The Mutual Fund Show: The Two Sides Of Inter Scheme Transfers

Jhaveri: Balanced Advantage Fund is just a generic term for what we call dynamic asset allocation fund. What the Balance Advantage Fund category does is, based on the valuation they increase equity allocation if the markets are correcting and the valuations are becoming cheaper and cheaper, and they decrease equity allocations when the market valuations are becoming more and more expensive. So it’s basically a rebalancing scheme rather than a balanced fund.

So, these are rebalancing schemes based on valuation matrix, it can be price-to-book, price-to-earning, a combination of price-to-book, price-to-earning and so and so forth. The general category would have minimum 30 percent in equity and maximum of say 100 percent in equity. But since Manish is here, I’ll talk about ICICI Prudential is 30-80 percent in equity.

Banthia: So, I’ve always believed that fixed income is an essential part of any person’s portfolio.

Returns on equity are more volatile and from that standpoint, people generally have to be at the right point of the market. But as far as fixed income is concerned, it does a balancing act in people’s portfolio and it adds a steady sort of cash flows to investors.

Now, in the current phase where we are I think, the debt part of the asset class has a special importance in people’s portfolios. Because what we’ve observed over the last one, one and a half years and particularly, after the Covid situation, you see that the economy has slowed down. Inflation has been low in India over the last three to four years, and suddenly we have come to a situation where instead of inflation we may stare at a deflationary situation.

Banthia: So the way I would approach this question is, first, I’ll go to the philosophy of the fund—Balanced Advantage Fund. Sunil did point out what the Balanced Advantage Fund is, but I will just, you know try and make it more clear to the investors, what is the fund about.

Look, investing is a behavioural science. Normally in euphoria, people add to risk and generally in phases of pessimism, people tend to cut risks, and which is where the fallacy of investing is all about. 80 percent of the investors fall into that category, which is when we kind of conceptualised this product—Balanced Advantage Fund—where we thought that a dynamic asset allocation strategy is the right strategy for the investors where when markets are expensive, they need not run the same amount of equity risk, and therefore they should cut down the risk, and whenever markets are cheap, there may be pessimism at that point of time; there may be a general scare at that point of time, the fund generally tends to take more equity risk. So that’s the philosophy of how you manage the investor’s money, and over a period of time, on a steady state basis, this strategy gives a much better investor experience. This is what we have observed through our years of managing the Balanced Advantage Fund. As far as the strategy is concerned, the fund keeps on increasing and decreasing the equity allocation. So, in the month of March, when equity markets were falling, the in-house model which we use for managing the Balanced Advantage Fund, suggested that we should increase our equity allocations, and we sold debt at that point of time. Now with a lot of packages being announced globally, the global markets are performing better and also expectations of packages in India, fiscal as well as monetary packages, in the month of April we saw that equity market started moving up. Now the model suggested that we should cut our equity exposure, and which is why we sold equity in the month of April. So that is the general philosophy of how we manage the equity part.

And while we manage the equity part, the fund has a debt component and an arbitrage component. As Sunil rightly pointed out, the fund has a 30-80 percent allocation to equity. The fund has 20 to 35 percent allocation to debt. Sometimes when equity goes to 30 percent, debt is at you know, 30 or 35 percent, the remaining moves into arbitrage kind of charts, which is more of equity oriented in nature. So, the debt is what is defined by how much equity allocation the fund has and whenever the fund increases the equity allocation, the debt allocation goes down.

By the month of April, as I said, as the debt allocations went up to substitute the equity allocations. The way in which we look at the debt part of it is it’s a total return strategy for us, where within the total return strategy, we’ll look at a part of the market, every part of the curve including AAA corporate bonds, AA corporate bonds, all sorts of investments. And therefore we look at, which is the best asset class in terms of risk and reward. We already talked about the segment AAA and AA, what I want to also talk about is the credit process which goes beyond where we choose, and how we choose the AA. So, effectively, the debt strategy is a total return strategy, and therefore, when a particular segment in the debt market becomes very cheap, we make allocations to debt part of this package.

So, in the month of April, after the Franklin event, a particular part of the debt market, which is the AA part of that debt market, it became very cheap. The yields in the debt market on the AA segment became way high and from a risk reward point of view, it became very attractive to get into that part of the segment. So we invested in that part of the segment. We bought bonds from markets, banks, funds or some of the inter-schemes which you were talking about.

Largely, part of the strategy was to hold more AA securities because the spread between a AAA asset and a AA asset was almost 400-500 basis points, which was a historically high spread to capture. As a strategy, it has paid off. Yields from that point of time are much lower as we are talking. That strategy has paid off for the fund.

Jhaveri: As Manish rightly pointed out, the markets had gone down in the month of March when they aggressively invested in equity and in the month of April the markets shot through the roof. And that’s the reason why they had to get out of equity and get into debt. Automatically, your 74 percent, which was there in equity had to be brought down to, I think 67 percent, if I’m not mistaken Manish. So that’s 7 percent gap they had to fill with the debt which they had to buy in the market.

There is a composition of a market valuation based on that the debt component increasing, so it has nothing to do with AA rated papers going up or down or etc. If you actually notice, these are minuscule percentages of the overall portfolios or even the scheme portfolio. I am assuming one number of a thousand crores, maybe inter-scheme transfer into a Balance Advantage Fund, is only 3-4 percent of the overall AUM of that particular scheme, but they had to increase the debt component by 7 percent.

Jhaveri: Industry at large has gone into a hybrid category, I would presume that some portion of that should be allocated or attributed to the valuations of the debt markets where you had to increase the exposure to debt. Industry at large, I would assume, is the same because most of them are following that counter cyclical Balanced Advantage Fund kind of a theme where they have to increase allocation to debt when the markets are going up and vice versa.

Banthia: It depends on how much equity is there in the portfolio. But as I said, there will be points of time where a particular asset class looks very attractive and allocations to that asset class will be a little overweight. So at this point of time, there will be a little overweight allocation to AA because as I said AA is the most attractive segment from the fixed income perspective.

Banthia: So effectively, if look at the past portfolios as well of the Balanced Advantage Fund that we manage, we’ve been managing it more as an accrual product over the last few years, where a portion of the investments have been made in assets in the AA category. And effectively if the total debt portion is 20 percent, the allocation of AA assets in the portfolio would largely remain the same. Now, as the debt allocations increase to 35 percent, the absolute amounts may increase but the percentages would largely remain thereabouts. So effectively, what I’m saying is we look at total absolute returns on portfolios from the fixed income side, we manage it from a total returns point of view on a risk reward basis and whichever asset class looks extremely attractive, we increase an overall allocation to that. At this point of time, AA asset allocation looks extremely attractive from a risk reward point of view. So we are slightly overweight on the AA asset class.

Banthia: Right, so in fact, even with the Balanced Advantage Fund, debt has been a big contribution in terms of returns over the last five years. If you look at the debt returns versus equity returns, debt returns over equity returns would largely be similar. At points of time, debt would have given higher returns. From a fixed income point of view, you have to look at your horizon.

Gupta: So, I was listening into the discussion and I would say more than red flags, there is an evaluation mechanism for Balanced Advantage Funds or most hybrid funds. I think there are three things investors have to look at and we can talk about as many of them as are relevant on the show.

One, Balanced Advantage Funds as everyone said shift between equity and debt. Now whether it’s 30 to 80 or 10 to 90 doesn’t matter, but they shift. So what is the mechanism that they use to make that equity to debt shift, you have to look at that. There has been a lot of discussion on the show about valuation based mechanisms. There are other mechanisms, including the one that Edelweiss uses. They have their own effectiveness in different markets and we can talk about that, but it’s very important to note that different funds follow different methodologies to shift between debt and equity. In my opinion, that’s the primary driver of performance of Balanced Advantage Fund.

Second, equity component which tends to be pretty standardised across all funds.

Third, which is what you alluded to, and I think is what investors need to look at is of course the fixed income component of Balanced Advantage Funds.

Now, I’m not even going to go into the inter-scheme domain, but the fixed income component in my view, and I wrote this in an article, needs to have a defined philosophy. In our view at Edelweiss, Balanced Advantage Funds are not the place that you take credit or duration risk. So, they should ideally be run with two to three years kind of duration and very high quality credit because if an investor wanted to take credit risk; and you have seen what’s happened with credit risk, they don’t necessarily come to a Balanced Advantage Fund nor are they aware of credit risk in a Balanced Advantage Fund. So I think these are the three points that you need to look at when you evaluate this category and within all of these, I think all your risks become present.

Gupta: They do, they absolutely do. A Balanced Advantage Fund typically holds only about 20 to 30 percent in debt as total debt allocation because the rest is equity. Like we hold 20 percent debt. Within that, what I always tell investors is please take a list of the securities that your BAF holds and ask for that list of securities and see if you feel comfortable with the composition. For instance, the stance that we’ve taken in our fund is that we hold four securities- they’re all banking, PSU kind of papers. So, that’s the stance that we’ve taken. It is okay, I’m again saying, I’m not criticising anybody for holding AA or AA minus, but that is a risk. So, it’s important that awareness is there. AAA portfolio, whether in a pure debt scheme or in a BAF scheme is different from a AA portfolio.

Jhaveri: I’m saying that we are doing this discussion on a national level only because one person just created a WhatsApp and said, ‘Oh, look at this, invest in us first’.

I am not saying BloombergQuint is doing that, but I’m saying, generally, that is the hot topic of discussion currently in our WhatsApp groups, in the IFA segment, in the AMC segment, everywhere else. All that person had to do was if he has put the cat among the pigeons right now which are already scared and there is a trust deficit in the mutual fund industry, all he had to do was complete the analysis and said, what are the protocols which these inter scheme transfers have taken? Have they undertaken this based on SEBI guidelines? Yes, they have taken it based on SEBI guidelines. Have they done that in the past? Yes, they’ve done that in the past. Have they moved these credit space into a non-credit space? If that is not the case, then why are we discussing why credit has been transferred? Has it been done at the market valuations currently? If it is done at the market valuation and not at the cost of one scheme versus the other scheme, then all this becomes a very academic discussion currently to start with. And this chaos and the confusion which has been created was not necessary at all. Because there is a trust deficit, this is the time to calm the nerves of the investors. Now the same investors who asking me, who now must have seen many of my webinars, ‘Sir, you have been saying that the Balanced Advantage Fund category should not have any credits’? But that is my personal view. I mean I’m not going to be asking a fund manager of XYZ AMC and say, you changed the entire mechanics of your investment philosophy based on my personal view. Balanced Advantage Fund of a particular scheme had already AA rated papers even earlier, and you have invested it with experience, then why are we questioning them right now is my only limited point on that inter-scheme transfer.

Gupta: Firstly, everything said and done, this is my faith, you asked me to pick one category of mutual fund I like, then this is the one that I would pick wholeheartedly. I personally invest 70 percent of my own personal capital into this category, so I absolutely love this category. And I think it is a category that serves a large mass of Indian investors because if you look at what the average investor wants, he wants reasonable equity participation but he also doesn’t want too much downside. Now, too much downside sounds like a very fuzzy word, but when markets are down 30 percent and I’ve seen this in our own BAF.

Gupta: I don’t like to time funds or time markets and I believe we do a terrible job at that. Equities, pure equity funds, I believe yes, you will need to do some thinking about valuations and when to invest. I think in BAF, that question of when to invest is frankly, less relevant because the fund house’s model is taking that call on when to invest. So I don’t think there’s a better time to do more BAF or less BAF. I think it’s an all-seasons product and you shouldn’t try to time it. Again, it’s part of your asset allocation so you have to think of it that way. In fact, I do an SIP and BAF with my monthly salary. So, that is another perspective.

Jhaveri: Absolutely bang on. Radhika has really hit the nail on the head. My favourite asset class. I’d say that BAF is basically ‘aloo ki sabzi’ in an investment ‘thali’ which fits into any strategy at any time. I went one step further by making a statement saying that BAF can actually be an entire thali... an investment thali. So if an adviser actually focuses only on BAF as one single product, focused product, and even invest either through SIP, STP or a lump sum, and I’ve shared that data with your team also—2004 to now, BAF has outperformed large-cap, mid-cap, small-cap and a combination of all of them in an SIP basis. Even the same thing, as far as short-term timings are concerned or medium-term timings are concerned.

Gupta: There was a lot of discussion on the debt category. I would only say and obviously I come from a different space that you should evaluate every BAF. There is a belief, and Sunil knows where I’m coming from, that every BAF runs the same way. I think a section of BAFs run and its fine, bases buying low and selling high. I think there are BAFs that run other strategies. Edelweiss runs one and that seems to be very successful also. So my only thing to investors is evaluate each BAF on its own merit. Everyone doesn’t do the same thing, and bases the choices they make things will perform well and badly in different market conditions. Understand the BAF you are investing in and understand it in these three buckets— the asset allocation model, the equity, and the debt—and I promise you and then you won’t be upset about your experience.

Jhaveri: Moltilal Oswal Dynamic Equity Fund is doing a great job, so is Kotak Dynamic Balanced Advantage Fund. So practically all of them have performed very well and that category is likely to grow, and according to me that should be one of the biggest categories rather than concentrating on large-cap, mid-cap, small-cap etc. because that’s where the journey of the investors is really not good. My ‘Unlearn to Relearn’ that series which I’m conducting right now, I’m making a statement, you can’t treat investors as aggressive or conservative, you have to treat your strategies as aggressive and conservative based on market valuation. All of us know that the most aggressive investors have become most conservative in the current market scenario, but that BAF would have actually made him an all seasons guy, a continuous journey. Our intention is to remember the bumps on the road, that’s what our advisers should be doing.