Saturday, October 27, 2007

Reliace Equity Fund

…or over-hyped? Reliance Equity Fund’s fall from grace has been a mix of both. But is it still worthwhile?

Remember Reliance Equity Fund (REF)? This is the same equity scheme that created history by collecting the maximum inflows in its new fund offer (NFO) period (Rs 5,759 crore), that any scheme had ever collected in the Indian mutual funds (MF) industry, in March 2006. Further, it also became the largest equity fund, at that time, without investing a penny in the market. Market sources told us that so happy was Anil Ambani, chairman of Reliance Capital, sponsor of Reliance Asset Management, that he awarded one Mercedes Benz car, each, to Amitabh Chaturvedi , then chief executive officer and Madhusudan Kela, head-equity, Reliance MF.

Circa 2007 and things are not quite the same for the MF scheme. REF lost Rs 2,293.2 crore or 40 per cent of its NFO collections between the time its NFO period ended and September 2007. Close to around 1,777.3 crore units have been redeemed from REF up to March 2007 – the last time MFs declared their half-yearly results - as its unit capital stood at Rs 3,949.9 crore, down from 5727.2 crore as on March 2006. The MF’s September 2007-end half-yearly results are yet to come out, but we do not expect the picture to be much brighter than this. In the meanwhile, REF underperformed many diversified equity funds (45.4 per cent returns on an average) as well as its own benchmark index Nifty (47.2 per cent returns) in the past one year ended 15 October 2007.

The twist
On the face of it, REF looks like many other diversified equity funds in the market. It is a diversified equity fund that invests in the top 100 companies, by market capitalisation and also companies that are available in the derivatives segment.

This is where the similarity ends. Unlike most other equity funds, REF also hedges its portfolio. The amount of its portfolio that it can hedge depends on Nifty’s price-to-earnings (PE) ratio. If Nifty’s PE ratio is up to 12, REF will hedge up to 10 per cent of its portfolio, if Nifty’s PE ratio is between 12 and 16, it will hedge between 10 and 30 per cent of its portfolio and so on, as indicated in its offer document. This caps the upside potential of the fund, but limits the downside should equity markets tumble.

Further, REF can also take derivatives exposure in stocks that it does not hold. This heightens REF’s risks and only time will tell how effectively REF will be able to use derivatives to protect its downside.

Tumbling expectations
Investors failed to recognise this attribute. REF is bound by its offer document to hedge its portfolio depending on Nifty’s PE. To that extent, REF is passively-managed. In the interim, Nifty went up by 38 per cent and diversified equity funds that did not hedge their portfolios outperformed REF, on an average. Investors expecting great returns from REF, like in other Reliance MF schemes, were disappointed; many of whom re-allocated their portfolios and exited REF.

Sources claim that since REF was the first equity NFO after the Reliance empire split, there was a need to prove a point. What followed was aggressive marketing and collections that helped the mutual fund jump to the number two slot in the corpus race, up from number five a month back. Mutual fund agents mobilised a substantial amount of short-term money too—a frequent scene in an openended NFO. And as REF charges 4.1 per cent NFO expenses to be amortised over five years—remember, it’s an open-ended scheme—existing investors will take a hit.

What should you do?
REF is not your typical equity fund. As equity markets rise, it will compulsorily hedge its portfolio. While this caps the upside, it will also limit the downside once equity markets correct. Expect to witness volatility in equity markets if you’re in for the long haul and only then will REF’s strategy yield results.

If you want to purely capitalise from equity markets and want pure equity returns, avoid REF. If you want some kind of protection to seep into your equity funds, REF is the perfect and most systematic way to go about it; stay invested.

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