The Hindu Business Line : Encounter

This fund aims
to reconcile the desire for higher returns with the need to limit downside.
— NIMESH CHANDAN, MANAGER, ICICI PRUDENTIAL EQUITY AND DERIVATIVES FUND

Several fund-houses have, of late, introduced equity funds that use a hedged derivative component to contain downside risks. ICICI Prudential’s Equity and Derivatives Fund- Wealth Optimizer Plan is one such plan that uses “dynam ic” hedging to generate “risk-controlled” equity returns. The fund’s manager Mr Nimesh Chandan explains the rationale for such products and how the concept works.

Excerpts from the interview:

This fund claims it uses dynamic hedging to contain downside. How is the structure of this fund superior to funds that use a debt-plus-marginal equity portfolio to deliver capital protection?

Capital protection oriented schemes are based on completely different investment objective or investment style/ strategy. While Capital Protection Oriented Funds aim at protecting capital from falling below the amount invested, the Equity and Derivatives Fund under Wealth Optimiser plan seeks to fight market volatility. The fund aims to generate low-volatility returns by investing in a judicious mix of cash equities, equity derivatives and debt markets. The usage of Equity derivatives in this fund is intended to hedge the portfolio against the downside risks, thereby allowing it to generate low-volatility returns. The fund focuses on the fundamental principle of “buy low and sell high” for which it uses three approaches: Quantitative modelling — which gives it the hedge ratio; fundamental analysis — aids in designing portfolio which is large-cap and select mid-cap dominated; Behavioural — which factors in investor sentiment and market response to event risk. This, in turn, aids the plan in creating strategic holdings while factoring tactical considerations based on market opportunities.

The key value-add offered by this product is the dynamic hedge ratio. If a fund manager is in a position to judge whether markets are attractive or not, won’t moving into cash offer sufficient cushion against downside?

The dynamic hedge ratio does not rely on the fund manager’s judgment. Rather it is arrived at through a rigorous analysis undertaken using a quantitative model. Second, instead of keeping part of the corpus in cash, we deploy it into less risky investment options, which yield some returns rather than keeping the cash idle.

While this fund’s structure helps contain downside related to the market, will the returns match that of the stock market in a bullish phase? Alternatively, what is the level of participation investors can expect in market upside?

Equity and Derivatives Wealth Optimizer Plan is a hybrid fund. The plan aims to invest 65-100 per cent in equity and equity derivatives while up to 35 per cent is invested in debt instruments. The fund aims to reduce exposure when markets appear over-stretched in order to contain the downside risks.

If you believe that the outlook for Indian equities is positive over a 3-5 year time-frame, wouldn’t it be better for investors to buy pure equity funds and hold for the long term, rather than to try and hedge against short-term downs ide? Is this product suitable for long-term investors?

Despite the much-talked-about long-term investment horizon, most investors do get driven by short-term movements and the sentiments of fear and greed. This, in turn, results in investors being at the losing end during market volatility. Apart from that, investment objectives also vary from individual to individual. For instance, some investors are aggressive and expect high returns while others are conservative and hence prefer relatively low returns with higher safety. This fund aims to reconcile the desire to earn higher returns with the need to limit potential downside:

By buying at market lows, the fund actually undertakes systematic investment on market movements.

Being an equity scheme, it also enjoys a tax advantage.

AARATI KRISHNAN

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