Alternative Investment Funds or AIFs are a rage with high net-worth investors. Employing a variety of strategies and skilled fund managers to do all the work, AIFs are capable of growing your wealth pretty fast. Unlike other mass products like mutual funds, AIFs have a handful of investors and this leads to a much more closer relationship between the fund manager and the investor.
Since its inception, RupeeIQ has strived to bring balanced and objective reviews of financial investment products. Today, we are looking at ICICI Prudential AIF Long Short Fund Series 1, which was launched in August this year.
Product name and category – ICICI Prudential Long Short Fund – Series I. This is a Category III Alternative Investment Fund.
Why long / short strategy – A conventional equity investment is buying an under-valued security and wait for appreciation in the price of the securities. That’s why most of us invest in stocks. It is a one-direction approach: buy low, and sell high. Then, there are asset allocation funds, which protect downside when markets fall. Asset allocation funds can capture a majority of the upside with relatively better downside protection. But, what if you use a strategy where you can profit from both the market directions? An advanced use of the quants model may not only aim to protect the downside, but it may also help in generating alpha by shorting the overvalued securities. This is Long/Short strategy. If employed well, you may profit from both, buying undervalued and shorting overvalued securities.
Is Long/Short doable – The Nifty 50 has delivered over 12% CAGR over the last 13 years. But this return has come with a lot of volatility which may give an opportunity of Long-Short kind of structure. In the last 10 years, the stock market has had its share of up days and down days. In fact, the market was positive on 52% of trading days. So, there were enough opportunities for Long-Short strategies.
How it works – In conventional hedging, an investment portfolio is hedged with index futures, but if the same portfolio is hedged with weaker/falling sectors, it can be a source of alpha i.e. excess return over the benchmark.
The ICICI Prudential Long Short Fund – Series I wants to use three boxes for its investment strategy. One, it aims to have cash position in the index and have it periodically hedged with futures. In this way, it aims to benefit from the direction of the market. Two, build positions through stock/index futures, which will be valuation based calls. This aims to benefit from valuation differences within sectors. Three, it will use index options for directional calls. In this way, it aims to benefit from even range-bound markets.
Look at the following slide to understand how the investment strategy will be put into action.
Fundamental thought – The traditional way of equity investing is buy and hold. It has its merits as well as demerits. In the alternative space, the idea is to capture gains or alpha as much as possible using various strategies.
The way to capture alpha is through an all-weather proof approach. Every year a different category of companies has out-performed within equity asset-class. In one year, large cap will be the best. In others, all – large cap, midcap and smallcap – are same. In some years, smallcap outperforms others.
Dispersion of returns across sectors is also a reality. You may have large caps but if the sector was wrong, you may not have great gains. For instance, large caps gave 76% in 2009 but if you had telecom large cap stocks you may have lost money that year! Sector selection plays a crucial role. In years when equity market were positive, few sectors gave negative returns which gave an opportunity to go short. This is where a long/short shines brightly.
Strategy benefits – You get risk-adjusted returns as the funds aim to deliver risk-adjusted returns across a broad array of market conditions. You experience lower volatility. Such funds aim to have lower volatility, as measured by standard deviation, compared to long-only equity strategies. You have potential downside protection. Also, you have investment flexibility since investment managers can adopt Growth, Value or blend strategy for ‘long only’ equity component.
ICICI Prudential Long Short Fund – Series I fund details
a. Fund Manager – Nandik Mallik. Nandik joined ICICI Prudential Asset Management Company Limited in January 2017. His past experience includes work at Fair Isaac, Bangalore, NM Rothschild, Mumbai ICICI Bank, Mumbai, BNP Paribas, London, Credit Suisse, London, and Edelweiss Asset Management, Mumbai. Nandik is an MS – Finance from London Business School, PGDM from IIM Calcutta and B Tech from IIT Kharagpur.
b. AIF minimum investment – Rs 1 crore
c. Capital contribution – 100% Upfront
d. Subsequent subscription/exit – Monthly / Redemption: Quarterly
e. Management Fee – 1.50% of the NAV pa (charged on a daily basis) for Class B & C, 1% of the NAV pa (charged on a daily basis) for Class A
f. Hurdle Rate – 12% p.a. (pre-tax)
g. Performance Fee – 20% per annum (p.a.) for Class A and B and 15% p.a. for Class C on pre-tax basis over hurdle, with high watermark. High watermark NAV is the closing NAV (after tax) of the year in which Performance Fees was last charged.
h. Exit Load – Class B & C: 3 months from the date of each allotment – 0.5% of the NAV, Above 3 months: Nil
Class A: Nil
Recent performance – As per documents, in September 2018, ICICI Prudential Long Short Fund – Series I had taken exposure to net short positions of the securities. The Investment Manager believed that macro factors in the Indian and Global markets were deteriorating and broader market participation was not visible. Also, the global rate hike cycle helped the manager to have net short positions, which in turn contributed to the 11.32% return earned during the month versus Nifty’s 5.6% loss.
But in October 2018, the scheme lost 8.37% versus Nifty’s 5% loss. The ICICI Prudential Long Short Fund – Series I had taken exposure to net short positions in the first half of October 2018. Since Mid Caps and High Beta stocks fell much less than Nifty and that contributed to scheme generating negative returns for the month. Constant volatile market moves in the second half of the month which got the scheme whipsawed and on a relative basis, the scheme ended up underperforming Nifty.
However, the scheme in the ‘since inception period’ has out-performed Nifty 50. Performance as on October 31st, 2018 for Class B1 Unit Holders since inception is +2% compared to Nifty’s 10% drop. Return mentioned for the scheme are after deduction of applicable expense. Further, the return may be subject to applicable taxes.
RupeeIQ take – The scheme was launched in August 2018. The fund’s September and October monthly performance show why AIFs are for sophisticated investors. It can swing either way depending on the call. The investment manager got the rate-sensitive short call right on September. But come October, the net short positions call did not work. Going forward, equity markets are expected to remain volatile due to various reasons like state and general election, earnings cycle and global reasons. So, the strategy, in essence, is ever-green. As long as volatility stays in the market, a long/short strategy is relevant.
Disclaimer: The article is only for informational purposes. Investors are requested to consult their financial, tax and other advisors before taking any investment decision.