A better model for balanced advantage funds
CIO – Equity
Reliance Nippon Life AMC
WF: In our last interaction in Dec 2017 (Click Here), you talked about the EM cycle looking good for perhaps another couple of years. Has the rise in US yields, rise in oil prices and the weakness in some EM currencies put the EM cycle in some trouble?
Manish: If we see the emerging market index, it had roughly doubled from the low of Feb’16 till Jan’18 and then corrected about 10% from the top. Definitely, the spurt of crude oil and US bond yields have been headwinds. Weak economic data from Europe, Japan has also had a role in pushing up the U.S. Dollar which in turn tends to be negative for emerging markets. However, it does not yet appear to be a structural change to impact the thesis of this being a phase of global and EM growth, as overall growth data is reasonable and commodity prices healthy. If US dollar appreciates further and commodity prices materially weaken, it would be a stronger sign that the EM cycle is under trouble.
WF: What is your outlook on Indian markets over the next 12-18 months and what do you see as the key drivers going forward?
Manish: The economy seems to be at a reasonable growth rate now but there are clearly a few macro challenges primarily in terms of oil and political uncertainty given the spate of elections ahead. Having said that, global growth is still healthy, the early monsoon trends appear positive, election related spending should be significant in FY19. Keeping these in context of the valuations, we believe on a 3-year basis, stock market returns will be attractive relative to most other major asset classes.
WF: In your Balanced Advantage Fund, why have you opted for a forward P/E based model rather than P/B which is a time tested model in some very popular dynamic asset allocation funds?
Manish: Various valuations variables were considered while making the model including Price to Book (PB). As we know, PB ratio is a measure of the market capitalization vis a vis the net worth of a company. Unless combined with measures such as Return on Equity, this measure may not be complete. Essentially, mere presence of capital may not mean much, unless such capital is put to an effective use. Price to Earnings (PE), on the other hand, captures the productivity of the assets, which may be a superior measure.
We believe Forward PE is a better measure when compared to any trailing metrics , such as PB particularly at the turn of cycles. At the bottom of the cycle, for instance, a trailing metric may be reflecting high valuation, where as a forward metric would smoothen out and would reflect a more appropriate valuation.
WF: Can you take us through “Trend Following”, which is a key input into your asset allocation model for your Balanced Advantage Fund?
Manish: Reliance BAF uses a combination of Valuation & Trend metrics to determine the relative attractiveness of markets, and accordingly chooses the net equity exposure. ‘Trend following’ is nothing but the market momentum, wherein we analyse Short Term and Intermediate Trends to understand the prevailing mood of the market participants.
WF: At what level is your net equity now and how low has it gone to in your back tested data and when?
Manish: Currently we have a net equity exposure of around 47.5%. As per the fund model, Low Valuation and High Momentum would result in Maximum Equity allocation, whereas High Valuation and Low Momentum would result in Minimum Equity allocation.
Based on the back tested data of approx. 10 years, the lowest Equity Level has been at 32.5%. Few of such instances are given hereunder:
WF: Some funds in the BAF/dynamic equity category have come under flak from advisors recently for not being “true-to-label” – for not cutting equity allocation entirely as guided by their models, in an effort to stay afloat in short term performance league tables. What leeway will be available for your fund manager in this context?
Manish: Reliance Balanced Advantage Fund will strictly adhere to the Equity Allocation determined by the model. While we will continuously strive to enhance the model, the fund manager will not have any flexibility to change model determined equity allocation. This is line with the core philosophy of the product to have an objective and unbiased equity allocation strategy.
WF: With an average equity allocation over time of around 54% on your back tested data, how different would the performance of your BAF fund be vis-à-vis aggressive hybrids that maintain a 65-70% equity allocation (erstwhile balanced funds)?
Manish: From a positioning perspective Reliance Balanced Advantage Fund would be placed between an Equity Savings Fund (Equity Allocation 35% - 40%) and an Aggressive Hybrid Fund. However, while both these categories adopt constant equity allocation strategy, Reliance BAF will have a dynamic equity allocation. We believe this dynamic equity allocation strategy can help the fund in creating ‘alpha’ despite lower average equity exposure.
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