Specialized Investment Funds: taking stock of what new they offer

They came with a promise of differentiation. Now is the stage of baby steps for the concept.

Earlier, the concept of Specialized Investment Funds (SIFs) was allowed by SEBI, in the space between Mutual Funds meant for the masses and PMS / AIFs meant for the classes. SIFs are allowed to have a different risk-return profile than MFs and the target audience, in the mass affluent segment, are expected to have a better understanding of the risk-return profile than the masses.

After the initial stage of boardroom deliberations and specific approvals from SEBI, a few SIF funds have been launched and more are in the offing. We discuss how you should look at it, for your investment portfolio, at this point of time.

Product differentiation with MFs

To understand the differentiation in SIFs, we will compare with MFs as that is something all of us are familiar with. While there are quite a few parameters where SIFs are different from MFs, the most prominent is the allowance for long-short funds in SIFs. In MFs, derivatives can be used only for the purpose of hedging.

As an example, in Arbitrage Funds of MFs, the fund takes short position or sell position in only those stocks that are there in the portfolio, and to the same extent as the exposure. The overall short or sell positions in the portfolio of an Arbitrage Fund is the same as the stocks in the portfolio e.g. if 65 percent is in equity stocks, then the contra or short position is also 65 percent. In Balanced Advantage Funds (BAFs) of MFs, they take short position in certain stocks which are there in the portfolio, as per the valuations in the market. However, the contra or short positions in a BAF is less than the equity component of the portfolio. This is known as hedged exposure i.e. a short position in derivatives against stocks in the portfolio.

In SIFs, they are allowed to have short or sell position in derivatives even in stocks where they do not have exposure. This is known as unhedged or naked position in derivatives. This strategy, allowed in SIFs and not in MFs, is known as long-short strategy. The implication is, the fund manager intends to benefit from prices going up in stocks where s/he is long (i.e. the stock is there in the portfolio) and benefit from prices coming down in stocks / indices where s/he is short (i.e. sell position in derivatives). This unhedged position is allowed up to 25 percent of the portfolio.

As per general understanding in the market and as per SEBI, a long-short strategy is a higher-risk-higher-return strategy as against long-only e.g. a plain vanilla MF portfolio of stocks. As per SIF fund managers coming up with funds with long-short, this is a lower-risk-higher-return strategy. This statement may be a marketing pitch, and may even play out in certain market conditions, provided the fund manager gets the calls correct. In a conventional long-only MF product, when the market is tanking, the fund manager can at most have some cash in the portfolio instead of stocks. In an SIF, the fund manager can benefit from the short position in derivatives, up to 25 percent. However, in a non-trended market, the separate long and short positions can both take a hit if the call goes wrong.

Evaluation parameters

For you as an investor, looking at an SIF, the relevant parameters are:

• Returns: there is no track record as of now, as SIFs are just getting launched. Only in the future we will be in a position to compare the performance with MFs.
• Liquidity: liquidity of exposures in your portfolio is relevant. Having said that, everything need not be liquid as in certain investments, the fund manager needs time for the strategy to play out. There would be a liquid component in your portfolio e.g. liquid funds or debt funds.
• Strategy: when there is a SIF product on offer and you like the strategy, you have to see where it fits into your portfolio. If it suits your objectives, it is good for you.
• Product positioning: currently, some SIFs are positioned as ‘Arbitrage Plus’ i.e. on the risk-return scale, slightly higher than Arbitrage Funds of MFs, whereas some are relatively aggressive long-short funds. Look at the extent of open equity in the portfolio.
• Taxation: SIFs are offered by MF houses and the tax treatment is the same as MFs. Hence over an adequate holding period, you get the efficient taxation rate of 12.5 percent plus surcharge and cess.
• Ticket size: it is minimum Rs 10 lakh in SIFs, but that is across funds from the same house. SEBI allows up to 7 SIF funds per house.

 
Originally Published in The Mint.

Author: Mr. Joydeep Sen, Corporate Trainer, Columnist