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Does Dynamism Work?

Dynamic Asset Allocation funds, which have the freedom to move between equity, debt and cash, haven’t been able to protect returns in the recent downturn.

The 2000 market collapse left equity fund investors high and dry with one question on their minds - why didn't fund managers move into cash and protect returns? Fund managers defended themselves by contending that they had been mandated to invest in equities.

When the markets roared again in 2003, the question of shielding returns when the markets tanked assumed importance once again. This prompted many fund houses to launch new funds armed with a specific mandate to move heavily into debt if required. The trend started with Kotak AMC introducing a provision, which allowed its equity funds to move up to 40 per cent of their assets into cash if they felt the need. This happened in the second half of 2002.

Thereafter, a slew of equity funds were launched with the freedom to move heavily into debt and cash spawning a whole new class of asset allocation funds. This included Prudential ICICI Dynamic, UTI Variable Investment - Index Linked Plan, FT India PE Ratio, IL&FS Dynamic Equity, Magnum NRI Investment FlexiAsset and Deutsche India Opportunity. Of these two funds, namely UTI Variable Investment and FT India PE Ratio linked their equity allocation to the Sensex and Nifty PE levels respectively. The other four left the allocation to fund manager based on his perception of market fundamentals and future direction.

Now that the big bull run has come to a screeching halt and the markets have entered a volatile phase, it is perhaps time to see whether these funds have succeeded. Between them, the six funds lost 12.43 per cent on an average in the single month of May, not faring much better than their diversified equity peers, which lost 14.88 per cent during the same period. Moreover, the category average loss for asset allocation funds was held back to a large extent by UTI Variable Investment, which was constrained by its index-linked mandate to invest less than 40 per cent in equities as the Sensex was above 4200 levels. Thus, the fund lost just 4.89 per cent in a sinking market. But the other five funds lost in the range of 12-18 per cent.

Moreover, looking at the changes in equity allocation of these funds, one is forced to ask: where is the dynamism? Only, two of the six funds (Prudential ICICI Dynamic and Deutsche Investment Opportunity) made any attempts of paring their equity allocation, while the rest of the pack were sitting on large equity exposures in a tanking market.

To be fair to the fund managers, the sudden fall in the markets in May was pretty much an instance of event risk. It came totally out of the blue and therefore, foreseeing it or dealing with it in anticipation was practically impossible. Asset allocation fund managers realised this and clarified beforehand that their mandate was to move into cash only if they felt that an event inflicted long-term sustainable damage. Thus, their freedom was not for an event risk eventuality and was more a broad call on valuation.

Even in the case of broad overvaluations, expecting perfectly timed moves in terms of catching tops and bottoms is absolutely unrealistic. At best, this freedom should thus be viewed as an attempt to mitigate downside risk in a long-term portfolio. As we have always said, timing the market is simply not possible, so don't attempt it and don't believe anyone who promises to do it. Rather, focus on your risk-return profile and the time you are willing to spend in the market. Invest according to your priorities and stay invested for best results.