatility first. So, volatility of the product should not go beyond the threshold level and try to optimise the return as a secondary objective. So, that is how we started to design this product.

For example, to arrive at a blue colour, you require various shades of blue colour. So, you make blue and white colour and you get different shades. Similarly, when you combine equity and debt, you can get different risk-return profiles, but you can't go beyond a certain permutation because you have only two colours. But, I use three colours—red, yellow, and blue. You can have a full range of colours. So now, consider all the possible asset classes like equity, gold, foreign equity, fixed income, commodities and everything. Now, you can create any number of returns and risk profiles.

So, for example, one-year volatility in a typical bond for the last 15 years is 7% on a one-year rolling basis. We take that volatility as a benchmark. So, our volatility should be around debt. Now, you have to optimise the return. So, now you combine equity, bond, gold and various other asset classes like foreign equity. How does it actually work?

For example, if I construct a 100% bond portfolio, I get 7% kind of volatility on an average. If I add 10% equity to it, what will happen? So generally, the perception is that volatility should increase, but actually it reduces because equity and debt have negative correlation on a one-year basis.

Next, for example, if I add gold to it, the volatility further reduces because gold has negative correlation with both equity and fixed income. Now, if you see the return profile of this investor, equity is on the higher side, bond is on the lower side and gold was in between and then you return different time frames.

So, if you combine them up judiciously, I will arrive at a target volatility and then I try to optimise the return. So, that is what a typical bond investor or mutual fund investor wants from his investment.

For any investor’s capital, there are three buckets, three mental buckets. One is a personal risk bucket, the second is a market risk market and the third is an aspirational bucket.

Now, the personal risk bucket is the portion which is the maximum or the biggest part of anyone’s portfolio because he doesn’t want to sacrifice his lifestyle. So, we put maximum amount over there. Generally, people put money into that traditional instrument, debt mutual funds and other NCDs and bonds. Then, comes the market risk bucket, where you have all equity fund, ETF, and index fund. The last is the aspirational bucket, which is a very small part. So, if you invest in a startup or venture capital or crypto, your life will change if you are successful. But if you are vice versa, there goes very little amount. So, we are trying to optimise the biggest part of the investors’ assets through this fund. So, it is a personal risk market.

Aashish Somaiyaa: It is more widespread. Each fund is created with a different thought process. When you look at Balanced Advantage Funds in India, or in fact, even if the multi asset allocation funds in the market other than our fund, you will find multi asset as well as balanced advantage, both categories other than ours, are actually created with a threshold criteria that they should meet—taxation of equity.

If you recall what Chirag said, when we started out, the threshold criteria was low volatility, or volatility compared to fixed income. So, when the starting point changes, then obviously which way the model will take you will change. So, if I say threshold criteria of equity taxation, it means you can do arbitrage and all but ultimately as an asset class, 65% to 70% money is directed to equity. So, what is left is 30% debt. Now, like you rightly said in a Balanced Advantage Fund, it gets calibrated up and down the effective equity position because you will run short positions to arbitrage futures. So, the effective equity position gets calibrated up and down. But ultimately the fund is 65% to 70% equity and the rest is debt.

Unfortunately, before we arrived, the entire industry had started multi-asset allocation funds with threshold criteria of equity taxation. So, again 65% equity ... what remains is equity. Also, here, we use futures and arbitrage. You need margin money. So, if you have 65% to 70% equity, then you are left with 20% debt and then, because it has to qualify as multi-asset, you have to put 10% gold because three asset classes are a must.

So, Balance Advantage Funds and Multi-Asset Allocation funds both, at least in our market, have threshold criteria of equity taxation. Hence, the asset allocation is directed in that manner. Then, according to me, it doesn't function like a Multi–Asset Fund actually.

Aashish Somaiyaa: I just exemplified it with numbers. Let's take an example. If I were to tell you that Indian equities on a one-year rolling basis and gold on a one-year rolling basis, let us say that the correlation is -0.2. Now, whenever you do this, you diversify for low correlation or no correlation. But that arithmetic is irrelevant if you're comparing one unit of equity with one unit of gold.

If I say that Indian equity and Indian gold prices have no correlation, that statement is relevant if I compare one unit of equity with one unit of gold. If I have seven units of equity and one unit of gold, then the discussion on correlation or low correlation is infructuous. It makes no sense really. So, that is why the mix has to be such that the correlations or lack of correlations should play out right. They should have an equal footing and hence, a chance to function. This is like rigged in favour of equity taxation ab initio (from the beginning). So then, that 10% gold has no chance to save you.

Chirag Patel: Just to add, it's like driving a car. So, acceleration is equity, brake what you want to calibrate your speed based on traffic and turn, but still, somebody can bump into your car and then you require an airbag, so the airbag is gold. If you have only one airbag, how can you survive an accident like subprime or a Covid. So, that's why a good proportion of every asset class should be there.

Aashish Somaiyaa: The model should be an unfettered model and then you optimise it. What if I put some overriding criteria that you can make the model as you wish, but it has to have this taxation or this return. Then it won't work.

Aashish Somaiyaa: If the equity proportion is higher than 65%-70%, it will be more attractive on taxation. But it won’t expose you to extremes ... One of the learnings of behavioural science is that people react emotionally when they are exposed to extremes. So, the only way not to make investment mistakes is to make sure your emotions don't surface and for that, you should never be in a product which exposes you to extremes. So, that is also something to keep in mind.

Talking of taxation here, it's not like we have really compromised heavily on the tax part because it is an optimisation game. So, under the new tax regime, the way we are structuring the fund, it will land up between 35% equity and 65% equity. So, if you hold this kind of fund for three years, it qualifies as a long-term asset. Hence, the taxation as per current regime is 20% less indexation factored in.

Let us say like to like, if you are in an equity taxation, at the end of three years, you keep getting 8%-9% compounded. Our kind of product gives 8%-9% compounded, in three years, you reach 130 and the comparable equity also reaches 130. Now, in three years in equity on 30, you will have a 10% surcharge. Let’s say Rs 3 or Rs 3.5.

In this kind of structure, let’s say 100 goes to 130, 118 is the index cost because of cost inflation. So, your gain is let's say 12, I am assuming 6% inflation; so, 119-120 is the index cost.

So, 130 less 120, you have a gain of 10 bucks. On 10 bucks, you will pay 20% plus surcharge. So, you will pay some Rs 2-2.5. A lot of times if equity gives higher returns, then you have higher return. But, if you compare like to like, this hybrid taxation is not bad, it's kind of attractive.

Chirag Patel: For example, we have done back-testing for the past 11-12 years. So, as we have targeted at specified volatility, so the asset range would be like your net equity should be between 15 to 45, gross equity will be 35, gold should be between 10 to 40, debt should be between 10 to 55 and then the rest is into foreign equity. So, when we do tactical re-balancing based on various valuation parameters, different asset classes exhibit different volatility during different economic cycles.

For example, during a recovery, equity will do well. When there is a boom, commodity will do well. When there is a slowdown, the bond will do well and when there is a recession, gold will do well. So, when we did the back-testing, the average volatility of the product was close to 7% and sometimes lower than that. And the average return that an investor may get on a three-year rolling period is 11%. That is on a gross basis. So, definitely the expense and operation costs will be there, but which will be still a good product for a conservative investor.

Aashish Somaiyaa: While back-testing, there are a few things to keep in mind. Back-test obviously, like he rightly said, shows the gross numbers. From our perspective, when you try to create a product and envisage a situation, you are actually hypothesising its potential. So, back-tests only tell us that okay, this hypothesis is workable. But I would urge that nobody should invest based on just the back-test. It is working data to know that okay, this hypothesis can work, and this is how it plays out under different market conditions.

Shweta Jain: So, I don't believe it can be a core part of the portfolio, but I do believe that it can be a part of your portfolio. 

Multi-Asset funds have investments in three or more categories of asset classes and in each of them at least 10% investment. This is SEBI’s classification. So, at any point in time, the investor may not know where his entire funds are invested and if this is the core part of the portfolio.

For somebody who's looking at investing in a fund that is stable, that is less volatile, that has equity, and has these different asset classes, this could be a good category. But, it may not necessarily be for everybody and this could be a smaller part of somebody's portfolio, not necessarily the core. The core should be what one really wants with their money. So, whether it's equity for long-term or debt for short-term, then this could be the core factor. For this reason, I don't believe that a Multi-Asset Fund could be a core part of the portfolio.

Shweta Jain: It's easier to say that when back-tested, this is what has happened. But we don't work in hindsight. We are looking forward. So, what has worked in the past will not necessarily work in the future.

Having said that, the client cannot control what kind of asset allocation his core portfolio has because he does not have control over the portfolio. It's the fund manager who's going to take these calls. So, when they don't have the kind of control that they should have, ideally over their portfolio, I don't believe that this can be a core part of the portfolio.

Of course, it's a great addition to somebody's portfolio for exactly the reasons that are mentioned. Lesser volatilities, higher stability... this is low volatility, you get good returns and that's a great addition to the portfolio for long-term because you don't know at any point of time how much exposure you might have to gold, for example, or debt.

You don't know what your asset allocation is. If you would like liquidity in the next couple of years, you can't withdraw this part of the core portfolio. You can't just withdraw the debt part and say, let the equity part grow. For that, you will still need to manage your cash flows according to that portfolio. So, you will need a portfolio which suits your needs. But like I said, I do believe, this is a great addition.

Shweta Jain: So, it's interesting, right? When somebody has these two very different sort of boxes in the same category, and you are comparing the returns it's actually not fair to even compare the returns, which somebody has.

For example, ICICI Multi Asset has a higher equity and has the advantage of taxation here. So, for the long term, it's treated as equity. But it's predominantly equity, 65% or more of the portfolio has to be equity. So, it leaves very little room for them to actually diversify into say gold and debt.

So, while taxation may be a positive, it's not really a great place for me to diversify. On the other hand, something like Motilal Oswal, which launched its multi-asset fund a year or so ago, also has the same category but very different treatment. It's treated as a debt fund, and it has foreign equity as well. It has debt, it has gold, it has domestic equity.

So, then it's true to label and that's why I can't really compare the returns between Motilal Oswal and ICICI equity for multi-asset for that matter. So, for me, I would stick to something which is more diversified rather than something which is treated as equity. It's an easier sell for people that you know, it's treated as equity and the capital gains will be accordingly.

So, we get a little bit of gold, a little bit of debt, and it's a stable fund. Also, the disadvantage, as it's worked against the truly diversified or truly multi-asset funds, when you compare the returns to Nifty, they will fall short over the benchmark, depending on how the markets have performed. But, they will, at times fall short of that and that may work against them.

So, while they are true to label and they might be doing fantastic and may be a great addition to the portfolio, that will work against them because at the end of the day, the investor is going to compare return in the same category of funds. I would go with a truer diversified Multi–Asset Fund.