FUND FULCRUM

March 2011

The average assets under management (AUM) of the fund industry surged 2.3% in February 2011 to Rs 7.07-lakh crore. According to data compiled by Association of Mutual Funds in India, the mutual fund industry witnessed inflows of Rs 25,757 crore in all schemes, with equity and money market schemes seeing inflows of Rs 2,495 crore and Rs 8,770 crore, respectively, in February 2011. The domestic mutual fund sector has seen a record high inflow in its equity segment in February 2011 since the entry load ban of 2009.

Piquant Parade

Market regulator, the Securities and Exchange Board of India (SEBI), has given the final approval to Indiabulls Financial Services, India Infoline, and Union Bank of India-KBC Asset Management to start their mutual fund business. Indiabulls and India Infoline had applied for a mutual fund licence in 2007 and 2008, respectively. Union Bank had applied in 2009. Currently, SEBI has around 23 pending mutual fund applications with it.

Goldman Sachs Asset Management Company would acquire Benchmark Mutual Fund, an ETF-focussed Indian fund house. Benchmark mutual fund manages assets worth around Rs 3000 crore. The deal would be finalised by the end of 2011, subject to regulatory approvals. Goldman would pay Rs 130.5 crore or approximately 4.3% of Benchmark's average assets under management (AUM). All Benchmark employees would be retained by the new management. Regulatory approval is expected in the next 3-4 months. Through the deal, Goldman Sachs aims to bring actively managed on-shore funds into India. The financial services major has an office in Mumbai with eight employees, providing research on Indian and BRIC equities for offshore funds. Though Goldman Sachs had received SEBI nod to enter India in September 2008, it kept plans on hold following the economic downturn of 2009.

Tamilnad Mercantile Bank Ltd. (TMB) and Birla Sun Life Mutual Fund have signed an MoU to distribute and market mutual fund products through branches of Tamilnad Mercantile Bank. Birla Sun Life Mutual Fund would benefit from TMB's 231 branches, especially in south Tamil Nadu and thus reach across to pockets where they have no representatives.

Regulatory Rigmarole

For the mutual fund industry (though not investors), the towering moment of the Union Budget was surely the decision to allow them to access foreign investors directly. Initial reactions were that not only could this be an important new market for India's mutual funds, it could also enhance the flow of foreign funds into Indian markets. Certainly, that was the way the Finance Minister announced it in the budget speech. However, this goal may not be achieved to any meaningful extent. In any case, India and other emerging markets are not core investments for anyone elsewhere in the world. No end-user's portfolio is made up of a majority of Indian stocks. India, at best, is a garnish on top of equities from the major western markets. This will not change in the foreseeable future. What might change eventually is the ease with which financial intermediaries operating in those markets can now get to offer Indian funds to their customers. However, for that to happen, Indian AMCs will be going through the effort of complying with the regulatory framework of those countries. This will take time and effort and each AMC will make its own cost-benefit calculations about doing so.

SEBI recently stated that asset management firms can use exit load to pay for their sales and marketing expenses. This means that investors will indirectly pay advisory fees to independent financial advisors (IFAs). This decision does not really hurt investors, as exit loads are only applicable for those who redeem units within a certain period. Nevertheless, the decision is significant as it indicates that the advisor-fee model introduced in August 2009 has not been successful.

SEBI’s latest note on the usage of load balance has drawn criticism from smaller fund houses who allege the step does not ensure a level playing field in the industry as it is advantageous to bigger players. The note also talked about segregating the load balance into two accounts. The first account to reflect the balance which existed till July 31, 2009, and the other for accretions since entry load ban came into effect. However, no restrictions were placed on the use of funds lying in the second account. It is clarified that though the unutilised balances can be carried forward, yet in no financial year, the total spending can be more than one-third of the load balances on July 31, 2009.

Mutual funds have given their distributors till the end of March 2011 to comply with stringent identity verification norms wherein agents are required to get biometric cards that carry information like finger-print impressions.

Taking the first step towards forming regulations to curb mis-selling of mutual funds by distributors, the Securities and Exchange Board of India sent a note to all AMCs, asking them to ensure that their distributors follow certain due diligence while selling mutual fund schemes.

Faced with the herculean task of handling lakhs of investor complaints, market regulator SEBI plans to rope in third party agencies for processing and maintenance of grievance so as to help it resolve these complaints on a fast-track basis. The regulator is said to be against outsourcing of the market entities’ core and investor-sensitive activities. The activities to be outsourced by SEBI include receiving complaints from investors, forwarding them to the concerned market entities and companies, tracking their status and conduct necessary follow-ups and preparation of periodic as well as ad-hoc reports on the investor grievances. Besides, the agencies would also be responsible for entry of the complaints into SEBI’s computerised grievance redressal system with proper categorisation and codification, updation of the system with Action Taken Reports (ATRs) and keeping investors informed about progress on their complaints. SEBI is putting in place this web-based centralised system, named SEBI Complaints Redress System (SCORES), for speedy redressal of grievances. SEBI’s existing investor grievance redressal mechanism lacks a centralised database and the resolution of the complaints often gets delayed due to physical movement of files from one desk to another across its various offices. Besides reducing time gap between receipt and redressal of a complaint, the new system would also help in storage of the investor grievances, whose numbers have swelled to over 2.7 million since SEBI’s inception. SEBI received more than 32,300 investor complaints in 2009-10, while the numbers are even higher at over 39,600 in the first nine months of the current fiscal. The new system would have a centralised tracking system for all grievances at various offices and divisions of SEBI. Currently, the list of investor grievances is maintained at various divisions and regional offices of SEBI.

Asset management firms — including private equity, portfolio managers and mutual funds — are believed to be increasing their presence and augmenting their teams in the emerging markets. In India, companies such as Goldman Sachs, BNP Paribas, Canara Robeco, Aditya Birla Financial Services, and Helix Investment Advisors are working towards expanding their bases and presence in India. There is huge potential in India as less than 2% of the population participates in the stock markets. There is more disposable income at hand and there is huge opportunity for these firms.

NFO NEST
March 2011

Resurgence?

NFOs have been few and far between since the 2008 crisis…But 2011 has been witnessing resurgence in NFOs thus far.

Pramerica Dynamic Monthly Income Fund
Opens: March 8, 2011
Closes: March 22, 2011

Pramerica Dynamic Monthly Income Fund aims to generate regular returns through investment in fixed income (debt and money market) instruments and to generate capital appreciation by investing in equity and equity related instruments. The asset allocation would be 70-95% in fixed income instruments and 5-30% in equity and equity-related instruments. Pramerica Dynamic Monthly Income Fund is a combination of fundamentals led asset allocation and active fund management, targeting generation of regular returns, with the help of Pramerica DART, a proprietary tool developed and managed by Pramerica AMC, to determine an optimum asset allocation mix between debt and equity, within the overall asset allocation of the scheme by taking into account key factors that have an impact on the market. When the markets are looking expensive, Pramerica DART is designed to book profits and when the markets are cheap, to increase the exposure to equities and thus reduce the impact of market volatility. Due to the current ongoing interest rate hike period, investing in fixed income makes sense. MIPs aim to provide investors with regular pay-outs (though dividends) and are suitable for senior citizens and others looking for regular income. MIPs also benefit those in the higher income tax brackets who are looking for investment alternatives to bank FDs (from tax saving point of view). The scheme offers Dividend Transfer Plan (DTP) – wherein investors can opt to automatically transfer (and invest) the ‘net dividend amount’ (net of dividend distribution tax) received under the existing mutual fund scheme into any other scheme of Pramerica Mutual Fund (of their choice). The fixed income portfolio of the scheme will be managed by Mahendra Jajoo and the equity portfolio will be managed by Ravi Gopalakrishnan. The Benchmark Index is the CRISIL MIP Blended Index.

Mirae Asset India-China Consumption Fund
Opens: March 9, 2010
Closes: March 23, 2010

Mirae Asset India-China Consumption Fund, the first of its kind in India, will focus on sectors/companies benefiting from consumption-led demand that is driving the world's fastest-growing economies—India and China. It will pursue a flavour of Indian and Chinese consumer stocks, providing Indian investors with the opportunity to benefit from the long-term structural growth trends in consumption and consumption-led sectors. In terms of asset allocation, the fund will seek to invest 65-90% of its assets in Indian equities and equity related securities of companies that are likely to benefit either directly or indirectly from consumption-led demand. The fund will also invest 10-35% of its portfolio in Chinese equities and equity-related securities of companies that are likely to benefit either directly or indirectly from consumption-led demand. The fund may take up to 25% exposure in money market instruments (including CBLO)/debt securities instruments in India and/or units of debt/liquid schemes of domestic mutual funds. The scheme will use a customised benchmark index that constitutes MSCI India Consumption Index (65%) and MSCI China Consumption Index (35%).

Peerless MF Child Plan
Opens: March 11, 2010
Closes: March 25, 2010

Peerless MF Child Plan is a multiple asset class product wherein the investment will be made in debt, equity, and gold exchange traded funds. The investment objective of the scheme is to generate long-term capital appreciation through a portfolio of fixed income securities, gold exchange traded funds (ETFs) of other mutual funds and equity and equity-related instruments. The fund invests a minimum 60% and maximum 90% in debt fund, 5-35% in equity and equity-related instruments and 5-35% in gold ETFs of other mutual funds. Mr Ganti N Murthy (debt) and Mr Kaushik Dani (equity gold fund) are the Fund Managers for the fund. The fund is benchmarked against Crisil MIP Blended Index + Price of Gold (85:15).

Birla Sunlife Capital Protection-oriented Fund - Series V
Opens: March 11, 2010
Closes: March 25, 2010

Birla Sun Life Capital Protection Oriented Fund - Series 5 (832 days) seeks to provide capital appreciation linked to equity market with downside protection at the end of the tenure. The fund expects to achieve down side protection by investing in debt securities with tenure comparable with the tenure of the plan, subject to the credit risk. The fund expects to achieve the market-linked appreciation (upside) by investing in the premium of exchange traded options. The fund proposes to restrict its derivative exposure only to the extent of buying of call options. Hence maximum loss could be equivalent to the premium paid, not any more. Moreover, the premium paid will be equal or lower to the coupon receivable from fixed income securities after providing for fund expenses. CRISIL Balanced Fund Index is the benchmark index. Satyabrata Mohanty and Ajay Garg are the fund managers.

IDBI Short-term Bond Fund
Opens: March 17, 2010
Closes: March 22, 2010

IDBI Short Term Bond Fund aims at providing investors with regular income for their investment. The fund will endeavour to achieve this objective through an allocation of the investment corpus in a diversified portfolio of debt and money market instruments. The scheme would allocate 65% to 100% of assets in money market instruments/debt instruments (including floating rate debt instruments and securitized debt) with maturity/residual maturity upto and including 2 years with low risk profile. On the flipside it would allocate upto 35% of assets in debt instruments (including floating rate debt instruments and securitized debt) with duration/maturity/residual maturity above 2 years and not exceeding 3 years with low to medium risk profile. Benchmark Index for the scheme is Crisil Short Term Bond Fund Index. The fund manager of the scheme will be Gautam Kaul.

Motilal Oswal Most Shares NASDAQ-100 ETF
Opens: March 16, 2010
Closes: March 23, 2010

The `MOSt Shares NASDAQ-100' ETF is India's first US equities based ETF and will track Nasdaq-100 index. This is the second global equity index based ETF in India. Last year Benchmark Asset Management had launched an ETF that tracks Hong Kong Stock Exchange's benchmark index Hang Seng index. Nasdaq-100 is one of the most widely traded and held index. It is also the second most liquid index in the world. Motilal Oswal Most Shares NASDAQ-100 exchange traded fund aims to mirror the performance of the NASDAQ-100 index, subject to tracking error. It will invest at least 95% of its total assets in the securities comprising NASDAQ-100. The Nasdaq-100 constituents generate 60% of their revenues from USA, Canada, Latin America and South America. Investing in the fund will bring the much required diversification for Indian investors. The fund is a good vehicle to participate in the much-awaited economic recovery in the US economy and the developed nations. The index fund further ensures that the investors get to invest in some of the best of non-financial companies in the US and at the same time there is no fund manager risk. However, investors may face the risk from a fizzled out economic recovery in the US and other developed nations. Again, the rupee-dollar exchange rate will also have a bearing on the returns. The fund will attract the taxation treatment of a debt fund. Rajnish Rastogi is the fund manager for the scheme. The units will be listed on BSE and NSE to facilitate trading post new fund offer.

Shariah-compliant personal investment products are slated to flood the market as exchanges and mutual funds seek to tap Muslim investors who refrain from trading in stocks and commodities. While the MCX-owned National Spot Exchange Limited (NSEL) plans to market shariah-compliant investment products in a fortnight, SBI Mutual Fund and UTI Asset Management are looking at ways to launch such products in the next few months. Tata Mutual, Benchmark Asset Management, Taurus Mutual and Sundaram Mutual Fund have ethics-based investment products already. Kotak Mutual, ICICI Prudential Asset Management, Reliance Mutual, HSBC, and UTI Mutual Fund have a series of shariah-tolerant offshore funds that allow foreign investors to invest in Indian stocks. Besides these, IDBI SENSEX Fund is expected to be launched in the coming months.

GEM GAZE
March 2011

Best of both worlds

Arbitrage funds thrive in a roller-coaster market. The benefits of arbitrage funds are best enjoyed during volatile markets, primarily due to the stability in the investment strategy of such funds. To attain the returns with bare minimum risk, the asset allocation of arbitrage scheme is split mainly between equity and debt components. The basket of arbitrage funds has provided an average return of 7% over the past one year, which is lower than those of the ultra short term debt funds. Over the past two years, these funds have done better than the liquid fund category. However, if we consider the tax advantage that the equity-oriented arbitrage funds offer, the post-tax returns of arbitrage funds look much better.

Currently, the Arbitrage Fund category is populated by 16 funds. Post 2008, some have changed colours and have transformed into pure debt funds. GEMGAZE March 2011 has narrowed down the list to five funds, considering their consistent performance.

UTI SPREAD Fund Gem
Spreading its wings

This five-year old five star fund sports an AUM of Rs. 116.34 crore. Though its one-year return of 5.59% has fallen short of its category average of 6.67% by a narrow margin, its consistent performance since inception may goad us to set this minor blip aside as a temporary aberration. Its average outperformance has always been higher (average of 22 basis points) than that of the underperformance (4 basis points).That is definitely a reward for its bold stance that often goes against the general market trend. A mere 7.85% of the portfolio is in equities, with services and technology being the top sectors. The entire assets allocated to equity are in 12 mid and small cap stocks. 59% of the assets are in debt with 33% in others. The low allocation to equity can partially explain the shortfall in one-year return, besides being instrumental in making it lose its equity-oriented tag. While the portfolio turnover ratio is a massive 870.1%, the expense ratio is very low at 0.92%.

HDFC Arbitrage Fund Gem
Silent resilience

In its three-year old existence, HDFC Arbitrage Fund has been able to reach an AUM of a mere Rs 76.18 crore. HDFC Arbitrage Fund’s trump card has been its resilience in a falling market. If we look at the period from January 2008 to March 2009, the market had been in the red for 10 months. Overall, during 11 of these 13 months, the fund has outperformed the category average. On the other hand, in the five months when the market closed in the green, the fund has been able to beat the category average in just two months. The one-year return of the fund is 7.31% as against the category average of 6.67%.This fund has a penchant for the energy sector. The sectors that come second and third in preference are services and FMCG. Top 5 holdings constitute 19.56% of the portfolio. Equities constitute 66% of the portfolio with 73% in mid and small cap stocks. The portfolio has 47 stocks and the portfolio turnover ratio is 100%. The expense ratio is as low as 0.83%.

Kotak Equity Arbitrage Fund Gem
Consistent calibre

Incorporated in September 2005, Kotak Equity Arbitrage Fund has an AUM of Rs 168.70 crore. The one-year return of the fund is 6.99% as against the category average of 6.67%. Top five holdings constitute 25.96% of the portfolio, with the equity exposure continuing to be nil and debt constituting 25% of the portfolio. The portfolio turnover ratio is 89.38% and the expense ratio is 0.95%.

JM Arbitrage Advantage Fund Gem
Whither advantage?

The Rs 78.80 crore JM Arbitrage Fund, incorporated in 2006, has earned a 1-year return of 6.48% a tad less than the category average return of 6.67%. Top five holdings constitute 32.52% of the portfolio with services, FMCG, and financial services forming the top three sectors. Equity constitutes 70.68% of the portfolio with 88% in mid and small cap stocks. There are 31 stocks in the portfolio. The portfolio turnover ratio is 18.76%. The expense ratio is 1.01%.


SBI Arbitrage Opportunities Fund Gem
Expensive opportunity

SBI Arbitrage Opportunities Fund, incorporated in October 2006, has an AUM of Rs 89.72 crore. Its one-year return is 6.56 % almost on par with the category average return of 6.67%. The top five holdings constitute 32.21% of the portfolio. Energy, finance, and services are the top three sectors. 65% of the portfolio is made up of equity with 53% in mid and small cap stocks. There are 33 stocks in the portfolio with a very high portfolio turnover ratio of 1408%. The expense ratio is very high at 1.22%.

FUND FLAVOUR
March 2011

To the brink and back again

"It was the best of times it was the worst of times." - Charles Dickens

No other mutual fund category has seen such wild swings in fortunes as the Indian Derivative Funds over the last seven years. Derivative/Arbitrage Funds made a small beginning when they were launched in 2004. As the world was rocked by the financial crisis, these funds turned in a spectacular performance. When the equity market tanked in 2008, arbitrage funds came up with a good show moving up 8.5% in the year. This was followed by a period of lull before the current display of effervescent performance backed by a volatile market. Arbitrage funds are back in the limelight with the category moving up in the performance charts in the three and six months’ time frame. With Sensex climbing all the way up to 21,000 points before slipping to 18,000 levels, these funds that thrive on volatility started gaining after a long gap. Arbitrage funds tend to do well in a turbulent market and are among the top-5 best performers in the past six months.

Arbitrage Funds Demystified

Simply put, in an arbitrage fund the buying and selling of stocks in cash and futures market happens simultaneously. Arbitrage takes place when the price of the same asset is different in two markets. This way, a fund manager would be able to earn risk-free profits by buying from one market at a lower price and selling it simultaneously in a different market at higher price. Typically, arbitrage funds cash in on the disparity between cash and futures markets. The ultimate objective of these funds is to hedge positions completely and identify stocks where spreads are higher. Identifying spreads and order execution is the key. Arbitrage funds can be useful when the markets are volatile and the returns from debt funds also remain on the lower side. Unlike debt funds, where there is a fair element of certainty about the actual returns as they invest mostly in bank CDs now, you would not be able to predict the gains from arbitrage funds. As these funds resort to heavy trading to maximise gains, expense ratios are also higher. These funds typically target opportunities that pay more than short-term debt. So monitoring the performance of these two categories would help you in taking an appropriate call. While you cannot expect mind-boggling gains, you can get risk-free returns.

Risk-free …

Arbitrage funds perform best in a volatile market. The objective of an arbitrage fund is to provide risk-free returns. Fund managers can hedge their risks by going long in the cash market and short in the futures market. Arbitrage funds are the safest options as they always hold hedge positions and toggle between cash and the futures options. In that sense, their risk profile is lower. At no point will these funds perform badly because of their hedge positions, except when the markets are either steadily moving up or moving down.

… or not quite?

Though arbitrage funds are referred to as 'risk-free' investments, this is not strictly true because there is some risk in the availability of arbitrage opportunities and their timing. Arbitrage funds depend heavily on the availability of arbitrage opportunities in the market. A long bear phase may create problems because the arbitrage strategy of buy stock, sell future will not work if the future price of the stock is trading at a discount to its spot price. On the date of expiry, when the arbitrage is to be unwound, the stock price and its future contract may not coincide. There could be a discrepancy in their prices. Thus, there is a possibility that the arbitrage strategy gets unwound at different prices, leading to a higher or lower return. In addition to scarce arbitrage opportunities, margins tend to be low and expense ratios high as such funds trade heavily. Arbitrage funds are also impacted by lower liquidity in the spot/future segment. Future contracts are always traded in lots i.e. one lot of a future contract of a particular stock will have multiple shares. If an arbitrage opportunity arises, the fund manager will have to buy the lot shares of the company from the stock market and sell one lot of its future contract.

Tax-efficient …

Arbitrage funds are, however, tax efficient. Since stocks occupy more than 65% of their portfolio, they are treated as equity mutual funds for taxation purpose. The dividend and long term capital gains from these funds are tax free.

Mutual funds come to the rescue of those who intend to take the arbitrage route but lack the expertise. Arbitrage funds aim to make risk-free profits, by capturing the price differentials across markets arising out of the inefficiencies of the markets. You can invest in such funds with a minimum of Rs 5,000. The ideal time horizon for investing in arbitrage funds is between one to two years. The expected rate of return can be slightly above that offered by the bank fixed deposits of similar tenure. An ideal avenue to surf through during volatile times…