Harish Krishnan, fund manager of Kotak Balanced Advantage Fund, which is currently at NFO stage, speaks to RupeeIQ about the new fund and which sectors and market caps it will focus on. This is a hybrid fund in which the fund manager has full freedom to move between debt and equity as per his market outlook. Kotak Balanced Advantage Fund opened for subscription on 13th July and will close on 27th July. However, the fund is an open-ended fund and will reopen for subscription.

Debt mutual funds have struggled over the past year and equity funds have also delivered a subdued performance. Why is now a good time to invest in a hybrid fund?

Any investment in a fund needs to be seen in the context of goals investors are trying to address and not necessarily based on the performance of asset classes over the last year. We believe a fund like Kotak Balanced Advantage Fund gives the investors key benefits as she plans for her goals in the future, namely – automatic rebalance between equity and debt depending on valuations and market sentiment, ability to buy low and sell high in each asset class using a model (that is devoid of typical human emotions of greed and fear).

Back-test results of the model since 2004 indicates that five-year rolling returns for an investment have been similar to traditional investment (like five year FD) when equity markets have given a subdued performance and have the potential to double wealth in a reasonable time-frame of five to eight years when markets have performed. Besides, as net equity allocation of the fund varies from 20-80%, (last five years average at 57%), the volatility experienced by the investor is significantly reduced.

What criteria or factors will you use to decide the equity-debt split in this fund at any given point of time?

Everyone loves to buy low and sell high, however very often, get swayed by extreme emotions of greed and fear. This leads to suboptimal results in asset allocation. Kotak Balanced Advantage Fund employs a model that aims to automatically allocate between equity and debt, removing these human biases. It employs a two-factor model to determine equity allocation of the fund.

The primary factor is trailing Nifty P/E. Trailing Nifty P/E have ranged from 10 to 30 over the last 20 years. Higher the P/E, lower the equity range and vice versa. However, many a time, high or low valuations can sustain for very long, and hence it is also important to gauge the sentiment or market trend.

This brings us to the second factor – to gauge the market trend, the model analyses rolling returns of Nifty across various time horizons. Along with other factors like volatility, 52-week high-low ratio and so on, the market sentiment is established. Thus, through a combination of both fundamental factors and market trend, the model determines equity allocation in the fund.

Will the fund have a particular market cap tilt? Concerns about the valuations of mid and small caps remain strong.

The mandate of this fund is to manage monies in a conservative fashion, which is why we have chosen a conservative range of 20-80% of net equity allocation for the fund. The core equity is managed from a universe of Top 150 stocks at most points of time. On occasions when the model suggests higher equity allocation (60-80%), we would incrementally be increasing allocations to midcaps.

The Balanced Advantage Funds give the fund manager total leeway to move into equity or debt in any proportion. Is this a problem for investors who want a hybrid fund, but one that is classed as equity for tax purposes? How can an investor know this type of fund’s tax status at the end of the financial year?

While net equity allocation of the fund is in the range of 20-80%, the fund will have gross equity exposure of at least 65% to enable it to qualify as equity oriented fund. When the model suggests net equity allocation lower than 65%, arbitrage positions will be taken up to ensure that while the fund complies for equity taxation, it dynamically adjusts equity depending on valuations and market sentiments.

Do you see any sectors being particularly attractive at this point in time? Several fund houses have launched pharma funds, while IT funds have delivered extremely high returns over the past year.

The equity portion of the fund will be managed in a diversified fashion across sectors. Across most of our various funds in Kotak, we are positive on consumption, retail-oriented banks, cement and capital goods and energy at this point in time.

On the debt side, do you see a larger opportunity on the credit side or on the duration side? Interest rates have been moving up for a while, driving up yields across the board

The debt portion will be managed on a conservative basis with a focus on short-term high-grade credit papers. In the event of a high probability of declines in yields, it will endeavour to build some duration in the portfolio. At this point, the focus on the debt portion will be to provide stability by buying into high-grade short-term papers.

Neil Borate

Neil Borate is Deputy Editor, RupeeIQ. He can be contacted at neil@rupeeiq.com.