Yet another innovative fund is on the cards, this time from Escorts Mutual. To be called Escort Derivatives Fund, this fund will be an open-end equity scheme. But what differentiates this fund from any other equity fund is that it will also invest in derivatives to enhance returns, reduce volatility and hedge against market risks for the underlying equity portfolio.
To be launched in July 2003, this fund, apart from investing in equity (mainly large-caps) and derivatives, will also have a mandate to invest in debt securities. Stocks in its portfolio will always cover the fund positions in derivatives. Hence, the fund will not have an uncovered position in the derivatives markets. This will eliminate the risk of pure derivatives investing.
While the market regulator, the Securities and Exchange Board of India (Sebi) permits all equity funds to use derivatives to lower portfolio risk, Escorts Derivatives Fund will also use derivatives for generating returns. ''As of today, no fund uses derivatives extensively in fund management," says K.K. Mittal, vice-presi-dent, Escorts Mutual Fund. The fund also claims that it has developed expertise in the field and is confident about its strategy.
All this is fine but how does the investor benefit? The fund manager feels that the fund is expected to give the same mean return as a growth fund would but with much lower volatility over the long-run. While this fund will underperform a rising market, it will outperform a falling market.
Let us take an example. Suppose the fund holds stock X whose price is Rs 200 and the fund manager feels that the stock is likely to fall but is bullish about it over the long-term. So, instead of selling the stock at Rs 200 and buying it back when it falls, the fund may write a call on the stock at Rs 200. If the stock price moves below Rs 200, the call will not be exercised and the fund will earn a premium. Since the fund holds the stock, there will be a loss in the portfolio, the premium earned though will reduce the overall loss. But if the price of the stock rises, the upside above Rs 200 will be lost, as the call will be exercised. The story sounds good so far, but the real challenge for the fund house will be to create awareness about such a unique offering and attracting investors.
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