InvestorQ : What exactly are multi-asset class funds (MACF) and how can retail investors make the best of such funds?
Arti Chavan made post

What exactly are multi-asset class funds (MACF) and how can retail investors make the best of such funds?

Crowny Pinto answered.
3 years ago

MACF is an extreme form of diversification that is available to mutual fund investors. One of the major advantages of investing in mutual funds is the benefit of diversification. It is actually quite a simple concept. If you are invested in just one stock, then your entire investment depends on the fortune of that one stock. On the other hand, if you spread your money across more stocks then your overall risk gets reduced because even as one stock may underperform, another stock could outperform. Thus your dependency on just one stock is eliminated through diversification. This also reduces your concentration risk. This is the first level of diversification of risk. When we talk of MACF, we are talking about the second and third level of diversification of risk. Here it is not intra asset class but inter asset class. Let us first understand the second level of diversification.

We can actually take diversification to the second level, wherein we can diversify by investing in equity and debt. Equity entails higher risk and therefore higher returns. However, debt gives your portfolio an element of safety and fixed returns. This can be achieved by investing in balanced funds that invest across equities and debt and you can get the benefit of equity and debt through a single mutual fund. But then equity and debt are both financial assets at the end of the day. This represents a very basic form of MACF. What if you want to also take an exposure to real assets like gold, silver and commodities? That brings us to the third level of diversification which can be done through a true blue multi-asset class funds (MACF)

Do multi asset class funds really make a difference to returns on a portfolio? Let us consider different scenarios to address this question. Multi asset class funds (MACF) are mutual funds that invest across equities, debt and physical assets like gold. Between January 2016 and June 2016, gold prices in the international market moved up from $1050/oz to $1360/oz returning nearly 30% in 6 months. Even in rupee terms, the price of gold during the period moved from Rs.24,900/10 gm to Rs.32,300/10 gm yielding a similar 6-month return of 30%. That makes gold among the best performing asset classes in the first half of 2016. Of course, Indian investors can buy gold through gold ETFs and through gold bonds but it is difficult for an individual investor to take a decision on when to buy gold and when not to buy gold. That is where multi-asset class funds (MACF) come in handy. But the real advantage of MACF is not just in the commodity diversification. The real merit lies in the fact that fund managers can take an intelligent and informed view on when to focus more on equity, when to shift focus on debt and when to diversify into gold. Of course, this does introduce a very big active element to the fund selection and asset mix but that is where you can actually create alpha for investors.

How MACF can be an important tool for portfolio allocation?

What exactly do we understand by asset allocation? In a nutshell, Asset allocation is all about shifting your asset mix based on an informed view on the market. Let us take a few examples. If the Nifty has corrected sharply and frontline stocks are available at 12-13 P/E, then it makes a lot of allocation sense to focus more on equities in the portfolio. Similarly, if the view is that interest rates are headed downwards, then the fund manager can increase exposure to long term government securities which will benefit substantially from a fall in interest rates. Additionally, if the fund manager expects that the global geopolitical uncertainty and too much of money printing will make gold more valuable, then they can take a large exposure to gold. Normally, what the fund does is to define broad allocation ranges for each asset class and then move these allocations within this range. For example, if the range for gold allocation is 10-20% then the fund manager will push the allocation to 10% when equities are strengthening and closer to 20% when the global geo political uncertainty is on an uptrend. These are decisions that individual investors will find hard to make. But mutual fund managers, with their research capabilities and their market intelligence will be in a better position to take asset allocation decisions. That is where an MACF can really come in handy. There is another major advantage in an MACF. Most investors find themselves stuck in equities at higher levels and therefore when the market falls, they do not have the liquidity to invest at attractive valuations. This problem can be automatically addressed through MACF based asset allocation. Let us look at this point from a more statistical point of view. For example, your allocation to equity / debt / gold is 60:25:15. Now when your gold range is 10-20%, your endeavour will be to maintain a mean allocation of around 15%. That is automatically achieved because at higher allocations the gold portfolio is unwound and at lower valuations the gold portfolio is added to. This problem is a lot more acute in case of equities. An MACF is a continuous allocator so at higher P/E ratios, the equity will be sold to bring the allocation back to normal. It will rarely happen that you are stuck with shares in a falling market or without liquidity in a market that is almost bottoming out. That is where MACF plays a big role.