Invest in multi-asset funds for protection against downside risk

Be prepared, however, for these funds to lag when there's a bull run in equities

Debt and gold funds currently outperform the major diversified-equity categories over the one-year horizon. With equities likely to struggle in the near future, investors need to pursue a diversified portfolio strategy. Multi-asset allocation (MAA) funds can help them do so.

Investment style

These funds must invest in at least three asset classes, with a 10 per cent allocation to each. While most offer exposure to equities, debt, and gold, some also invest in real estate and infrastructure investment trusts and international equities.

Most MAA funds have a defined asset allocation range they operate within. Says Chintan Haria, head-investment strategy, ICICI Prudential Asset Management Company: “In our active fund, the equity allocation is decided on the basis of an in-house model and the fund manager’s view. The debt allocation is decided on the basis of the outlook for the debt space, while the gold allocation is decided on the basis of the macro-economic outlook.”

In their passive fund, the allocation is based on valuation, triggers and technicals. “Various valuation indicators are used to ascertain whether an asset class is expensive or cheap. Triggers are events that can change the direction (positively or negatively) while technicals help select ETFs or index funds based on their relative performance,” adds Haria.

One-stop solution

The core advantage of these funds is diversification. “When wealth is spread across various asset classes, the potential to earn risk-adjusted returns can increase manifold,” says Ashish Naik, equity fund manager, Axis Mutual Fund. He adds that such a fund reduces risk exposure and increases the possibility of earning consistent returns.

Many investors don’t have the ability, time or inclination to decide where and how to invest. “This one fund can serve as a complete portfolio. The investor is also able to outsource to the fund manager decisions like when to increase or reduce exposure to an asset class,” says Manish Kothari, founder and chief executive officer (CEO), ZFunds.

MAA funds also undertake rebalancing on the investor’s behalf. “Rebalancing ensures that the fund always buys low and sells high,” says Gautam Kalia, senior vice president and head–super investors, Sharekhan by BNP Paribas.

If the MAA fund is equity-oriented (maintains average exposure during the year of 65 per cent or above to equities), it receives superior tax treatment. “The debt, gold and international equities in the portfolio also receive equity-like tax treatment,” says Kothari.

Don’t expect equity-like returns

MAA funds are likely to underperform equity funds in bull markets. “Investors who don’t fully understand their objective, which is to provide superior risk-adjusted returns, may be tempted to quit them,” says Kalia. These funds are likely to offer higher returns than debt but lower than equity funds.

Sometimes, asset classes that generally have a low or negative correlation don’t behave in the textbook manner. “In the past few years, many asset classes went up and down together, owing to liquidity,” says Kothari. In such circumstances, these funds will fail to provide the diversification benefit.

MAA funds follow a standard asset allocation. “That allocation may not suit all investors, especially those who want very high or very low equity exposure,” says Kothari.

If you hold several such funds, calculating your allocation to individual asset classes at the aggregate portfolio level will require effort. “Understanding attribution—how these funds have derived their returns—is also harder,” says Kalia.

Run checks

While selecting a fund, Naik suggests assessing how it will be taxed. If the fund is debt-oriented, it may not qualify for equity-like tax treatment.

Learn about the fund’s strategy on both the equity (is it large or flexi-cap oriented, exposure to mid- and small-cap stocks) and the debt side (whether it follows an accrual or duration strategy). “Only then will you know how risky the fund is and whether you are comfortable with it,” says Kalia.

Avoid selecting a fund based on trailing returns, which are subject to recency bias. “Calendar year returns and rolling returns will give you a better idea of the fund’s minimum and maximum returns across time periods, and hence its volatility,” says Kothari.

New investors and those who don’t want to invest too much time and effort on making investment decisions may go for these funds while those who wish to retain control over their asset allocation should opt for separate equity, debt and gold funds. Invest with at least a seven-year horizon for the diversification benefit to play out.