Should Investors Look at Multi-Asset Class Funds?

One of the major advantages of investing in mutual funds is the benefit of diversification. It is actually quite a simple concept. If you are invested in just one stock, then your entire investment depends on the fortune of that one stock. On the other hand, if you spread your money across more stocks then your overall risk gets reduced because even as one stock may underperform, another stock could outperform. Thus your dependency on just one stock is eliminated through diversification. This also reduces your concentration risk.

We can actually take diversification to the second level, wherein we can diversify by investing in equity and debt. Equity entails higher risk and therefore higher returns. However, debt gives your portfolio an element of safety and fixed returns. This can be achieved by investing in balanced funds that invest across equities and debt and you can get the benefit of equity and debt through a single mutual fund. But then equity and debt are both financial assets at the end of the day. What if you want to also take an exposure to real assets like gold, silver and commodities? That brings us to the third level of diversification which can be done through multi-asset class funds (MACF)

So, what are multi-asset class funds all about?

Multi asset class funds (MACF) are mutual funds that invest across equities, debt and physical assets like gold. Between January 2016 and June 2016, gold prices in the international market moved up from $1050/oz to $1360/oz returning nearly 30% in 6 months. Even in rupee terms, the price of gold during the period moved from Rs.24,900/10 gm to Rs.32,300/10 gm yielding a similar 6-month return of 30%. That makes gold among the best performing asset classes in the first half of 2016. Of course, Indian investors can buy gold through gold ETFs and through gold bonds but it is difficult for an individual investor to take a decision on when to buy gold and when not to buy gold. That is where multi-asset class funds (MACF) come in handy. But the real advantage of MACF is not just in the commodity diversification. The real merit lies in the fact that fund managers can take an intelligent and informed view on when to focus more on equity, when to shift focus on debt and when to diversify into gold.

Understanding the power of asset allocation through MACF…

Asset allocation is all about shifting your asset mix based on an informed view on the market. Let us take a few examples. If the Nifty has corrected sharply and frontline stocks are available at 12-13 P/E, then it makes a lot of allocation sense to focus more on equities in the portfolio. Similarly, if the view is that interest rates are headed downwards, then the fund manager can increase exposure to long term government securities which will benefit substantially from a fall in interest rates. Additionally, if the fund manager expects that the global geopolitical uncertainty and too much of money printing will make gold more valuable, then they can take a large exposure to gold. These are decisions that individual investors will find hard to make. But mutual fund managers, with their research capabilities and their market intelligence will be in a better position to take asset allocation decisions. That is where an MACF can really come in handy.

There is another major advantage in an MACF. Most investors find themselves stuck in equities at higher levels and therefore when the market falls, they do not have the liquidity to invest at attractive valuations. This problem can be automatically addressed through MACF based asset allocation.

So, why have Multi-Asset Class Funds not taken off in India?

To be fair, MACF is a relatively new asset class in India and hence we will have to give it more time to take off in a bigger way. However, there are a few key challenges that MACFs face in the Indian context:

• First is the problem of choice of assets available. Fund managers can get substantial exposure to equity and debt. On the commodities front, it is only possible to get exposure to gold. In other markets, MACFs have access to investing in silver, industrial commodities, crude oil, real estate etc. A bigger real asset basket will make MACF more meaningful for investors.
• Most fund managers in India understand equity and debt with a lot of depth. However, not many are really comfortable with the nuances of hard commodities. That could be an impediment to asset allocation.
• There is an ambiguity in classification. Currently, these MACFs are classified as debt funds and not as equity funds. This takes away the advantage that equity funds enjoy in terms of concessional capital gains tax treatment as MACF gains will be treated as long term capital gains only if held beyond 3 years.
• Currently, an equity fund will be tax free if it is held beyond 1 year (long term) and taxed at a concessional rate of 15% if held below 1 year (short term). In case of MACFs, the long term definition is increased to 3 years and also the tax rates on long term and short term capital gains are higher.

It must be said that absence of choice and unfavourable tax treatment has limited the rapid growth of MACF. But it is surely a product that can add value to individual investors from a risk management perspective.