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What are multi-asset allocation funds?
Multi-asset funds are kinds of funds which combine the attributes of different asset classes. We generally keep talking about equity funds and equity happens tends to be more volatile - everyday the market opens and the price goes up and down. Likewise, debt has an understandable character depending on the interest rate, the coupon of a bond, the price goes up and down depending on the outlook of interest rate and the quality of a bond. Then gold prices - there are commodities and other things which actually keep going up. Now, in India, it is possible to have real estate trust or investment trust. These are the kinds of assets which are possible.
So, this is a fund which is not an equity fund or a debt fund, but combines different kinds of assets in a single fund. And by doing this, the character of that fund changes because when a fund invests in equities, it is very much linked to the equity or the equity market in general. If it is investing in a particular sector - equity of a particular sector - we know what it is. If it invests in a certain kind of debt fund, we know it is. But the moment you combine equity and debt or gold in one fund itself, it gets the attributes of gold, equity and debt. The combination of the attributes in a single fund - it makes it a very unique cocktail, it becomes a very distinct thing. So, that is how the character of a fund changes completely. When a fund is a combination of multiple things, it's no longer one and depending on how much of it is invested in each, it changes, and it changes the experience of an investor completely.
What kind of returns do multi-asset funds generate?
Multi-asset funds have become prominent in the last few years, but they have existed in some form or the other in the last 10-12 years. And looking at returns, the multi-asset funds have given a return of little over 10 per cent in the last 10 years, which is okay and little more than what fixed income would have earned you or maybe presumably more than what fixed income will earn you. But compare that with an aggressive hybrid fund which will be allocating a quarter of its money to fixed income, three-fourth to equity and will keep a static or maybe about this much allocation, that has given about 35 per cent more - 13.62 per cent.
And when we look at the Sensex return - total return index from Sensex, that is 14 and a quarter. So, this is the pecking order - 14.26, hybrid funds giving 13.62, multi-asset allocation funds have given 10.18 per cent.
Are multi-asset funds less volatile than a hybrid fund with static allocation?
These funds tend to be less volatile than the aggressive hybrid fund simply because they have less equity. Equity adds to the volatility, but one should understand that volatility is not risk. Asset prices go up and down, that is the academic definition that if something goes up and down more often, that is considered risk. But the real risk is when you lose the capital and the permanent nature of that capital loss. And that is something which I would disagree with in a moderate way.
But yes, if we think that volatility is the risk, then aggressive hybrid funds tend to be more volatile than these multi-asset funds. But we should also look at the asset allocation. Those funds have 75 per cent equity and these funds typically have 50-55 per cent into equity going by the kind of allocation they have maintained so far in the last five to seven years.
Do multi-asset funds enjoy some tax advantage?
There's an interesting tax advantage created for these funds. Before the previous union budget, there was a tax rule, which said that debt funds will get indexation benefit. The rule of this indexation benefit was debt funds were defined as a fund with over 65 per cent into debts, bonds and remaining in equity. So, those funds were getting that benefit. You hold it for three years, you will get the indexation benefit. Indexation benefit was the return that over and above the inflation was taxable. Inflation as defined by the tax authorities. Every year in the budget, the cost inflation index is announced. So, the amount of tax you had to pay was only over and above the inflation. So that used to really reduce your tax liability substantially.
And now that benefit is gone. If you invest in a bond fund, all the returns that you get from a bond fund is taxable, and it is taxable in the year in which you realise it. So all the return that you get is added to your income, exactly the way it happened for bank deposit - the interest income is taxable, it is added to your income and you pay the tax depending on the tax bracket you fall in.
Here is a very interesting thing that has been created. Equity is taxed in a different way and the definition of equity is 65 per cent or more in domestic equity. The definition of debt fund is 65 per cent or more in debt. Now, here is the fund which is less than 65 per cent into equity and less than 65 per cent into debt. So these funds are going to get the benefit of a non-equity fund and they will get the indexation benefit if you hold it for three years.
So, just based on the merit of tax, if you are a conservative investor and you want to invest in equity, and you somehow have low tolerance for the extremes of the equity, then these funds might be useful because they will be relatively more stable, they will not scare you, you will not lose your sleep, and if you hold it for three years, the tax bill will be very low.
Should you invest in multi-asset funds?
At Value Research, we believe in asset allocation. Everybody should have equity and everybody should have debt. And we strongly believe that gold is not a great investment. But we have been proved wrong in the last 10 years - few years gold does well and few years it does very poorly, and overall it has done okay. But it has not been a huge dent and definitely gold stands out when there is absolute calamity in the debt as well as equity market. So I will say that it's alright to have a little bit of gold, assuming that you're doing this. But you have a choice - you should be investing in equity and debt yourself or you should be investing in these funds. I think if you are careful about your asset allocation, have a defined asset allocation and adhering to that will be a better choice. But some of these funds are also very interesting. Consider three or four of them which are proving to be very impressive by their tactical allocation to different asset classes, which has translated into substantially higher return in the multi-asset category.
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This article was originally published on July 21, 2023.
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