A new kind of mutual fund scheme is pretending to do dynamic financial planning. It is flawed in multiple ways
Debashis Basu & Jason Monteiro
What if you could you invest in just one mutual fund scheme and let the scheme manage your savings in an appropriate mix of debt and equity (asset allocation) over the coming decades, according to requirements and age? This would help you meet all your savings and investment goals. Such schemes are called lifecycle funds because they stay with you for your entire cycle of life, helping you meet various financial goals such as education, marriage, retirement, etc. Asset management companies have launched such goal-oriented funds in the past but you don’t hear much about them. Now, Axis Mutual Fund and ICICI Prudential Mutual Fund have come out with schemes in which the mix of asset allocation varies over the period of the scheme. Asset allocation will change such that the scheme reduces risk as it approaches the completion of the cycle. Should you go for these funds?
We have seen similar schemes in the past, but these had a fixed asset allocation. Franklin Templeton India came out with FT India Life Stage Fund which had asset allocation depending on the age. According to your age, you could choose one of the following—the 20s plan, 30s plan, 40s plan, 50s plus plan—each of which had a fixed asset allocation. Considering that young investors should be ready to take on more risk, a high portion of their investment would be allocated to equities in the 20s plan. Like the Life Stage Fund, there are other asset allocation fund-of-funds schemes such as Fidelity Wealth Builder Fund and ING Optimix Financial Planning Fund. Nearly all have an aggressive plan, moderate plan and conservative plan and follow a static allocation, according to the plan nomenclature.
The problem is in the basic principle: a fixed percentage mix. It cannot be useful for investors who have dramatically different goals and these goals change at different periods of life as well. If the asset allocation does not change a) with age and b) with your particular requirement, such schemes are practically like any other equity diversified fund, branded differently for marketing reasons.
Fund companies have now moved a step forward. They are launching dynamic asset allocation plans which would change the asset allocation as per your age. Axis Mutual Fund is planning to launch Axis Life Plan Fund which will offer four different plans—Plan 2020, Plan 2025, Plan 2030 and Plan 2035. The name of the plan mentions the target date (31st December of the respective year). The target asset allocation of the plans changes over time, decided by the number of years between the current date and the target date of a particular plan. The assets of the scheme will be allocated in a wide range of mutual fund schemes including equity funds, debt funds, gold ETFs (exchange-traded funds) and offshore funds. The scheme will also invest in debt and money-market securities for liquidity. This is supposed to be a complete product. You don’t have to separately buy equity, debt and gold; also, you don’t have to change the mix—the Fund will do that for you. It is a sophisticated idea, wrapped in simplicity.
You are, of course, a prisoner of the asset allocation chosen for you. This Fund, though innovative, follows a conservative approach. As seen in the asset allocation chart, if you enter Plan 2030 with a view to invest for a 15+year term, just 50%-55% of your assets would be invested in equity and that too for a period of only three years (2012-2015). And it includes gold. Therefore, you would be investing far less in equities than what you should ideally do for a term of 15+ years.
ICICI Prudential Lakshya Fund is another such scheme which will follow an asset allocation pattern linked to the number of years up to the end of a specified plan cycle, reducing the risk over the period. There would be six different plan cycles ranging from three years to 18 years. An investor who has an investment goal of three years would invest in the three-year plan; those with a six-year investment horizon would invest in the six-year plan and so on. The scheme restricts its assets to equity and debt mutual funds.
There is another asset-allocation decision embedded in this Fund. The allocation for mid-cap and large-cap funds changes over the number of years to the end of the plan cycle. For example, a plan with over six years to go would have a significant portion of its equity investment invested in mid-cap funds, with the rest in large-cap funds; this allocation for mid-caps would reduce later. This is in line with the strategy of the Fund of taking more risk when the investment horizon is longer.
The allocation of Lakshya Fund is the other extreme—far too aggressive. For a period up to five years preceding the end of the plan cycle, the scheme would invest 90%-100% of its assets in equity funds. The allocation towards equity and debt changes in the last five years only.
This aggressive strategy of the Fund can be disastrous for investors in a number of cases. Given that market movements are never smooth, this could erode a significant amount of the wealth generated in the earlier years, if you are unlucky.
Moneylife research shows that with three years to the completion of an investment goal, to have around 60% to 80% in equities is just too risky. Imagine the situation of someone who was supposed to need the money in late-2008 and invested in early-2006 in the Lakshya Fund. A lot of his wealth would have been decimated by the target date.
In the Lakshya Fund, a major change in asset allocation happens only in the last five years. An investor can easily manage this kind of allocation and does not need to pay a fund manager to do it. Secondly, as the majority of investment of these schemes would be in its own funds, an investor would be better off if he is able to choose from the best performing funds available in the market. Thirdly, as this is a fund-of-funds scheme, the investor would receive no tax benefit in investing for the long term in equities and would have to pay tax on capital gains.
Long-term capital gain tax would be 10% (20% with indexation) and short-term capital gains would be taxed according to the income slab of the investor. The fundamental flaw with all these schemes is that, all fixed formula-driven approaches that are not flexible enough would give random results, as was pointed out in the book More than You Know by Michael Mauboussin, chief investment strategist at Legg Mason Capital Management. For instance, towards the end of 2008, the markets were at a low—the Sensex was around 9,000—but picked up significantly in the following years. Had this been a time for a change in allocation, the scheme would have sold around 5% of its assets invested in equity which it may have purchased at a time when the Sensex was around 15,000-18,000. Such an approach is not flexible enough to take into account random and volatile market movements. In other words, your goal may or may not be met. One other issue is: Should you buy these schemes and nothing else? If so, how much of your savings should go into them? Fund companies are silent on this.
More significantly, how can two fund houses have such completely different asset allocation strategies for similar investment horizons? If fund companies have such a wide disagreement on something as basic as asset allocation, they cannot really claim to employ a method to deal with the madness of the markets.
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