Weekly Musings – NFO Pick (DSP Multi-Asset Allocation Fund)

16 Aug 2023 , 09:36 AM

We had last discussed about a multi-allocation fund more than 2 months back and in this period we have seen a lot of interest building up in these multi-asset allocation funds. As the name suggests, these funds invest across asset classes like equities, bonds, derivatives and even in REITs. However, that is not the only big story in the multi-asset allocation funds. What is unique is the leeway given to the fund manager in deciding on an allocation rule and the tax benefits on such funds as the combination of equity and futures gives the fund a predominant equity flavour. This ensures that post-tax returns on these multi-asset allocation funds are still attractive. In this week, we will look at the DSP Multi-Asset Allocation Fund NFO, which opens on September 07, 2023 and will remain open till September 21, 2023. These multi asset allocation funds investing across asset classes like equities, futures, bonds, gold, silver, and even new-fangled asset classes like REITs and INVITs. In the process, these multi-asset allocation funds address the challenge of asset allocation but doing it at a fund level. This will be an open ended fund.

Key features of the DSP Multi-Asset Allocation Fund

Like any multi-asset allocation fund available in the market today, the DSP Multi-Asset Allocation Fund  too will be invested across different asset classes. The unique advantage in such a fund is that it does not take speculative punts on various asset classes. Instead, they reduce risk by taking hedged positions. This permits opportunistic returns combined with the safety of a hedge position. Here are some of the stand-out features of the DSP Multi-Asset Allocation Fund

• In terms of the asset allocation universe, the DSP Multi-Asset Allocation Fund will be predominantly a fixed income portfolio with additional exposure to equities, gold, and silver along with a partial exposure to REITs and INVITs, where such opportunities exist. The allocations are typically done in a rule-based manner to avoid the risk of fund manager bias stemming from a very discretionary approach. The DSP Multi-Asset Allocation Fund will combine the relative safety and stability of fixed income with the alpha generating capabilities of equities. The precious metals would be more of a portfolio diversifier while REITs would be more of a portfolio approach to investing in real estate and infrastructure assets. 

   

• The exposure of the DSP Multi-Asset Allocation Fund to equity, gold, and silver will be predominantly through the arbitrage route. In an arbitrage, the long position in the asset class is hedged with a similar short position in futures. The fund or investor having such a position either makes profit from rolling over the short futures each month or can also make occasional profits from unwinding the arbitrage position amidst high volatility. Effectively, in an arbitrage position, the fund locks in the arbitrage spread, which is more like a compensation for cost of funds. Like in equities, it is also possible to arbitrage between the spot market and futures market in gold and silver; and that is what the DSP Multi Asset Allocation Fund NFO will be focusing on.

   

• The DSP Multi-Asset Allocation Fund would be ideally positioned above an equity arbitrage fund in terms of risk and return, but it would be positioned below hybrid equity savings fund. The returns, in this case, is lower than direct exposure to equities but the risk would also be much lower.

   

• Let us look at the likely portfolio mix of the DSP Multi-Asset Allocation Fund and its implications for tax treatment of gains. The portfolio will be an amalgam of fixed income products, arbitrage between equity / futures and arbitrage between gold / silver spot-futures. Other than pure debt, which will be a naked position, the exposures to higher risk asset classes like equity, gold, and silver would be fully hedged. This has important implications for taxation. Here is why. Currently, returns on pure debt funds are taxed at the peak rate of tax. However, if the debt fund has an exposure of over 35% to equities, then the fund would be taxed at 20% of long term capital gains with indexation benefits. That is likely to make the DSP Multi-Asset Allocation Fund more tax efficient than any pure debt fund, since the exposure to equity and to derivatives would make it a more tax efficient package.

One key aspect of the fund is that it would be a lot less volatile compared to other pure equity or pure debt funds. That is because, substantial portion of the fund portfolio is hedged, which is a neutral position from the risk perspective.

What is the driving force for investors in DSP Multi-Asset Allocation Fund? 

The idea of the DSP Multi-Asset Allocation Fund NFO is to provide investors an actively managed portfolio of multiple asset classes, but based on some basic ground rules and investment philosophies. There is a logic to it. If you look back at the asset class winners of the last 20-25 years, then you have seen equities, bonds and even gold being outperformers at different points of time. This kind of risk-return diversity is captured by the asset allocation fund. Even when the multi-asset allocation fund invests in equities, the idea is to replicate a fixed income asset through arbitrage spreads rather than by taking a directional view. The focus is more on optimizing returns by minimizing risk rather than maximizing returns by taking on more risk. 

A typical asset allocation fund lays down broad rules for allocation, but gives discretion for allocation within the asset class. Here are some broad allocation themes adopted.

• The exposure to equity and equity related instruments can range from a low of 10% to a high of 80%. This includes cash equities, futures, and options.

   

• The exposure to debt and debt related instruments can also technically range from a low of 10% to a peak level of 80%. The fund will predominantly be a debt type fund, where other asset classes will also replicate debt type of stability.

   

• The exposure to commodities through commodity ETFs and commodity derivatives would be restricted to between 10% and 30% of the fund corpus, and most it is veering towards the lower side of this allocation range.

   

• Finally, the fund has also allowed a small window of up to 10% for taking exposure to REITs and INVITs, in case they are looking attractive as an asset class.

To sum up the likely portfolio strategy of the DSP Multi-Asset Allocation Fund NFO; It will have an exposure of 35% to 40% to equity arbitrage. There will be no naked equity exposure. The exposure to gold and silver arbitrage would be between 10% and 15%. The predominant portion will be the fixed income instruments, which will be in the range of 45% to 55%. Normally, these multi-asset allocation funds spread their bond holdings across G-Secs, SDLs and AAA rated debt only, with a targeted Macaulay Duration of 1 to 3 years.

Why post-tax yields on DSP Multi-Asset Allocation Fund NFO will be attractive

What makes the multi-asset allocation strategy specifically meaningful is that it gives dual benefit. But, first here is a quick view on debt funds. Finance Bill 2023-24 changed the definition of debt funds by breaking them into two parts. Prior to April 2023, all debt funds (non-equity funds) were taxed at 20% on long term gains (held for more than 3 years) with additional benefit of cost indexation. However, post the Finance Bill, only debt funds with at least 35% equity exposure were given than benefit of being taxed at 20% with indexation benefits. If the equity exposure was less than 35%, all capital gains on such debt funds would be classified as short term capital gains and taxed at the peak incremental rate applicable. In the case of multi-asset allocation funds, due to the substantial notional equity exposure due to futures hedging, the fund would be subject to 20% tax with indexation. This makes the DSP Multi-Asset Allocation fund more tax friendly for investors.

Now for the comparison. A typical such fund like the DSP Multi-Asset Allocation Fund NFO would be taxed at 20% (22.88% including surcharge and cess). However, due to the indexation benefits, the effective tax rate will come down to 7%, which his very attractive. In contrast, the applicable rate of tax is 11.4% for arbitrage funds and 34.32% for pure debt funds. This makes the product specifically attractive to the HNIs, although in the last few months, there is also a lot of retail interest in such funds, as evidenced by the surge in folios.

Glance at the DSP Multi-Asset Allocation Fund NFO 

Here are some details of the DSP Multi-Asset Allocation Fund you must know to decide on investing in the fund.

1. The fund opened for subscription on September 7, 2023 and the NFO subscription will close on September 21, 2023. 

    

2. The multi-asset allocation fund is classified as a hybrid fund with a relatively higher degree of risk. The DSP Multi-Asset Allocation Fund offers an opportunity to investors to diversify across asset classes through a more passive approach.

    

3. Entry loads do not exist in India, and the fund also will not attract any exit load if it is held for the minimum stipulated period.

    

4. The minimum investment in the DSP Multi-Asset Allocation Fund would be Rs100 in the NFO and in multiples of Rs1 thereafter. 

    

5. The fund will offer growth and IDCW (income distribution cum capital withdrawal) options. Within the IDCW option, the fund also offers dividend payout option as well as dividend reinvestment option. The fund offers regular and direct plans for the investors in the DSP Multi-Asset Allocation Fund.

    

6. How will the fund be benchmarked? It will be a mixed benchmark comprising of 40% weight to Nifty 500 TRI, 20% weight to MSCI World Index, 20% weight to Nifty Composite Debt Index, 15% weight to domestic gold prices and 5% weightage to MCX I-COMDEX Composite Index. 

The DSP Multi-Asset Allocation Fund is an opportunity to benefit from the risk interplay of multiple asset classes like equity, debt, gold, silver, and REITs. More importantly, it is also tax efficient compared to other debt funds.