Right asset allocation provides consistent returns and smoother investment experience

Asset allocation is not really well understood and appreciated among large sections of the retail investor population in our country. Investing is still largely based on sentiments. Please explain the importance of asset allocation from a risk/return perspective?

Different asset classes such as equity, debt have their own cycles which often do not move in tandem. Thus one asset class may be experiencing a bull phase while another may be in a cyclical downturn. Investors can enhance their returns by moving money from the asset class which is close to cyclical peak (where most of the positive returns have already been made) to another asset class that is just entering an upcycle. However, typical investor behaviour is quite opposite. Money chases recent performance. Often investors flock to an asset class that has already been in an established uptrend and maximum money flows to an asset class close to its peak. This results in sub optimal investment returns and disappointment for investors.

Proper asset allocation has been found as the key reason behind good investment performance across time periods. Right asset allocation provides consistent returns and smoother investment experience with lower volatility.

After 15 months or so of high volatility, it seems that confidence has returned with Nifty near its all time high. At the same time, there are concerns about earnings growth and economic slowdown. What is the importance of asset allocation in such conditions?

Asset allocation strategies are relevant in all types of market conditions. The fund manager assesses return potential of different asset classes and their valuation cycles and chooses an optimum combination of asset classes to enhance investor returns. Thus in early stages of economic recovery, the strategy can have higher allocation to risky assets and vice versa. The aim of asset allocation is to give consistent returns with much lower volatility by investing in different asset classes at appropriate time. Investing in a single asset class & experiencing the volatility of the said asset class has its own perils. Asset Allocation is very important in investing, this diversifies the risks, reduces volatility and enhances the investment experience and gives consistent returns.

You are shortly launching ITI Balanced Advantage Fund. What is the investment objective and other salient features of this scheme?

The investment objective of the Scheme is to seek capital appreciation by investing in equity & equity related securities and fixed income instruments. The scheme aims to provide long term consistent returns in all market conditions to investors. The fund actively manages allocation between equity and debt using our research based asset allocation framework. Net equity exposure of the fund can range from 0 to 100%, however from a tax efficiency point of view the gross equity exposure (ignoring hedged derivative positions) will be minimum 65%. Debt allocation can range from 0 to 35%. The fund will only invest in debt securities with residual maturity of upto three years so as to generate smooth accrual based debt returns.

Many retail investors identify balanced funds with the traditional equity oriented hybrid funds. Please explain the key differences between the equity oriented (minimum 65% equity) hybrid funds and balanced advantage funds. Please discuss the risk/return profiles of these two product categories for investors to make informed decisions?

Equity oriented balanced funds will normally have a minimum net equity exposure ranging between 65%-80% and therefore their risk profile and returns will be similar or slightly lower than equity funds. Balanced advantage funds on the other hand can significantly change their net equity exposure from 0 – 100 %, depending on the market conditions. Thus, the returns from balanced advantage funds should normally be less volatile and more consistent across different phases of markets. From risk adjusted point of view, they are much better than either equity funds or equity oriented balanced funds. They provide better downside protection in falling markets and also participate in upsides in a rising market, thus are likely to provide consistent returns across market phases and bring down the volatility in the fund.

There are several balanced advantage schemes in the market. Different schemes have different dynamic asset allocation strategies; most schemes follow counter-cyclical strategies while some have pro-cyclical strategy. Please describe the asset allocation strategy you will follow in ITI Balanced Advantage Fund. What are its advantages?

We follow an internally developed research based asset allocation framework. The framework is based on three factors – market valuations, trends in earnings and volatility in different asset classes. We use price to book as the primary valuation indicator as it has been a good predictor of market tops and bottoms across global markets as well as Indian markets. It is less impacted by short term or one off factors and better at handling cyclicality. We have studied how these factors have operated in our markets over the last 25 years and tried to work a solution that provides optimal asset allocation and consistent returns.

What will be your stock selection strategy for the equity portion of the BAF portfolio?

We will use our ‘SQL’ Investment philosophy to construct the equity portion of BAF where;

S stands for margin of Safety – This means the fair value of business minus the current share price. The fund house will look to buy stocks with a good safety margin so that there is more room to generate long-term wealth for our investors.

Q stands for Quality of the business – This is crucial as quality businesses are long-term wealth creators. These are strong and sustainable businesses with a track record of good ROEs and ROCEs. Quality companies generally give positive surprises in earnings.

L stands for Low leverage – Low leverage companies are generally cash rich. Therefore, they can invest and grow their business. In addition, high leverage companies are at a greater risk in case of business downturns.

At least 80% of the equity investments are in ‘core’ set of stocks i.e. companies are strong and sustainable businesses with competitive advantages in their respective field and have good capital allocation track record. Tactical bets i.e. companies with significant upside potential but going through temporary problems and at the same time trading at beaten down prices can be taken upto 20% of the portfolio.

What will be fixed income strategy for the scheme?

Our fixed income strategy is to generate accrual income from a high credit quality portfolio. The fixed income investments will only be in papers with residual maturity of upto 3 years so as to avoid duration related volatility. Our debt investment philosophy is based on SQL too. While choosing a debt instrument Safety, Quality of the business and Liquidity are taken care, so as to provide superior investment experience to investors.

What will be the tax treatment for this scheme?

The gross equity exposure in the scheme will be minimum 65%, thus taxation of equity funds will apply to this scheme. Long term capital gain is applicable on completion of one year of investing into the fund and the rates applicable would be 10%.

Balanced Advantage Funds are ideal for first time investors because these schemes are much less volatile than equity funds and even aggressive hybrid funds. Which investor profiles will find ITI Balanced Advantage Fund suitable for their investment needs?

We feel the balanced advantage scheme is meant for all categories of investors. The first time investors also mostly have a smooth investing experience and would experience less volatility. The more experienced investors also benefit of a disciplined asset allocation strategy with far lower transaction costs and tax efficient structure. The optimal asset allocation generates very good long term capital appreciation by reducing losses in bear phases and enjoying the strong returns of bull phases.

How long should potential investors plan to remain invested in this scheme (minimum recommended investment tenure) and why? What can they expect across different market conditions and over their investment tenures?

Investors should come with an investment horizon of 3-5 years to experience wealth creation. The full potential of balanced advantage funds is realised when the investor stays invested across different market phases (bullish or bearish) and thereby could experience smoother & more consistent returns.

Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.