The Mutual Fund Show: Why Investors Should Look At Multi-Asset Funds

Vishal Dhawan: So essentially, what a multi-asset fund does is, it tries to pick different asset classes and puts it together in a package so that it becomes much easier for investors when they are trying to make decisions on which asset class to invest in.

This package is mostly managed actively by a fund manager to decide on for example, within equities, which stock should I buy? Should they be in large-cap, mid-cap, small cap? Should they be value or growth style?

So, all those pieces are typically also decisions that get made and what the manager does typically is rebalances this portfolio between equity, debt and gold in a manner where, depending on the view that the manager may have, on a particular asset class, that decision also gets taken by the manager, himself or herself.

So, it's a good package deal for investors to look at and of course, there are some funds which also may look at adding in international investments. They could look at adding in products or things like REITs and InvITs etc. So, I think as an overall package, it's a sort of readymade asset allocation solution, but not exactly that.

Kirtan Shah: No, it does not. I think it’s not just the multi-asset fund, you pick up any hybrid fund as a category, I don't think that replaces your asset allocation requirement because look, what happens is asset allocation requirement is very individualistic, depending on what your risk profile is, what your goals are, how much time do you really have to reach those goals.

The asset allocation is very customised with respect to what your requirement is. At the fund level, you can't have one customisation done, which is going to be equivalent to everybody who's invested in the funds. So, the funds’ asset allocation cannot always be correct for individuals who are invested in the fund.

Also, what happens is at the fund level, the asset allocation is pretty tactical in nature. As Vishal also mentioned, it is a fund manager's prerogative depending on the objective of the fund, which asset class does he want to focus more on.

If the fund manager feels that equity valuation is down, they might increase equity valuation but that does not or may not suit everybody who's invested in the fund in terms of asset allocation. So, at the fund level, the asset allocation is pretty fluid and tactical in nature.

Whereas when you look at an individual's asset allocation, which is largely going to be constant, so, at the fund level, you can't really have asset allocation that matches everybody who has invested in the portfolio. 

Vishal Dhawan: So, at least a few of them are very clear. The behavioural aspects around investing tend to be a very important part of how end outcomes end up being for investors.

Historically it is seen that when equity markets go up, money flows into equity and at points that might be the wrong time for that to happen, because markets may be very expensive at that same point.

So, when you have a multi-asset allocation fund, you end up having exposure to multiple asset classes. The last one year is a very good example, so, if you went back to a year ago, I don't think a lot of people believed that gold is going to be the best performing asset class over the next 12 months and therefore a lot of people were cutting down gold exposures and actually adding equity.

Whereas if you look at it today, you will find that gold actually outperformed equity. Therefore, it's very interesting that by having a multi-asset allocation fund, which is managed on the basis of some sort of model that a fund manager decides, you could actually be buying low and selling high which is actually what you want to do as an investor.

The second benefit of a multi-asset fund is that you don't need to be tracking every asset class at every stage because you're busy as an investor in your own profession and doing other things and maybe you're not even skilled enough to be able to make those choices and what the fund manager does is therefore takes on that role for which you are paying him or her a fee.

The third advantage, which has probably just about happened in the last couple of months, has been the change in tax treatment on debt and gold, relative to structures where there are combinations where equities at the higher level. And what has now happened is that there is some tax arbitrage as well available to investors buying multi-asset funds, where the tax treatment of the entire structure is of equity, even though the underlying may include some debt and some gold as well.

Vishal Dhawan: So, it would get taxed as debt in that particular case, which means long-term capital gain benefits would not be there. But what one would expect managers to do in those situations is use strategies like arbitrage to get the equity tax treatment going for the fund. 

Kirtan Shah: I think this is very individualistic. I think the biggest problem here is as retail investors everybody's trying to understand what purpose multi-asset fund is solving. I think they will have to understand that the industry is pretty divided.

So, if you look at those 12-15 funds that are available today, or probably the new funds that are going to come in, first thing that the retail investor will have to do is to understand how one fund is different from the other because I presume that there are multiple funds in this category today and in the future that are going to come up, which will have completely varying strategies from each other.

Now one fund may use arbitrage, so that they can add those 65% as equity allocation, so that they can get taxation, in a certain sense, wherein there is this another fund which completely does justice to what a multi-asset fund should ideally be.

So, I think first point, before you decide whether this falls into your choices of funds for investment is to be able to figure out there in the industry, when you have so many of these funds available, which one suits your need the most, because you cannot place all multi-asset funds together and say they are all apples to apples, they will not be the least six months from today, this is one.

Second, it also needs to understand that largely in theoretical concept, you will look at a multi-asset fund in the context of a fund which when compared to an equity fund, let's say for example, will not have as much volatility as equity but will not generate returns as much as equity would. So, I would place it somewhere in context saying that a multi-asset fund is a fund probably which might be able to generate for you debt plus some returns with debt kind of risks.

I think that is what you all as investors should keep in mind before you end up choosing a multi–asset fund that will play a role in the portfolio or not. But like I said, strategies are very different from fund house to fund house. So, picking the right multi-asset fund will also play a really important role.

Kirtan Shah: It's actually not. I will tell you why because these multi-asset funds have hardly been around and most of the funds that we see are predominantly in some other category.

So, I think we have to give it some time for us to be really able to understand the actual performance or the strategy of these fund houses vis-à-vis the execution on the ground. So, I don't have a fund that I really want to name but if I were to pick one, I would definitely look at the strategy, because I think the strategies are very different from each fund house to fund house.

Dinesh Balachandran: Just to explain the SBI multi-asset allocation fund in more detail. So, this fund is expected to have three asset classes: equity, fixed income, and gold, and as you rightly mentioned, in each of these asset classes, we need to have a minimum 10% allocation, that is as per the regulatory mandate.

But in terms of how we actually manage it, this is based on an internal model that we have developed, where when you think about the model in very simplistic terms, what it is trying to do is essentially look at the risk profile of these asset classes.

Now what do we mean by risk profile? This is measured more in terms of volatility, or the fluctuations in prices for each of these asset classes and the thought process is that an asset class that is showing more volatility, more fluctuations, you would want to have lower allocation to that asset class, while a different asset class that is better well behaved where you don't see like too much turmoil or too much volatility you want to have a higher allocation to that particular asset class, in theory terms, this is called as a risk parity model.

But the thought process is very simple: you want to allocate more to asset classes that are better behaved.

Dinesh Balachandran: Like Charlie Munger used to say, the number one rule of investing is to not lose money. Often by not losing money, you end up essentially making enough returns.

So as long as they are able to take care of the downside, the upside is automatically going to come. So, while this might not be the highest return, generating funds over a longer period, because we are a lot more mindful of the downside risk, in my opinion, this can generate sufficient returns, that should keep most investors happy. I think the answer is yes. 

Dinesh Balachandran: Yes, so we have leeway to go all the way from 10% to 80% in each of these asset classes, so we have sufficient room. So, in terms of how we have actually ended up using it, think about what fixed income did over the last year and a half.

If you exclude this year, the volatility in fixed income post Covid started moving up significantly, where interest rates around the world started going up and people probably were not prepared for it. So automatically, you started seeing the volatility which is basically the fluctuation in prices of fixed income go up and so from a model framework perspective, it made sense for the model then to have lower allocation to fixed income and have higher allocation to equities because equities after the Covid crash and then subsequent recovery was actually much better behaved.

So, the thought process is that at any given point in time you try to sort of figure out which asset classes relatively well behaved, where the chances of a meaningful downside risk is lower and you allocate more to that asset class. And the reason why we chose this particular framework is when you think about equities, you can think about in terms of earnings, cash flow. When you think about fixed income, you can think about interest rates. These are very intuitive things for most people.

But when you think about gold, gold is not a cash flow generating asset. So how do you then think about gold and when you want an asset allocation that involves equity, fixed income and gold, you can't speak in terms of cash flows, you have to think about other ways to decide on asset allocation and that is how we ended up with this risk parity paradigm.

Dinesh Balachandran: Yes, when we look at the fixed income landscape, sometime in the end of last year we could again see a change in paradigm where essentially, signals started coming out that maybe we have seen a peak in interest rates, the volatility in fixed income markets also started coming down and that allowed us to actually increase our allocation to fixed income securities.

So, that has actually worked out well over the last six months or so. Now, when I think about what is going on in the fixed income space, there are two schools of thought and honestly, it is not clear which camp is going to come out and there is one school of thought that essentially says that interest rates are peaked and growth has started slowing down, which means that at some point you are going to have interest rate cuts.

If that is the case, then fixed income markets, even at current levels after having done quite well over the last six months, look very attractive. The other camp essentially says that okay, rates have gone up enough and maybe RBI and others because we are probably going to pause for the time being, but do not mistake the pause for interest rate cuts, which means that you can essentially be in a higher rate for a long sort of cap.

You can be in that kind of space. In that scenario, yields are more likely to be range bound, and further upside from current levels is less likely. At this point, honestly, the jury's still out there. We also don't have very firm opinions because a lot of it is based on macro factors that are evolving.

At this point all I can say is the majority of the yield move is probably done and at the margin, we are more looking for higher accrual or higher carry in the fixed income.

Dinesh Balachandran: The holding in cash was more of a temporary affair because we were waiting for certain securities to be issued. So, we were very interested in this Road InvIT which was going to be launched and we wanted to have some cash set aside for that and we also were very interested in buying two specific fixed income securities that were going to be launched soon.

So, the high cash level was more a by-product of waiting for the securities to be issued so that we can deploy that money. Post that, the cash levels have come down significantly and so it's no longer at that 15% level that we saw in the last fact sheet.

Dinesh Balachandran: So, the asset allocation has moved meaningfully over the last couple of years. When I look at the equity component, the equity component would have broadly speaking moved in a range between 25% to 55%, while the fixed income component, between 30% to 60%, and in fixed income, I am also including cash, so the range has been roughly 25% to 30% over the last two years, which again speaks to the fact that asset allocation in this framework is going to be dynamic in nature. Depending on how the situation evolves, we are going to sort of move the asset allocation in a non-trivial manner.

Dinesh Balachandran: We are not in the camp that gold prices have peaked. When you think about the factors that normally drive gold, two major factors are real interest rates and systemic stability. Particularly when I think about systemic stability, I have this concern that there are a lot of systemic risks not in India, but in developed markets, where these risks have probably been under-priced by market participants.

We just saw this episode of the bank crisis where depositors were sort of removing money from a lot of the smaller regional banks in the U.S., that story hasn't fully played out, in my opinion. We are now also entering this debt ceiling debate where it's anyone's guess in terms of how it is truly going to happen.

So, broadly speaking, when I think about the developed market, there are several risks that are rather systemic in nature and from that perspective, having that gold as part of the asset allocation mix, in my opinion, is a very effective hedge against these kinds of system events. Not to mention, when I think about real interest rates, as growth slows down, there is a possibility, again, we will have to see how it exactly evolves.

But there is a possibility that central bankers might start becoming more dovish, which is essentially saying that real interest rates can potentially start going down. If that happens to be the case, then gold can do very well in that scenario as well.

So overall, gold has done well, yes. Should gold not at all be part of the asset allocation mix at this point? I beg to differ, I think that there are good reasons to have gold also as part of the asset allocation.

Dinesh Balachandran: So, in general, we are actually in favour of cash flow yielding assets, where if we are getting attractive yields, is something that we would definitely like to invest.

As I mentioned earlier, we have invested in an InvIT. The reason why we haven't invested in REITs is that in our opinion, the pricing of these assets was very aggressive to begin with and there was nothing left on the table. So, it's not as if the asset class has any problems, it was more the pricing of these assets that was the problem. As asset pricing becomes more attractive, we will definitely be interested in looking at these securities.

Dinesh Balachandran: So, the equity portion is going to be managed by how we would manage a pure equity fund. But what I say here is this, in this case, we have decided that we will be market cap agnostic, which means that we are not going to sort of force ourselves to be large-cap only or mid-cap only or small-cap only.

We are going to go where the opportunities are. So, at this point, for example, the fund has a higher allocation to small-cap stocks, mainly because we see a lot more opportunities in the small-cap space. As and when that changes, and if we feel that risk-reward is much better in the large-cap space, we wouldn't mind having a 100% large-cap stock equity portfolio. It really is a function of where the market opportunities are.