This fund starts out with the prime objective of avoiding losses, which is done by lowering volatility. Broadly, it is safe to say that the model seeks to lower volatility to a quarter or a third of the Indian market. Last year, the Nifty delivered 18 per cent while Edelweiss Absolute Return delivered 13.33 per cent and Crisil MIP Blended (benchmark), 7 per cent. The market standard deviation was around 16 per cent, that of the fund was 5 per cent and it was 2.51 per cent for Crisil MIP Blended. The end result that this fund is working towards is that if investors stay invested for a reasonable period of time, they will not lose money (hence the term absolute return).
The investment takes place in three categories which are defined by strategies. One is the low-risk strategy where investments are made in fixed income or arbitrage. The second refers to special situations in terms of corporate actions. These are episodic in nature, such as mergers, open offers, delisting and capital raising. The third is the regular equity portfolio which would sport anywhere from 25 to 45 stocks.
How is volatility contained? By two moves. The low-risk investment strategy (first category) contributes to the overall low volatility. Secondly, the third category, which is the equity portfolio that should logically contribute to the exceptional performance, is hedged to contain volatility. So while the investment takes place in a portfolio of stocks, this portfolio is hedged using Options or Futures. The amount used to hedge the portfolio varies depending on market conditions. So the fund will never be short, always long, but whether it is long 10 per cent of the fund or 50 per cent depends on market conditions. But because the fund is hedged dynamically, it is not always hedged at an identical percentage. If the market is moving upwards, the hedge would be at lower levels and vice versa.
So the quant model determines which stocks to pick, in what proportion they should be represented in the portfolio and the daily hedge limits. The universe within which the model operates is the top 200 companies by way of market capitalisation. To throw up the stocks which provide superior risk-adjusted return, the expected return of stocks (growth, value, consistency, quality) and risk of the stock (Value at Risk, volatility, average traded volume) are taken into account and stocks are accordingly ranked along with the recommended weightage so that the tilt is not heavily towards one sector.
Being a very new fund, it does not have much of a past to go by. But looking at its short history, it has delivered what it set out to do. The entire premise of this fund is based on the principle that if volatility can be taken out of the investment equation (an impossibility in equity) or at least significantly reduced, it would serve a wider range of investors. With that in mind, it’s obvious that you can never expect this fund to deliver a stellar performance in a bull market (and it did not in 2010). But neither will it collapse like a pack of cards. Its 1-year return (January 31, 2011) of 11.33 per cent is slightly above its category average of 11.06 per cent. However, the current returns show that in a falling market it manages to hold its ground.
This fund should have been more aptly named a managed volatility fund. The fund’s volatility, as measured by standard deviation, has indeed been very low relative to other funds and the equity indices. If you want an equity exposure in an all-debt portfolio or would like an equity product that is less volatile compared to the other components of your portfolio, you should consider this fund.