The Hindu Business Line : Serving up a triple AAAce

Capital protected products have only recently made their debut in Indian markets, with a few mutual funds and portfolio managers rolling out such schemes. JM Financial recently launched Triple AAAce under its portfolio management services. This scheme invests in a basket of mutual funds to deliver capital protection through the Dynamic Portfolio Insurance (DPI) method.

What distinguishes this product from the other capital protection schemes in the market is its open end structure, says Mr Vipul Shah, Associate Director and Head - Private Wealth Group, JM Financial Services. Business Line spoke to him to find out how various capital protection products differ: Excerpts from the interview:

Why should an investor own capital protection products? Aren’t fixed income investments such as FDs better options for investors seeking capital protection, as they deliver an assured income in addition to capital protection?

The biggest challenge with Indian investors has been that, due to the very high volatility and risk attached to equity markets, they have shied away from investing in Indian equities and lost a big opportunity on wealth creation over the past four years. There is enough anecdotal evidence to suggest that the Indian public holding in listed companies has fallen, while FII holding has risen, during this period.

On the other hand, inflation is a huge wealth destroyer and if an investor puts his money in debt, he will get very low to negative real returns. Hence, the dilemma before him is how to get the safety of a debt instrument but increase the return profile.

This is exactly where products such as Triple AAAce fit in. It carries the risk profile of a debt instrument, as it is rated AAA(so) by Crisil, while has the potential to earn returns closer to underlying equity investments. In fact, Triple AAAce has two performing equity mutual funds — Reliance Vision and HDFC Equity as its underlying equity assets. Globally, capital protected structures have found a big allocation in large wealthy families in past five years, and we believe a similar trend will emerge in India. Such capital protected structures provide a high risk-adjusted return compared to both equity and debt.

What are the various strategies commonly used to deliver capital protection?

Capital protection started with the simple methodology of investing, say, 70-80 per cent in debt in such a way that it will grow to 100 per cent by end of the term, with the remainder of the portfolio invested in equity or equity options, to give upside. However, such structures did not allow investors to get close to 100 per cent equity participation. In fact, investors could have achieved the same themselves through Asset Allocation.

Then came Constant Proportion Portfolio Insurance, which allowed a higher equity participation. But since the exposure to equity remained high until maturity, if there is a large correction, say, of 20-30 per cent in stocks, the investor fails to get his equity return and just gets back his principal.

Through Triple AAAce, JM Financial is introducing Dynamic Portfolio Insurance Methodology (DPI), where Societe General of France, rated as the leader in such structures, will act as consultants to JM Financial in managing this structure.

What DPI does is that based on volatility (simplistically speaking), it reduces equity exposure as markets fall, and raises equity exposure once volatility reduces. Historically, it is proven that equity markets have a negative correlation to volatility. This enables the structures to give close to equity market returns, while lowering the probability of just returning principal. This is the difference between DPI and CPPI. In India till date, most of the structures are based on CPPI.

How are these products superior to a plain vanilla balanced strategy where a fixed portion of the portfolio is allocated to equity and debt re-balanced at frequent intervals?

There is a big difference, as DPI allows you to decide the optimal mix between equity and debt and hence allows the investor to get returns closer to pure equity investments. A plain vanilla balanced strategy tends to reduce equity exposure in rising markets, since a fixed allocation between equity and debt is maintained.

How exactly does this product work?

JM Financial’s Triple AAAce is India’s first PMS product rated AAA(so). It has some unique features. It endeavours to give full capital protection. It allows investors to participate in the equity market upside for the next five years, with liquidity at any time. The investor can exit any time during the life of the product.

Finally, during the life of the scheme, that is five years, whatever is the peak value of the portfolio of the investor, the structure will endeavour to give 85 per cent of its peak value.

If the portfolio value rises from Rs 100 to Rs 300 and then declines to, say, Rs 150, the investor will still get 85 per cent of Rs 300 or Rs 255 at maturity. Hence, he need not worry about timing the peak and hence in the true sense can remain a long term investor.

What are the triggers that will be used for dynamic allocation — are these quantitative or qualitative?

The triggers used are levels of equity market volatility and expected return.

What is the selection process for the equity funds that make up the equity portion of this portfolio?

We follow a rigorous process of selecting the underlying equity funds. JM Financial has an extensive mutual fund research team that monitors all major funds. In addition, Societe Generale and Crisil too have a strong MF analytical team and they provide us with their inputs.

Several parameters are considered while selecting the fund, such as risk-adjusted return, assets under management, period for which the scheme has been active, market outperformance, fund management team and fund house track record.

Who are the target investors for this product?

The target investors will include both equity investors as well as debt investors. For equity investors, Triple AAAce is an opportunity to lock their gains and still continue to participate in any upside provided by equity markets. For debt investors, Triple AAAce provides a window to invest in equity without taking equity-related risks. It’s a win-win for both.

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