The DSP BlackRock A.C.E. Fund Series 1 is among the latest new fund offers (NFOs) to hit the market. But unlike many other NFOs, this one is not run-of-the-mill.

A close-ended, multi-cap equity scheme with tenure of 37 months, the NFO has a key differentiator — downside protection through put options — that can be useful with the market now trading at above-average valuations.

Portfolio construction A.C.E is short for Analyst’s Conviction Equalised. The scheme plans to invest in 45-55 high conviction stocks picked across sectors by analysts from a 16-member investment team.

Benchmarked to the Nifty 500 index, the scheme will adhere to the Nifty 500 sector weights, thus having no sector allocation bias. Within a sector, there will be equal weights for stocks, thus having no stock allocation bias. The scheme will invest across large-cap, mid-cap and small-cap stocks and could also go beyond the Nifty 500 universe if there is a high conviction bet.

While stock inclusion and exclusion will happen real time, the portfolio will be rebalanced on a quarterly basis for removing sector or stock bias.

The scheme intends to allocate 94 per cent of the portfolio to stocks, and 6 per cent to buy put options on the Nifty 50 Index to hedge the portfolio against down markets.

What’s new, what’s not An NFO makes sense for investors only when it offers something new. A multi-cap scheme investing in high conviction stocks picked by analysts is not quite novel — many multi-cap schemes would claim to do that even if the selection process varies.

But there are three features in the DSP BlackRock A.C.E. Fund NFO that are new — sector allocation in line with the Nifty 500 index, equal weight for all stocks within a sector, and downside protection through put options.

The key differentiator is the put option feature for downside protection. Put options on the Nifty 50 will be bought for the entire value of the equity portfolio.

While the Nifty 50 put options will not be a perfect hedge, given that the multi-cap portfolio will comprise stocks from across the Nifty 500 universe and possibly even beyond, it will still offer a good level of protection from downside risk.

The cost will be limited to the premium to be paid for the put options.

With market volatility currently low compared with levels in the past, the put options are available at a reasonable price, says fund manger M. Suryanarayanan. While the cost of the put options could erode returns somewhat in a rising market with the options rendered worthless, they will be handy in restricting losses in declining markets.

This loss-containment risk management could appeal to investors who seek to participate in the market but are wary of the current high valuations. On a risk-adjusted basis, the DSP BlackRock A.C.E. Fund could put up a better show than peers that don’t hedge exposures.

Why close-ended? Unlike open-ended funds, exit option and flexibility are restricted in the A.C.E Fund as it is close-ended. An investor cannot redeem units with the fund house before the tenure of 37 months. At the end of the tenure, the fund will be redeemed, irrespective of market conditions. The scheme will be listed on the exchanges but liquidity for mutual fund schemes is low on the bourses.

Why a close-ended fund instead of an open-end one? M Suryanarayan explains that the portfolio protection feature would be difficult to implement in an open-ended scheme with continuous fund inflows and outflows, and the risk of higher market volatility that could make put options quite expensive.

He also points that with the portfolio protection feature, the risk of loss on redemption at fund maturity is significantly mitigated.

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