Equity FundsThere is a new fund from Kotak Mutual Fund stable. Kotak India Growth Fund Series 5 will invest in companies across sectors and market capitalisation. The fund will also use ‘Put Options’ to protect investors from losses.’ This strategy of using Puts (a type of derivative) is becoming increasingly popular among mutual funds.

Earlier launch, Kotak India Growth Fund Series 4 followed a similar strategy and so did another fund DSP Blackrock ACE, Series 2. A put option gives the owner, the right to sell a stock or index at a given price. In return, the owner pays out a fixed sum, called a ‘premium’. The owner of the put profits when the price of the stock or index drops below the price specified in the Put, called the ‘strike’ price.  The strategy offers a direct alternative to open-ended ‘balanced’ funds, which some investors fear do not go far enough to limit risk.

The fund will invest 80-100% of its assets in stocks and 0-20% in debt and money market instruments. It can also invest in derivatives (such as puts). However, the money spent on Put premiums cannot exceed 20% of the net assets of the scheme.

When does a ‘Put Strategy’ work?

The premium for a put costs money and will reduce the returns of the fund to some extent. If the market does not decline below the put levels then the premium would be in effect ‘wasted.’

What if the market declines and then goes up? Well, this is precisely the scenario in which the fund proposes to outperform. Kotak India Growth Fund will keep selling puts as the market goes to lower and lower levels and ‘cashing in’ on the fall. When the market subsequently rises, it will make money from the recovery and will keep the money from the puts it has sold.

What if the market declines and stays low? In this case, the fund’s puts will mitigate the loss to some extent but not completely.

Here’s an illustration (figures are hypothetical, not actual):

Nifty Level at Fund Inception Scenario Performance
10,600 Market declines to 9000 and then recovers to 12,000 after 3 years Best of Both Worlds: Fund gets the best of both worlds. It gains from the fall by selling its puts and also from the recovery.
Market declines to 9000 and ends at 9000 An overall decline in the fund but better than unhedged: Fund loses money on its equity holdings. However, it makes some money from the puts giving it better returns than an ordinary unhedged equity fund.
Market goes straight up from 10,600 and ends at 14,000 Fund up but worse than unhedged: The fund makes money from the gain in the market but it has in effect ‘wasted’ the premium money on its puts.

Note that the fund proposes to use ‘Index Options’ to hedge its downside while investing in index and non-index companies. In other words, there is a risk here. If non-index companies fall while index companies fall less or rise, the Put will fail to protect investors.

With regard to its holdings, the fund will follow a ‘Business, Management and Valuation’ model. It will evaluate the company’s business environment, quality of management and valuation of the stock concerned. It will be jointly managed by Harsh Upadhyaya who also manages Kotak India Growth Fund Series 4 and Kotak Select Focus Fund among others and Harish Krishnan who manages Kotak India Growth Fund Series I and Kotak Infrastructure and Economic Reform Fund along with others.

Key Details

NFO Period: 25th April to 9th May 2018

Term: 1099 days (A bit over 3 years)

Fund Managers: Harsh Upadhaya and Harish Krishnan

Plan: Regular and Direct. The regular plan includes distributor commissions and the direct plan does not.

Option: Growth and Dividend Payout

Minimum Application Amount: Rs 5,000

Benchmark: Nifty 200

Neil Borate

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