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Trying to Protect Returns

The new breed of funds called Dynamic Asset Allocation Funds have armed themselves with a mandate to move heavily into debt if needed, thereby protecting returns when equity markets turn hostile.

When the markets collapsed in 2000 lots of investors wanted to know why fund managers did not move into cash and protect returns. The most common answer by the fund fraternity was that they had been mandated to invest in equities. This mandate was thus strictly followed irrespective of market conditions.

Now when the markets are roaring this question has once again come to haunt fund managers and investors. This time around some funds have armed themselves with a mandate to move heavily into debt if needed. The trend started with Kotak AMC introducing a provision allowing it to move upto 40 per cent of its assets across its equity funds into cash if it felt the need. This happened in the second half of 2002. After this a series of equity funds have been launched, which have the freedom to move heavily into cash.

Whether this strategy will help in protecting returns and how successful can it be are open questions. At the first level a fall in the market could be due to specific sudden events like 9/11. Event risk such as this comes totally out of the blue and so dealing with this before hand is impossible.

While agreeing with this contention Dileep Madgavakar, CIO, Prudential ICICI mutual fund, clarifies that "We will move to cash if we feel that an event inflicts long-term sustainable damage". PVK Mohan Fund Manager at IL&FS Mutual fund also agrees that "this freedom is not for an event risk eventuality. It is more a broad call on valuation."

Asset Allocation: Dynamic Funds
Fund  Equity Range  Debt Range
Deutsche Investment Opportunities 5-100 0-95
HSBC India Opportunities 50-100 0-50
IL&FS Dynamic Equity 0-100 0-100
Prudential ICICI Dynamic 0-100 0-100
(In per cent)

Thus if you are expecting a move into cash for every 100-250 point fall in the market then forget it. Madgavakar further clarifies the issue when he says, "this move would be strategic in nature and could be based on overvaluations based on very high PEs or a bottom up view that the overall portfolio is very expensive".

Even in the case of broad overvaluations expecting perfectly timed moves in terms of catching tops and bottoms is unrealistic. With the schemes not having any history there is no precedent or track record to draw conclusions from. At best this freedom should thus be viewed in terms of an attempt to mitigate downside risk.