Multi-manager fund of funds (FoF) Axis All Seasons Debt Fund, which is open for subscription till 22 January, is the first of its kind in India’s debt funds space. The fund will invest in the units of other debt-oriented mutual fund schemes. But unlike other FoFs that typically invest only in the schemes of the same fund house, Axis All Seasons Debt Fund will select schemes across fund houses.
With investors having far from satisfactory experience with debt funds over the last one year, the FoF structure may provide an efficient way to diversify fund manager risk. The success of the dynamic strategy again rests on the manager’s assessment of the risk-reward relationship across duration and credit segments. Here, too, the multi-manager FoF structure is expected to provide investors the advantage of the best investment and research ideas of different fund houses. What does this structure mean for investors and what should they keep in mind while making the investment decision?
What the fund is about
Axis All Seasons Debt Fund will be managed with a dynamic strategy that seeks to look for opportunities that arise from interest rate movements, liquidity, credit situation, and others, in any segment of the debt market and change the underlying portfolio to benefit from it.
The advantage of using the FoF structure to dynamically manage investments in debt markets is that there is a professional—the fund manager—to select the schemes and to rebalance the portfolio when required. Reading the rebalancing signals in debt markets is difficult for retail investors.
The new FoF will hold 6-10 funds, which will be selected based on their suitability to implement the fund manager’s views. “We plan to have a top-down approach to the duration and credit stance and within that, each fund manager will have a fair amount of leeway in managing the portfolios. We want the best ideas from different fund managers to come through this portfolio," said R. Sivakumar, head, fixed income, Axis Mutual Fund.
They will also take care to ensure that the funds selected reflect the FoF’s duration and credit stance. “We will be classifying the funds on the basis of their actual portfolio rather than on categorization," said Sivakumar, talking about the process of portfolio construction. “So when we say AAA-oriented fund, we mean that a minimum of 75-80% of the portfolio would form that bucket, irrespective of the nomenclature," he added, on managing the possibility of credit risk sneaking into the FoF via a duration portfolio where there is no regulatory prescription on credit quality.
Axis All Seasons Debt FoF is also expected to bring greater diversification since it may invest in schemes other than that of Axis Mutual Fund. While the format reduces the risk of fund house concentration, there is the possibility that the portfolio may see higher risk from concentration in securities from an overlap with the different funds holding the same securities. This concern is addressed through the selection of schemes, said Sivakumar. “When we take a basket approach to building the portfolio and take a mix of both credit and AAA-duration funds, we see two things happening. The first is that the overlap comes down and the second is that the number of issuers in the portfolio go up from an average category range of 25 and 35 in a duration fund and credit risk fund, respectively, to close to 200, with non-AAA issuers moving from 30 to 130-140 issuers. The risk will thus get better diversified across issuers. The concentration in the top 10 issuers as a percentage of the AUM (assets under management) also drops meaningfully from the 60% mark to 40%," he said.
How it compares
The FoF structure brings better diversification benefits and the views of multiple fund managers in one portfolio in comparison to dynamic bond fund. Mutual fund investors may also try to replicate the dynamic strategy by holding funds in different debt fund categories and manage the allocation to reflect the views on which segment is likely to do better. But that may be inefficient from an execution point. There may be a delay in being able to implement a recommendation or view, affecting the benefit the investor can get. Taxation is also a consideration—investors have to hold a debt fund investment for at least three years to be able to get the benefit of indexation for long-term capital gains. But this does not apply to an FoF. There are no tax implications for FoF when the portfolio is rebalanced to reflect a market view and there is greater efficiency in executing the view.
A major consideration is that the FoF structure implies costs to the investor at two levels. One which is charged by the FoF and the other by the underlying scheme. This has been perceived as a disadvantage for investors. Capital markets regulator Securities and Exchange Board of India (Sebi) has addressed the issue by capping the total expense ratio that an FoF can charge, including the weighted average of the total expense ratio levied by the underlying scheme(s) at 2%. “The management fees and the expenses at the FoF level are being kept to the bare minimum so that the total expense ratio, including the expenses of the underlying funds, are contained in line with other actively managed debt funds," said Sivakumar.
A look at the performance of dynamic bond funds as a proxy for an FoF that will look to follow a similar strategy shows that the average returns of the top five funds in the five-year and three-year periods was 8.68% and 7.29%, respectively, as on 10 January. While the returns were marginally higher for dynamic funds relative to short-duration funds, the volatility was higher too with standard deviation of the top five dynamic bond funds at 2.74 as compared to 1.46 for short-duration funds.
What should you do?
“The scheme is good for a DIY investor who does not have access to an adviser. However, someone who wants to take concentrated bets in the debt space will not find it useful," said Amol Joshi, founder, Plan Rupee Investment Advisors.
Consider this FoF if you want to be able to take advantage of debt market opportunities and have the stomach for volatility in returns. You must be ready to hold it for at least three years both from the point of view of taxation and from giving the strategy time to show results. Keep a watch on the expense ratio of the fund. If stability is what you are looking for from your debt portfolio, then stick to short duration funds.