Multi-Asset Funds:Better Investment Experience

Multi-Asset Funds:Better Investment Experience

Multi-asset allocation invests in different asset classes in different proportions to provide a well-diversified portfolio to the investors. In this article, you would gain more insights about this category and also understand what kind of investor should consider investing in them.

The incessant fall in the equity market in the first quarter of 2020 has spared no one. Hybrid funds, which are considered less volatile as a category, too saw a negative impact due to the virus pandemic. Apart from arbitrage funds, which on an average stand to gain 2.27 per cent year-till-date (YTD), all other sub-categories among hybrid funds are staring at negative returns. Among hybrid funds, aggressive hybrid and balanced hybrid are the ones that faced maximum loss of 17.70 per cent and 15.36 per cent respectively on YTD basis. This was followed by multi-asset allocation funds, which on YTD basis are down by 12 per cent.



This underperformance was led by the equity part of the portfolio that nose-dived. However, despite all the advantages that a multi-asset allocation strategy carries, its performance seems to be quite disappointing. As we can see from the graph alongside, arbitrage funds have performed better than any other fund in this category in the entire timeframe. If we look at multi-asset allocation funds, they have consistently done poor in all timeframes. So, this raises a quite obvious question about whether or not to invest in a multi-asset allocation fund. But getting deep into this issue, let us first understand the fundamentals of a multi-asset allocation strategy and how it works.

Defining Multi-Asset Allocation Funds
A multi-asset allocation fund is part of the hybrid funds’ category. As per Securities and Exchange Board of India (SEBI) circular on rationalisation of schemes, multi-asset allocation funds are those which invest a minimum of 10 per cent in at least three asset classes. In 1986, Gary Brinson, Randolph Hood and Gilbert Beebower (collectively known as BHB) carried out a study to explain the effects of asset allocation policy on returns of pension plans. In their study, they concluded that 93.4 per cent of the fund’s average returns can be accredited to proper asset allocation.

The objective of a multi-asset allocation fund is to generate long-term capital appreciation by investing in different asset classes, allowing investors to have a well-diversified portfolio. By investing in a multi-asset allocation fund, an investor can get exposure to equity, debt and exchange traded commodity derivatives (ETCD), gold exchange traded funds (ETF), real estate investment trusts and infrastructure investment trusts. Multi-asset allocation funds can be further classified into two types: risk tolerance funds and target date funds. Risk tolerance funds are those where asset allocation of the fund depends on the risk appetite of an investor.

For investors having a high risk appetite, the asset allocation would be more tilted towards equity investments while for conservative investors it would be more inclined towards fixed income investments. Target date funds are those whose asset allocation depends on investors’ preferred investment horizon. Funds that are currently available are pretty much different from that of both the types mentioned above. The above types would be mainly available in a portfolio management services (PMS) product where they are more focused towards individual investors.

Meanwhile, in mutual funds the focus in more on catering to the masses. Hence, the funds that are currently available are dynamic in nature. This means that the fund manager at his own discretion can change the asset allocation depending upon the market conditions instead of concentrating on an individual investor and his goal. If he feels that the markets are overvalued, the fund manager would shift the asset allocation that would be more inclined towards fixed income and gold and will moderate his position.

Purpose of Multi-Asset Allocation Fund
The multi-asset allocation fund diversifies an investment portfolio by investing across various asset classes. However, don’t expect this category to shine as the best performing category in any given year. This is because the purpose of these funds is to diversify and protect them from high volatility and not to generate higher returns. Through diversification, these funds aim to contain the risks associated with investing in just one asset class. Therefore, the ultimate purpose of these funds is to provide a smooth investment experience. How they are different from other funds? Within the hybrid category there are sub-categories such as conservative hybrid funds, balanced hybrid funds, aggressive hybrid funds and dynamic asset allocation funds that aim to invest in both equity and debt. Then how are multi-asset allocation funds different from them? The major difference between multi-asset allocation funds and other funds in the hybrid category is that they are not restricted to just equity and debt. Apart from that, they can also invest in gold and ETCD, though they cannot invest more than 30 per cent in the latter.

How does its asset allocation look like? Most of the multi-asset allocation funds have chosen to allocate at least 65 per cent to equity and the remaining to debt and gold. Looking at the Scheme Information Document (SID) of multi-asset allocation funds, following is the how the asset allocation looks like:

Most of the funds follow the above asset allocation strategy. There are funds like Essel 3 in 1 that follows a more conservative approach by investing 50-70 per cent in debt. Having minimum of 65 per cent of allocation to equity has aided it to consider itself an equity fund from a taxation viewpoint. Hence, the tax treatment of such funds is similar to that of equity funds. This means that for any short-term capital gains (i.e. realised gains arising within 365 days), a flat 15 per cent would be levied and for long-term capital gains (i.e. realised gains arising post 365 days), 10 per cent would be levied with Rs 1 lakh exemption. However, you need to remember that if in any given year the fund is not able to satisfy the ‘minimum 65 per cent allocation to equity’ requirement, it would then be deemed as a debt fund and would be taxed accordingly.

Performance
Now let us dive deep into understanding the performance of a multi-asset allocation fund. For this we would check its performance as against the S & P BSE Sensex. This will help us to gauge how it is able to perform as compared to the market. As can be seen from the graph alongside, though in some instances the multi-cap funds underperformed or performed in line with the Sensex, the volatility seems quite lower than the Sensex. We know that the purpose of multi-asset allocation funds is not to generate higher returns but to provide a better investment experience.

However, let us now understand how individual funds haveperformed as against the Sensex. As can be seen from the graph, only ICICI Pru Multi-Asset Fund and UTI Multi-Asset Fund are able to outperform the market whereas HDFC Multi-Asset Fund performed in line with the Sensex. In the coming paragraphs, we would see how volatile they are compared to the Sensex. We would be taking standard deviation as a measure of volatility.



The table above explains the volatility of multi-asset allocation funds along with the Sensex. Only the Quant Multi-Asset Fund is more volatile than the Sensex. Though ICICI Pru Multi-Asset Fund is not as volatile as the Sensex, is highly volatile compared to other funds in this category. So, let us see which fund was better in providing a smooth investment experience. For this we would rely on ulcer. Lower the ulcer, better the investment experience.

In terms of the investment experience, ICICI Pru Multi-Asset Fund and Quant Multi-Asset Fund proved to be the worst performers. However, HDFC Multi-Asset Fund and SBI Multi-Asset Allocation Fund proved to be the best in terms of investment experience. That said, all the funds in this category gave a better investment experience than the Sensex.

The Need for a Multi-Asset Allocation Fund
An investor in consultation with a financial advisor may create a mutual fund portfolio that suits his or her requirement. This portfolio usually includes a combination of equity, debt and gold mutual funds. So, does such an investor need a multi-asset allocation fund? To find the right answer, we carried out a study where we created an equal weighted portfolio of equity, debt and gold which is rebalanced annually. We have assumed S & P BSE Sensex as equity portion, 10-year sovereign bond index as debt investment and the domestic gold prices. While doing so, we have also accounted for 2 per cent of annual expenses to have a level playing field with multi-asset allocation funds as they have an expense ratio of around 2 per cent and you also need to pay transaction cost to create your portfolio.

Further, we went ahead to compare the same with the multiasset allocation fund category. As can be observed from the graph alongside, a multi-asset allocation fund is seen performing better than the portfolio of equal asset allocation between equity, debt and gold with annual rebalancing. Even the worst fund is not underperforming the portfolio. In fact, it is in line with the portfolio. Now let us understand the volatility and ulcer index of both types of investments to gauge risk and investment undertaken.

The above table tells us that in terms of risk, the portfolio of three assets is lower than the multi-asset allocation fund. However, when we look at the ulcer which shows us the investment experience, both performed on similar levels. Even the worst performing fund gave a better investment experience than the portfolio despite a similar performance. Hence, based on the above analysis we can say that a multi-asset allocation fund is better than the equal weighted portfolio of equity, debt and gold.

Investor Profile
Who should invest in a multi-asset allocation fund? These funds provide a smoother investment experience and hence can be preferred by conservative investors who don’t want to risk their investment. When the markets are not doing well these funds tend to protect you from downside risks. However, as its main aim is not to generate higher returns, these funds should be strictly avoided by aggressive risk-takers and those who have a goal of wealth creation. If you are a person who doesn’t have a stomach for market shocks, this fund would be ideal for you. As multi-asset allocation funds diversify across various asset classes, they won’t be taking the risk of investing in a single asset class. But then they miss on the higher returns generated by individual asset classes. At the end, such funds have a moderate risk and return profile. Hence, even investors with a moderate risk profile can consider investing in these funds.

Conclusion
An investor with low to moderate risk appetite can consider investing in multi-asset allocation funds. They have practical advantages linked to them. Have a professional fund manager to manage the asset allocation for you. Depending upon the market dynamics and economic situation, he can take the right call and adjust the asset allocation accordingly. It might be difficult for investors to take such decisions on their own as it requires adequate knowledge and even if you have the knowledge you need to give dedicated time in managing the portfolio.

Even though the risk-return profile is moderate, since the allocations are changed from time to time, the risk-return profile of the fund might also change. Hence, investors should be cautious before opting for such schemes. Before investing you should check the asset allocation and if the asset allocation fails to match your risk appetite, consider exiting from such funds. If your investment horizon is short-term, then consider investing in short-term debt funds or money market funds. But if it is five years or more, consider investing in a multi-asset allocation fund. And if your expectation is about high returns, avoid these funds as their main aim is to provide a better investment experience rather than generating juicy returns. 

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