The Hindu Business Line : <I>Long-short, the future of fund investing </I>

Reliance Equity can be considered India's first hedge fund. It is also the largest ever offer made in the Indian market, though that is not necessarily an advantage.

`Long-short' strategy is excellent for diversification
Promise absolute returns in all years
Risk profile can be matched with a mix of index and `long-short' funds
Selecting the right fund manager though is not easy

At Rs 5,700 crore, Reliance Equity Fund is now the largest offer ever made in the history of Indian stock market, even bigger than the capital offers by companies.

Well, what do you expect, you might say. Indices are at record highs, retail investors want to enhance their exposure to equities and they are assailed by high-decibel advertisements that promised to enhance returns and reduce risk. In this case, however, investor exuberance may not necessarily be a bad idea. This is because Reliance Equity is not a conventional `long-only' fund. Investing in a fund that would go long as well as short on stocks is much less of disaster than investing all your money in a fund that promises to invest in bluechip stocks today. Reliance Equity's mandate allows it to buy stocks and sell derivatives. It can even sell derivatives of stocks it does not hold.

The long-short strategy that Reliance Equity hopes to follow also makes it a sort of hedge fund. This is one innovation whose success can fundamentally alter mutual fund investing in India. This class of funds is perceived as all-weather funds, generating positive returns at all times. Now, it would be even more helpful if such fund houses as HDFC, Franklin Templeton and Prudential ICICI follow suit and launch their versions of a long-short fund. This could be the future of mutual fund investing.

New opportunities

Typically, equity funds buy stocks. When they do only that, they are considered as going long on stocks, and are called long-only funds. Given the introduction of derivatives, Indian investors can now also take the contrarian position in stocks. Suppose you think the market is going down, you sell Nifty futures.

Reliance Equity is allowed to buy stocks that it thinks will appreciate. It can also sell stock futures, write call options on stocks or buy put options. Operations on the derivatives side need not be restricted to stocks that they hold.

This opens up a plethora of opportunities for the fund manager. He can go long on value stocks and short on growth stocks, or vice-versa. He can go long on large-cap stocks and short on mid-caps. He can now obtain a portfolio that represents his views much more comprehensively. Given that there are considerable restrictions to short-sell in the cash market, there could be considerable inefficiences that can be exploited. Theory says that if you balance equal amounts in long and short, it can help neutralise market risks. That is, the influence of index movements on the portfolio's value will be minimised. Fluctuation in values of such a fund will be considerably lower than that of an average `long-only' equity fund. What the fund generates in terms of returns would then be attributable to the manager's selection skills.

For retail investors too, this opens up several possibilities. They can now mix index funds and long-short funds in their portfolio. The proportion would depend on the risk preference. If you have a number of skilled fund managers, the task becomes even more challenging.

Hold your horses

As pointed out, the potential of `long-short' is immense and, without doubt, investors have been impressed by their promise. That explains the huge response to Reliance Mutual's offer. Retail participation also appears to be high, with the fund receiving record number of applications.

There are, however, quite a few reasons not to go overboard. Research abroad has confirmed that long-short funds indeed do add value to `long-only' portfolios. The risk of selecting a wrong fund is, however, higher in this class of funds compared to `long-only' funds.

Research also indicates that there is less consistency in their performance. That is, if you chose a fund because it did well this year, it may not necessarily do well the following year. The long and short of the performance of such funds abroad is that it is less easy to succeed in the `long-short' format than it is with `long-only' format. In the case of Reliance Mutual, the fact that its ambit is restricted to the top 100 stocks and the large size of assets could be additional negative factors. Investors who have not yet invested in Reliance Equity Fund could therefore wait and watch before rushing into it.

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