Should investors look at multi-asset class funds?

Mutual funds have offered investors a variety of alternatives to participate in asset classes. We have had pure equity funds and we have had debt funds in their most basic form. Then we have had balanced funds and MIPs which have relied on a mix of equity and debt in differing proportions. There are arbitrage funds which leverage on the spread between equities and futures. There is “Fund of Funds” (FOFs), which enable the Indian investor to participate in global markets. Finally, there are passive funds like index funds and ETFs which allow investors to participate in indices as well as other asset classes like gold. In the last few years, a new class of funds has emerged which are known as Multi Asset Class Funds (MACF). While there are not too many options in the market, they offer a different perspective wherein equity, debt and even other commodities like gold become part of the fund. Here are some interesting perspectives on these funds…

They offer a natural diversification…

The beauty of these MACFs is that they offer an in-built diversification across asset classes. Typically, gold has never moved in tandem with equities as an asset class. This gives a broad diversified portfolio for the investor to hold on to. Since gold generally tends to be negatively correlated to equity as an asset class, this reduces the risk of the portfolio substantially. It is evident in the last 2 months wherein gold with returns in excess of 20% has emerged as the best performing asset class globally. Gold normally tends to outperform in times of global and domestic uncertainty or when the volatility is too high. Thus including gold in your portfolio tends to diversify away the risk of equities and ensures that your overall portfolio downside is kept in check.

Adding rule-based aggression to your portfolio…

These MACFs are a natural method of adding rule based aggression to your portfolio. Like a dynamic allocation fund, one can set rules where the relative proportion of equities, debt and gold should be tweaked. For example, there can be a P/E based rule for deciding the quantum of allocation to equities. A low P/E can automatically increase equity allocation and the reverse can hold true in case of a high P/E. Secondly, in case of debt we can have an allocation based on interest rate expectations. A dovish interest rate expectation can mean increase in G-Sec holdings while a hawkish rate expectation can trigger either an exit from debt or an exposure to floating rate funds. Lastly, gold allocation can be tweaked based on the uncertainty represented by the VIX. A higher VIX can trigger a higher allocation to gold and the reverse can hold true in case of lower VIX. Such dynamic allocation to an MACF combination can also help the investor tweak asset class combinations and generate alpha.

But tax concerns continue to be an issue…

The major disadvantage of these MACFs will be the tax perspective. They will be classified as non-equity funds and hence they will be at a disadvantage in terms of withholding tax on dividends paid out as well as in terms of capital gains. The capital gains will become long term only if it is held for more than 3 years and even then it will be taxed. The short term capital gains will be taxed at a much higher rate than if it was an equity fund. This will take away a large part of the excitement of these MACFs. Equity funds are not subject to a distribution tax but non-equity funds will be. This will further reduce the effective return on these MACFs. As long as the tax treatment of MACFs continues to be negative, this concern will remain and they will not become popular as an asset class.

Returns are not too attractive:

If one looks at the historic returns of such MACFs, the track record of returns has not been too attractive. The nominal returns are in the range of 8-11%. Probably, a dynamic asset allocation can add a couple of percentage points to the returns. But when you consider these on a post-tax basis, they will hardly yield enough to cover the risk of inflation. This largely makes this product a non-starter.

This is one of the reasons that these products have not taken off and not too many fund houses have been keen to launch this product. Of course, they are critical as an added choice available to Indian investors. But retail investors need to be entirely conscious of these twin disadvantages in terms of lower returns and an unfavourable tax treatment as far as MACFs are concerned.

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