FUND FULCRUM

March 2017

Mutual fund industry's asset base rose to an all-time high of Rs 17.89 lakh crore at the end of February 2016, primarily on account of strong inflows in equity, income and money market segments. Besides, buoyant investor sentiment, growing participation from retail investors and phenomenal growth in systematic investment plans (SIPs) also helped in the growth of assets under management. The industry, comprising 43 active players, had average assets under management (AUM) of Rs 17.37 lakh crore at the end of January 2017, according to the latest data of the Association of Mutual Funds in India (AMFI). The industry AUM had crossed Rs 10 lakh crore in May 2014, and it is expected to reach Rs 20 lakh crore this year. Overall inflow in mutual fund schemes stood at Rs 30,273 crore in February 2017. Of this, income funds, which invest in a combination of government securities saw Rs 10,864 crore coming in while liquid funds or money market category, which invest in cash assets such as treasury bills, certificates of deposit and commercial paper for short investment horizon, witnessed an infusion of Rs 8,227 crore. Further, equity and equity-linked saving schemes saw an infusion of Rs 6,462 crore. With the latest inflow, total mobilisation in equity schemes has reached Rs 62,151 crore in April-February of the current financial year. The robust inflow has pushed up assets under management (AUM) of equity mutual funds to Rs 4.96 lakh crore at the end of February 2017, from Rs 3.86 lakh crore at the end of March 2016. However, gilt and gold exchange-traded funds (ETFs) witnessed a pull out of Rs 772 crore and Rs 46 crore, respectively during the period under review.

According to the latest SEBI data, the mutual fund industry has witnessed an addition of over 7 lakh folios in February 2017. The AUM of the mutual funds industry rose to an all-time high of Rs.17.89 lakh crore in February 2017. This growth is largely because of increase in equity folios. SEBI data shows that equity funds have added 4 lakh folios in February 2017. The folio count went up from 3.15 crore in January 2017 to 3.19 in February 2017. Experts attributed this to rising number of SIP accounts. The MF industry has received inflows of Rs.4300 crore through SIP of which 99% is in equity funds. In February, equity funds have received inflows of 5465 crore. ELSS funds have also witnessed a good traction in February 2017 due to tax season. The category has added over 2 lakh folio this month. AMFI data shows that ELSS has received net inflows of close to Rs.1000 crore in February 2017. Balanced funds continued the positive momentum by adding 1.09 lakh folios.  The category received net inflows of Rs.4562 crore in February 2017. ETFs, which track the equity indices, witnessed a drop in its folio count this month. The category has lost close to one lakh folios in February 2017 largely because of profit booking. Barring ETFs, all other categories either saw a growth or remained flat in terms of folio count. Equity mutual funds witnessed an addition of around 41 lakh investor accounts, or folios, in the current fiscal so far. Overall, the mutual fund industry has been witnessing a continuous increase in its folio count. In order to boost mutual fund penetration, many awareness initiatives have been taken up by the fund houses. 

Piquant Parade

Financial services major, IDFC, has decided to buy Natixis Global Asset Management's 25 percent stake in IDFC Mutual Fund for over Rs 244 crore. The shares will be purchased through IDFC Financial Holding Company, a wholly-owned subsidiary of IDFC. IDFC Financial Holding Company holds 75 percent stake of IDFC Asset Management Company (AMC) and IDFC AMC Trustee Company. The remaining 25 percent stake is held by Natixis. In December 2010, Natixis had entered into a share purchase agreement to pick stake in IDFC AMC and IDFC AMC Trustee.

As part of the agreement, there was a requirement that both shareholders would review the partnership at the end of five years. Following a review clause in the agreement, IDFC "agreed to acquire through IDFC Financial Holding Company the balance stake (about 25 percent) in IDFC AMC and IDFC AMC Trustee from Natixis Global Asset Management", the financial major said in a filing. It has agreed to buy the stake for Rs 244.24 crore. The deal, subject to regulatory approvals, is expected to conclude by the end of March 2017.

Regulatory Rigmarole

Issuing a clarification on its latest circular in which SEBI has allowed fund houses to take an exposure to REITs and InvITs, the market regulator has directed them to provide an exit option to the investors if they incorporate such changes in the investment mandate of the fund. That means, investors who wish to discontinue the fund due to exposure of REITs and InvITs can redeem their investment without any exit load. However, SEBI has given a window of 15 days from the date of announcement to avail this benefit. SEBI has said, “Any existing scheme intending to invest in units of REITs/InvITs shall abide by the provisions of regulation. For investment  in  units  of  REITs/InvITs  by  an  existing  mutual  fund  scheme, unitholders of the scheme shall be given a time period of at least  15 days for the purpose of exercising the exit option.” Earlier this month, SEBI had allowed fund houses to invest up to 10% of their corpus in REITs and InvITs, adding that only 5% of the corpus can be invested in the units of a single issuer. This has come into immediate effect.

SEBI has expressed concerns over a few mutual fund houses allowing investors the option of instant withdrawal from their liquid schemes. In the recent past, a few fund houses have begun offering retail investors an option to withdraw upto Rs 2 lakh in a day. Investors who opt for this facility get the money in their bank accounts via the IMPS (immediate payment service) route. The regulator feels instant redemption is akin to a bank account dispensing money on demand. Currently, Reliance Mutual Fund, ICICI Prudential Mutual Fund and DSP BlackRock Mutual Fund offer instant redemption facility for their liquid funds, while Birla Sun Life Mutual Fund launched instant redemption facility under Birla Sun Life Cash Plus Fund two weeks ago.

The capital market regulator, Securities and Exchange Board of India, is mulling a review of performance benchmark index for mutual fund schemes. SEBI is contemplating linking mutual fund schemes to total returns indices for benchmarking equity mutual fund schemes. Currently, equity schemes are benchmarked against primary indices provided by exchanges, such as Sensex and Nifty, which are typically principal returns indices. SEBI’s argument in linking mutual fund plans to total returns index is that fund companies, while computing net asset value of some schemes, should take into consideration the valuation of securities the scheme holds as well as corporate actions such as dividends. For instance: If an equity scheme claims to have returned 10 percent, versus 8 percent returns for the benchmark Nifty, the Nifty's return does not include the 1.5-2 percent dividend yield that the index may have clocked. SEBI now wants to change the methodology to calculate NAV and bring them in line with global standards that are used to assess fund returns. As per Global Investment Performance Standards or GIPS, all portfolios must be valued in consonance of fair valuation. In 2012, SEBI had amended regulations to incorporate the fair valuation norms, which prescribes that ‘in order to ensure that there is fair treatment to all investors, including prospective investors, the portfolio should be valued on the principles of fair valuations and it should be reflective of the realizable value of the assets’. The SEBI regulations also prescribed that a uniform method should be used to calculate total returns. However, industry experts have a different argument on the proposal. They say that while linking fund schemes to a total returns index formula may drive it from principles to a prescriptive approach, it may not be suitable for all market conditions. In a total returns index, the assumption is that the returns figure is a measure after all dividends are re-invested. However, the practice of dividend distribution is not uniform across all equity mutual fund schemes. A few schemes also have the dividend option while a few only have growth option. A total returns index may not be a uniform measurement for both the dividend and growth schemes. While total return index will more aptly represent portfolio stocks that regularly issue dividends, some Nifty stocks may not issue dividends at all, even as a total return index assumes all stocks issue dividends. If the regulator decides to go ahead with Total Return Index, it needs to address this dichotomy to avoid confusion among investors. Further, it remains to be seen whether NSE and BSE will make a total returns index on Nifty and Sensex public and transparent on daily basis to enable the fund industry have a transparent benchmark. In the 2012 reform of mutual fund regulations, when realizable value of assets was installed as the fair value principle, this was the over-riding principle for all valuations. Thus, re-prescribing a standard formula will take back to prescription days again rather than the principle based days (Principle based regulation is high on the agenda of International Organisation of Securities Commission in developed markets). To conclude, if a total return index is prescribed, the actual total returns for each equity portfolio may be different. So, will a single formula based—Total Returns Index do justice to all schemes in that category.

Mutual fund industry is likely to double its investor base and register growth in the next three years. The industry is betting big on investor awareness initiatives like Mutual Fund Day to achieve the goal. The mutual fund industry has seen a moderate growth in investor folios-from 4.7 crore to 5.3 crore in last five years-while retail participation has shown a healthy growth with overall MF AUM touching Rs 18 lakh crore at present from Rs 3.5 lakh crore in 2007. The Mutual Fund Day initiative, launched by Reliance Mutual Fund, is amongst the biggest investor awareness initiatives to encourage investments in mutual funds. As per industry estimates, less than 3 percent of the country's population invests in mutual funds. With recent policy changes and the revived investor interest in the mutual fund  sector, the industry will cross the Rs 20 lakh crore in AUM faster than expected. Currently the mutual industry is getting Rs 4,000 crore every month only from SIPs, and we see this number rising significantly in future.

NFO NEST

March 2017

NFOs of various hues adorn the March 2017 NFONEST.

DHFL Pramerica Dual Advantage Fund – Series 1

Opens: March 6, 2017

Closes: March 20, 2017

DHFL Pramerica Mutual Fund has launched a new fund named as DHFL Pramerica Dual Advantage Fund - Series 1, a close ended debt Fund. The tenure of the fund is 51 months from the date of allotment. The objective of the fund is to generate income by investing in fixed income securities maturing on or before the date of the maturity of the fund and to generate capital appreciation by investing in equity and equity related instruments. The fund will invest 65%-95% of its assets in debt and debt related instruments, 0% - 10% of assets in money market instruments and 5%-25% of assets in equity and equity related instruments including derivatives. Benchmark Index for the fund is CRISIL MIP Blended Fund Index. The fund managers are Mr. Rakesh Suri and Mr. Alok Agarwal.

HDFC Charity Fund for Cancer Cure

Opens: March 10, 2017

Closes: March 24, 2017

HDFC Mutual Fund has launched a new fund named as HDFC Charity Fund for Cancer Cure, a close ended fund with a maturity of 1136 days from the date of allotment. The fund has two plans – Arbitrage Plan and Debt Plan. The investment objective of the Arbitrage Plan is to generate income through arbitrage opportunities between cash and derivative market and through investments in debt and money market instruments and that of the Debt Plan is to generate income through investments in Debt/Money Market Instruments and Government Securities maturing on or before the maturity date of the Plan. The Arbitrage Plan is benchmarked against the Nifty 50 Arbitrage Index and the Debt Plan is benchmarked against CRISIL Short Term Bond Fund Index. The fund managers are Mr. Krishan Kumar Daga, Mr. Anil Bamboli and Mr. Rakesh Vyas.

ICICI Prudential Capital Protection Oriented Fund – Series XI Plan E

Opens: March 15, 2017

Closes: March 27, 2017

ICICI Prudential Mutual Fund has launched a new fund named as ICICI Prudential Capital Protection oriented Fund – Series XI Plan E, a close ended fund with a maturity of 1222 days from the date of allotment. The investment objective of the fund is to seek to protect capital by investing a portion of the portfolio in highest rated debt securities and money market instruments and also to provide capital appreciation by investing the balance in equity and equity related securities. The debt securities would mature on or before the maturity of the fund. The fund is benchmarked against CRISIL Composite Bond Fund Index (85%) and Nifty 50 Index (15%). The fund is managed by Mr. Vinay Sharma (Equity portion), jointly by Mr. Rahul Goswami and Ms. Chandni Gupta (Debt Portion) and Mr. Ihab Dalwai (ADR/GDR and other foreign securities).

BNP Paribas Balanced Fund

Opens: March 17, 2017

Closes: March 31, 2017

BNP Paribas Mutual Fund has launched a new fund named as BNP Paribas Balanced Fund, an open ended balanced fund. The fund seeks to generate income and capital appreciation by investing in diversified portfolio of equity and equity related instruments and fixed income instruments. The fund would allocate 30%-60% of assets in equity and equity related instruments, invest 5%-10% of assets in Net Equity Arbitrage Exposure with medium to high risk profile and invest 30%-60% of assets in debt and money market instruments and/or units of liquid fund with low risk profile. The performance of the fund will be benchmarked against CRISIL Balanced Fund Index. The fund managers are Karthickraj Lakshmanan (Equity Portfolio) and Mayank Prakash (Fixed Income Portfolio).

UTI Nifty Next 50 Exchange Traded Fund, Sundaram Capital Protection Oriented Fund 3.5 Yrs Series (17-18), Reliance CPSE ETF FFO 2 and SBI Dual Advantage Fund Series XXII – XXIV are expected to be launched in the coming months.

GEMGAZE

March 2017

All the GEMs from the 2016 GEMGAZE have performed reasonably well through thick and thin and figure prominently in the 2017 GEMGAZE too. 

Kotak Equity Arbitrage Fund Gem

Incorporated in September 2005, Kotak Equity Arbitrage Fund has an AUM of Rs 5,629 crore. The one-year return of the fund is 6.20% modestly trailing the category average of 6.55%. The top three sectors are finance, energy, and healthcare. Top five holdings constitute 22.22% of the portfolio, with the equity exposure at 68.1% and debt constituting 27.41% of the portfolio. The portfolio turnover ratio is 341% and the expense ratio is 1.12%. The fund is benchmarked against the Nifty Fifty Arbitrage Index with Mr. Deepak Gupta efficiently managing the fund since September 2008.

JM Arbitrage Advantage Fund Gem

The Rs 3828 crore JM Arbitrage Advantage Fund, incorporated in July 2006, has earned a one-year return of 6.59% a tad higher than the category average return of 6.55%. Top five holdings constitute 33.73% of the portfolio with finance, energy, and FMCG forming the top three sectors. Equity constitutes 67.86% of the portfolio with 29.15% in debt. The fund is benchmarked against the CRISIL Liquid Fund Index. The fund is managed by Chaitanya Choksi since February 2011 and Asit Bhandarkar and Sanjay Kumar Chhabaria since July 2014.

SBI Arbitrage Opportunities Fund Gem

SBI Arbitrage Opportunities Fund, incorporated in November 2006, has an AUM of Rs 891 crore. Its one-year return is 5.88%, as against the category average return of 6.55%. The top five holdings constitute 38.47% of the portfolio. Finance, energy, and healthcare are the top three sectors. 70.11% of the portfolio is made up of equity with 29.52% in debt. The portfolio turnover ratio of the fund is a massive 1020%. The expense ratio is comparatively low at 0.98%. The fund is benchmarked against the CRISIL Liquid Fund Index. The fund is managed by Neeraj Kumar since October 2012.

IDFC Arbitrage Fund Gem

IDFC Arbitrage Fund is a nine-year old fund with an AUM of Rs 2777 crore. Its one-year return of 5.97% is a tad lower than its category average of 6.55% at present. The fund is amongst the more consistent players in terms of beating the CRISIL Liquid fund Index over 70% of the times on a rolling – return basis. Top five holdings constitute 29.41% of the portfolio, with finance, energy, and auto being the top three sectors. The entire assets allocated to equity are 66.84% and 35.06% of the assets are in debt. While the portfolio turnover ratio is high at 250%, the expense ratio is very low at 0.93%, an icing on the cake, indeed. The fund has been managed by Yogik Pitti since June 2013, Harshal Joshi since October 2016, and Arpit Kapoor since March 2017.

ICICI Prudential Equity Arbitrage Fund Gem

Incorporated in December 2006, ICICI Prudential Equity Arbitrage Fund has an AUM of Rs 7094 crore. The one-year return of the fund is 6.25% slightly trailing the category average of 6.55%. The top three sectors are finance, FMCG, and auto. Top five holdings constitute 15.36% of the portfolio, with the equity exposure at 68.35% and debt constituting 36.18% of the portfolio. The portfolio turnover ratio is a towering 1135% and the expense ratio is 1.02%. The fund is benchmarked against the CRISIL Liquid Fund Index with Mr. Manish Banthia and Mr. Kayzad Eghlim efficiently managing the fund since November 2009 and February 2011 respectively.

FUND FLAVOUR

March 2017

Safety, tax efficiency…

Is there any mutual fund scheme as safe as debt mutual funds with better taxation for short term and long term gains? Yes. There is a set of mutual fund schemes which offers the above-mentioned features. They are called Arbitrage Funds. Arbitrage fund is an equity based mutual fund which provides consistent performance, similar to debt mutual funds, but is taxed like an equity based fund. Arbitrage funds are classified as equity funds from the taxation perspective. This is the best part. It means, you are taking less risk (similar to debt funds) but getting better taxation benefits of the equity funds. Effectively, they provide consistent returns like debt fund, and do not fluctuate much like equity funds do when the stock market goes up/down.

…consistency et al

Let us understand the concept of how arbitrage funds actually work. These funds invest in something called “arbitrage opportunities” in the market. The opportunities occur where there is a difference in the prices of a share at two different times/locations. It can be a difference in share prices at a moment in BSE and NSE exchanges, or it can be a difference in the prices of the stock in spot and F&O market. When such an opportunity occurs (and it almost always does), these funds buy and sell the shares at the same time in two different markets. They buy the share from where it is cheaper and at the same time sell it where it is expensive. This way, they earn some money and this money is called the arbitrage money. As they buy and sell at the same time, there is not much risk involved. Even if the stock prices go high or low, it does not make any difference to them because they have already earned their money. This is the reason why these mutual fund schemes are able to offer consistent performance over time.

Risk-free profit opportunity

Arbitrage means a risk free profit opportunity. So, by definition Arbitrage funds are very safe. However, safety of a financial instrument can again be divided into two parts:

1.      Assurance of capital protection

2.      Assurance of returns

As far as a bank FD is concerned, your money is safe on both aspects, i.e. your capital is protected and return is guaranteed. However, in arbitrage fund, only the first one holds true. Since arbitrage itself means risk free profit opportunity, there is virtually no risk of the fund value going down (once in every few days, the NAV may fall by a bit though).
But when it comes to assured returns, it is not offered by arbitrage funds. Your returns will be variable and you cannot be sure of how much profit you will earn. Arbitrage funds are not as safe as bank FDs, but compared to other mutual fund types, it has the potential to provide higher returns at much lower risk. And of course, since the returns are tax free after one year, your after tax gains may be higher than bank FDs. Arbitrage funds (mutual funds) take advantage of the arbitrage opportunities in the equities and futures (derivatives market) and invest. Derivatives market price the differential, that is known as carry cost. Arbitrage funds are able to capture this and pass it on to you. Returns will not be phenomenal. It will range between 8 and 10% per annum. What you can be sure about is that principal will be intact. There will no risk of NAV coming down. 

Minimal risk is one of the biggest advantages of arbitrage funds. Since each security is bought and sold at the same time, there is almost no risk associated with long-term investments. Besides, these funds invest partly in debt securities that are largely considered as stable. If there is a shortage in profitable trades, the fund may invest heavily in debt, which makes them appealing to investors having a low-risk appetite. Arbitrage funds are perhaps the only low-risk investment instruments that can flourish in volatile markets. Volatility causes uncertainty among investors. The difference between futures and cash market burgeons. Stable markets mean individuals share prices are not showing much change. Sans any clear bearish or bullish trends that may reverse or continue with the status of the market, investors will not have reason to believe that equity prices over a one-month horizon will change drastically from the current levels. Risk and volatility go hand in hand. You cannot pocket huge gains, or suffer big losses, without either. These funds are a great choice for risk-averse investors who want to reap the benefits of a volatile market, but with negligible risk.

Risk factors of arbitrage funds

Arbitrage Risk:

There is an amount of risk factor in Arbitrage Funds as well. It is the risk of spotting the rightful arbitrage opportunity in the market and acting upon it before the thought is over, i.e. very quickly. This is because the price difference will no longer exist when people realize the difference in the prices! So the arbitrage opportunity will then cease to exist. Thus, the opportunity needs to be identified and acted upon even before the opportunity actually arrives!

Liquidity Risk:

An arbitrage fund, unlike a Liquid Fund takes 3 days to be redeemed and your account to be funded whereas in a Liquid Fund, the amount gets credited into your account in one day. An arbitrage fund, being classified as equity due to taxation advantage, and redemption will materialize after T+3 days, thereby losing float for 2 interim days. However, a Liquid Fund gets credited into the account on redemption in T+1 day.

Exit Load Risk:

Some, almost all, arbitrage funds have an exit load of 60-90 days unlike that of liquid funds. Thus, any money, which is definitely there for a period of 3 months to a year’s time can be invested in this fund over liquid funds.

Arbitrage fund performance

Most Arbitrage funds follow a similar investment mandate. Under normal circumstances for instance, Birla Sun Life Enhanced Arbitrage Fund, HDFC Arbitrage Fund, and IDFC Arbitrage Fund invest between 65 to 90% in equities and derivatives and the remaining 10 to 35% in debt instruments. Invesco India Arbitrage Fund, on the other hand, allocates between 65 and 80% in equities and derivatives and the balance 20 to 35% in debt and liquid instruments. However, in exceptional circumstances, when arbitrage opportunities become unavailable, their asset allocation can shift to safer debt instruments, with 65-100% holdings in them; equities and derivatives will then make up the rest. Some funds may even impose a cap on purchases. For instance, ICICI Prudential Equity-Arbitrage Fund imposes a cap of ₹10 crore per investor. Effective July 2016, the fund changed its benchmark from CRISIL Liquid Index fund to Nifty 50 Arbitrage Index. Arbitrage fund returns depend on prevailing interest rates in the market and the availability of arbitrage opportunities. For instance, over the last year, while the Sensex and Nifty 50 were flat, these funds managed to gain around 6.4%, at par with the liquid fund indices. During a three-year period, as the broader markets gained around 15%, the returns from these funds were around 8%. However, over a five-year period, the gap reduces For Arbitrage Fund, the fund category returns over the one-year, three-year, five-year, and ten-year period historically is 6.5%, 7.88%, 7.98%, and 7.74% respectively. Thus, Arbitrage Funds have historically given 7-8% return over 5 to 10 years and top performing Arbitrage Funds have done better by about 1%. Thus returns of top performing arbitrage funds have mostly varied from 8-9%. Average returns were around 8% while the Sensex posted gains of 10%. As investments are based on price differentials, the expense ratio of arbitrage funds tend to be lower than that of diversified equity funds, thereby boosting overall returns. While the expense ratios of the actively managed funds are in the 2-2.5% band, arbitrage funds report a much lower 0.5-1%.

Less understood and under-purchased

Arbitrage funds are treated as quasi liquid as they bear almost the same risk as liquid funds but benefit from more advantageous taxation rules. And yet the total assets under management (AUM) of arbitrage funds stands at just Rs.22,000 crore as against that of liquid funds, which stands at around Rs.3 lakh crore. This lack of enthusiasm from investors may possibly be because they have little or no information about arbitrage funds and do not understand its potential, especially when compared with other types of funds in the same category of investment horizon such as liquid funds. Arbitrage Funds are one of the least understood types of funds and people who understand it, are the ones who make the most of it.

Rising popularity of arbitrage funds

Arbitrage funds have gained popularity among investors due to its favorable tax treatment ever since Union Budget 2014 tweaked taxation rules that favoured them. This is evident from the fact that arbitrage funds are now 33% of overall net inflows in equity funds. AMFI data shows that of the Rs.46,000 crore of net inflows in equity funds, Rs.15,000 crore has come through arbitrage funds in April-December 2016. The data further shows that arbitrage funds constitute 35% of gross sales under equity schemes. In fact, AUM under arbitrage funds stood at Rs.37,891 crore out of 419,562 crore in equity funds as on December 2016 which is about 9% of total AUM under equity schemes.

Arbitrage is the answer

There is a perception among investors that arbitrage fund is an all season fund due to low risk assets in the portfolio. It is expected this fund will perform well in bull as well as bear markets. An arbitrage fund usually performs well in a volatile market as the probability of mispricing increases. When the market is on its bull trend, investments in equities in portfolio stand to benefit as futures are usually high priced than the cash, thus fund managers sell the futures and buy the stock in the cash market thus booking risk free return. However, these funds face a challenge in a bearish market as the future would be less priced than the stock. Thus, arbitrage opportunity vanishes. Invest in arbitrage funds in a tactical manner to replace some portion of liquid and short term debt funds in overall portfolio with a view to earn better tax efficient return in bullish and volatile markets. If you are looking for debt investments with equity taxation benefit, or 6-9% returns without any equity exposure and yet reap the benefits of equity investment, then Arbitrage Funds is the answer to your needs!