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B. Venkatesh

PRUDENTIAL ICICI Flexible Income Plan returned 16 per cent since its launch last September. The holding period return does not, however, capture the high fluctuation in monthly returns due to the fund's aggressive portfolio strategy.

The fund may not be an appropriate investment at present for the following reasons:

First, the fund follows a dynamic asset allocation strategy — it shifts between government and corporate bonds based on the market condition. This portfolio strategy has resulted in high volatility in monthly returns.

For instance, the fund generated 3 per cent in December last, but lost two per cent the following month. On a risk-adjusted basis, the fund performed well in only six of the last 14 months.

Second, the portfolio risk is enhanced by the fund's strategy to increase exposure to long-term bonds; the average portfolio maturity has increased from four years in April 2003, to 9 years in October.

Such a portfolio strategy combined with dynamic asset allocation is aggressive. On the positive side, a portfolio with long maturity will generate high returns if the bond market moves up. On the flip side, such a portfolio will decline sharply if the bond market reverses direction.

Third, the sharp increase in asset size from Rs 563 crore in April 2003 to Rs 1,823 crore in October may lead to concentration risk. This is the risk of a decline in the net asset value (NAV) because the fund is overweight on a single bond or maturity sector. The fund has, for instance, Rs 275 crore exposure in the 7.46 per cent 2017 government bond. A decline in this bond's price will naturally impact the NAV.

Fourth, the large asset size suggests that a sizeable proportion of the investor base constitutes high-net-worth investors. The problem is that such investors typically make short-term investments to adjust their cash flows, forcing sub-optimal portfolio construction.

The portfolio manger may be, for instance, forced to move into cash during financial year-end when such investors seek more liquidity. Moving into cash lowers returns (cash drag) for unit-holders.

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