Nowhere to go

FUND TREND

Asset allocation funds are caught between a rock and a hard place due to the turmoil in the markets.

Diversification is a good way to minimise risk and that is what asset allocation funds are meant to offer through active fund management. These funds seek to straddle debt and equity. But with both asset classes looking bearish of late, can they do anything to help you earn positive returns?

Equity is not an option
In the month of May, when the markets reached their peak and started falling, asset allocation funds proved to be ineffective in protecting capital. But then, to be fair, they fared better than pure equity funds.

For instance, pure equity fund SBI Magnum Equity Fund delivered negative return of about 21.72 per cent between May 11 and June 29, whereas the same fund house's asset allocation plan called SBI Magnum NRI Investment Fund Flexi Asset Plan (FAP) delivered negative return of about 16.55 per cent during the same period. 
 

FUND VS BENCHMARK Performance as on June 29, 2006, in per cent
	1 month	3 months	1 year
DWS Investment Opportunity	-10.68	-13.88	35.83
S&P CNX Nifty	-6.75	-10.62	36.79
SBI Magnum NRI Investment FAP	-4.99	-7.79	53.98
Crisil Balanced	-4.10	-5.49	23.35
UTI Dynamic Equity Fund	-21.29	-23.80	11.37
S&P CNX Nifty	-6.75	-10.62	36.79
UTI Variable Investment Scheme	-1.16	-1.80	16.61
Sensex	-6.37	-9.13	42.73

How did fund managers achieve better returns? Some fund managers had predicted the fall and they had started booking profits well in advance. For instance, in case of SBI NRI Investment Fund FAP, the cash component in the month of May was the highest in the past six months.

Sanjay Sinha, head equity, SBI Mutual Fund says, "The cash component is higher because we booked profits in the month of May. We started booking profits since April as we felt that stocks had reached fair valuations." Sinha further adds, "Besides, we invested more in money market instruments as they were giving better returns."

Others considered the fall in the second half of May as a buying opportunity and acted accordingly. For instance, UTI Dynamic Equity Fund's equity proportion was the highest in the month of May.

Justifying this, Chandraprakash Padiyar fund manager, UTI Dynamic Equity Fund says, "The markets fell in the month of May so we considered this as a good buying opportunity and hence increased our allocation to equity."

Nor is debt
Even as fund managers are raising cash levels, their investment strategy is hardly allowing them to improve returns substantially. This is because rising interest rates is making bonds vulnerable to capital erosion. Yield on the 10-year government paper which was hovering around 7.4 per cent in March is now over 8 per cent.

Even after the sharp rise, fund managers are not convinced that the worst may be over for debt. The only saving grace thus is money market instruments which offer around five per cent currently.

Thus far, three out of the four asset allocation schemes have steered clear of debt instruments. Sinha says, "The debt segment is not performing well since the yields are going up."

Agreeing with Sinha's views, Padiyar, says, "With rate hikes, the returns from debt will be poor. Moreover, fund managers invest in debt only when their view on the stock market is negative. The main reason why we have not invested in debt is because we are bullish on India. I feel there is still room for increase in share prices in the long-term."

Playing the contrarian
The only asset allocation fund that has always invested some portion in debt is the UTI Variable Investment Scheme. Fund manager Swati Kulkarni says, "The overall call on macro level asset allocation between equity and debt is more important. This fund follows a well-defined and disciplined investment approach to asset allocation, it endeavours to provide returns across market cycles for long-term investors."

The equity and debt exposure for this fund is predetermined based on Sensex levels. For instance, if the equity index is below 7,150 the exposure to equity would be higher, say 90 per cent. If the Sensex climbs to, say, 7,500 the exposure to equity would be scaled down to 80 per cent and correspondingly the exposure to debt will move up from 10 per cent to 20 per cent and so on.

This would result in the fund booking profits on sale of equity with every 550-point rise in the Sensex. Simultaneously, the fund would earn higher interest income on debt portfolio thanks to increased exposure to debt.

Kulkarni says, "This fund is different from the typical asset allocation funds. As the Sensex increases we reduce our exposure to equities as we book profits periodically."

She further adds, "Also, we have not invested in long-term debt instruments due to the pressure on interest rates. We have invested only in short term papers, central government securities, corporate debt with minimum credit rating of AA or equivalent, money market instruments and bank deposits."

From 40 per cent exposure to equity as of Jan 31, 2006 at BSE Sensex level of 9,400, the fund reduced equity allocation to 26 per cent as of April 28, 2006 at BSE Sensex level of 11,852.

"This change in allocation helped the investor limit the downside in NAV (net asset value) during the market slide. Against the fall of 19.7 per cent in BSE Sensex since May 10, 2006, the NAV of this fund has fallen only 5.2 per cent." 
 

ASSET ALLOCATIONS
Date	Equity	Cash
DWS Investment Opportunity Fund
31-May-06	94.83	5.17
30-Dec-05	98.46	1.54
SBI Magnum NRI Investment Fund - Flexi Asset Plan
31-May-06	69.85	30.15
30-Dec-05	78.28	21.72
UTI Dynamic Equity Fund
31-May-06	90.89	9.11
31-Dec-05	65.02	34.98
Date	Equity	Debt	Cash
UTI Variable Investment Scheme
31-May-06	30.48	34.41	35.11
31-Dec-05	45.20	36.95	17.85

Banking on a bounce back
Going forward, the equity and debt scenario doesn't seem too enticing in the short and medium term. Hence, achieving even retuns equivalent to prevailing bank deposit rates may be difficult unless asset markets bounce back.