Investing in hedge funds is the privilege of the very wealthy. IIFL Capital Enhancer Fund is not a hedge fund (it is a mutual fund) but it follows a strategy similar to a hedge fund, in one basic way. It uses long-dated puts to protect your downside. ‘Puts’ are a form of derivative (futures and options) which give their owner the right but not the obligation to sell his shares at a given price. In return for this ‘right’, the owner of the put pays a premium. The fund will invest in large-cap stocks, mostly from the Nifty 50 and also buy one year puts to protect its downside. It will open and close for inflows and outflows in specific windows (called Specified Transaction Periods or STPs). Once the STP closes, you are locked-in for one year. This makes it different from ordinary open-ended funds.
The essence of this fund is the use of puts. Even if you understand them, long-dated puts are not available to Average Joe traders in the stock market (where only 1-3 month puts are traded). These long-dated are only traded between large institutions such as IIFL. This is precisely the advantage that the fund seeks to pass on to ordinary investors.
You can find a full review of the fund by the RupeeIQ team here. Further to our analysis, we also spoke to Shashi Singh, a partner at IIFL Wealth and IIFL AMC, to know about the fund better:
IIFL Capital Enhancer Fund adopts a hedged strategy to protect itself from a market downside. What is the fund’s outlook towards the markets?
The idea of the fund is to help investors build long-term wealth in equity and at the same time have downside protection built into it. Over the long term, we have seen equities help in building significant wealth for investors. However, in the intermediate periods, there are phases of volatility due to multiple external events which impact the short to medium term return in the market. We believe the next 12 months is one such period where uncertainty levels would be very high owing to the domestic political events and global geopolitical events.
The hedged strategy indicates that the fund will outperform its unhedged peers if the market falls and will underperform if the market rises. To what extent is this interpretation justified?
IIFL Capital Enhancer Fund intends to safeguard returns and is not focused on out-performance or under-performance. The equity composition of the portfolio would be entirely large-cap and hence any performance comparison has to be done with similar large-cap funds. The backtesting of the proposed portfolio shows significant outperformance of the portfolio over its benchmark Nifty-50 index over the past 15 years in all market conditions. We believe outperforming index and safeguarding against erosion in gains and capital is what sets the fund apart from any other equity fund in the market. Thus surely the fund would outperform similar comparable equity funds on the downside and could either outperform or underperform the peers in a rising market depending on how the equity portfolio performs.
The fund adopts a unique ‘interval’ structure, opening itself to inflows and redemptions in select window periods. Is this structure a result of the fund’s hedged strategy? Does it compromise on investor liquidity?
The fund takes Long dated Nifty puts maturing in 1 year and hence the fund has kept a 1-year lock-in for its investment and is positioned as an annual interval fund. For liquidity purpose, the fund would be listed on NSE and hence have liquidity like any other closed-ended fund.
The Indian market is still relatively underdeveloped when it comes to futures and options. Typically only one-three month puts are traded in the active options segment. Will the fund be able to implement its put strategy given liquidity constraints and high premiums?
Yes, Indian derivatives market is still in its nascent stage and needs more participation from large institutions to increase the liquidity of long-dated options. The fund would be able to source and execute all the options needed for its hedge as we deal directly with large institutions who have large derivatives desk and such option underwriting of long-dated options is easily done. It’s not possible for a retail investor to get access to these institutional underwriters and that is where IIFL Capital Enhancer Fund gives retail and HNI investors a level playing field.
Retail investors do not typically understand or use futures and options. Through this fund, are you giving them a chance to benefit from derivatives through the expertise of a fund manager?
Yes, we are providing the expertise of our fund management team in managing the risk and returns associated with derivatives market and using that to protect the downside in the retail investors’ portfolio in a falling market.
The fund will invest predominantly in Nifty 50 stocks, focusing on IT, energy and financials. Are you more positive on large caps than mid or small caps? If so, why?
The fund would be predominantly investing in the Nifty 50 stocks and the sector allocation in the portfolio would be similar to that in the Nifty-50 with marginal variation. We would be ideally choosing around 25 stocks from the Nifty-50 and have same sector allocation. Since the fund would be taking a Nifty hedge, so it is important for the fund to have a large-cap orientation in order to have as close to possible a perfect hedge, and cannot have midcap smallcap exposure.
Can you give us some details about the sectors that the fund is positive on?
As mentioned above, the fund would have the same sector allocation as Nifty and there would not be any sector preference.
What type of investor is the fund best suited to?
The IIFL Capital Enhancer Fund, in spite of being a pure equity fund, has a Medium Riskometer rating from SEBI. The fund is suitable for the following types of investors:
Investors who are predominantly still investing in low yielding fixed income products and are averse to equity owing to the risk associated with equity.
Investors who are existing investors of equity funds but are worried about the volatility in the market over the next 1 year and want to protect their returns and wealth which they have built in the market over the past couple of years
Investors who have current Large Cap Equity MF allocation which is unhedged and would prefer to have the similar Large Cap MF allocation but with a downside protection.