Understanding Passive Multi-Asset Funds

The global equity markets saw huge gains post the pandemic. The last two years look like a distant dream now for an investor as the markets have started correcting. Indian equity market on a year-to-date basis is down over 10 per cent and the near-term outlook looks uncertain. Some of the factors that could cause market volatility are rising crude oil prices, aggressive monetary tightening and interest rate hikes by global central banks, a stickier inflation profile on the back of supply-side disruption and uncertainty around the ongoing Russia-Ukraine war. As a result, it may be a challenging phase for an investor who is new to investing.

Given the uncertain times, we believe the road ahead calls for prudent investment strategies and it begins with adhering to asset allocation. Every asset class – equity, debt, gold, international equities - has a distinct role to play in a portfolio. Historical performance data of various asset classes show that a winning asset class keeps changing every other year. While the equity market tends to generally perform well in expansionary economies, debt tends to generally perform well in contracting economies. Another asset class - gold - acts as a good hedge against inflation and so cannot be ignored from the portfolio mix. So, the key is to put together a portfolio that has optimal asset allocation to meet one’s requirements.

Challenges faced by an investor

Emotional/behavioural biases: The most common emotions that an investor encounters are greed and fear. Both of them limit an investor’s ability to make the right investment decisions. Even at market lows, investors refrain from investing as fear acts as a strong deterrent. On the other hand, investors tend to hold on to loss-making investments in the hope that someday they will be able to recover the losses and make good on the investment.

Inability to decide on asset class exposure: It is a well-established fact that one should invest across asset class such as equity, debt, gold etc. Since each asset class has a unique role to play in a portfolio, one cannot ignore any asset class altogether. However, as an individual investor, it is a challenging prospect to decide on how much to invest in each asset class and more importantly when to exit or rebalance a portfolio. This calls for some finesse.

Inability to select right investment instruments: There are a variety of offerings available within the equity and debt mutual fund space. Each fund has its own unique investment strategy or philosophy. Making a choice among these schemes which best meet an investor’s requirement required an element of research. Additionally, if one wishes to take exposure to international equities, there is an additional layer of complexity which comes in.

Managing tax impact: Every buy and sell transaction made as part of the investment journey is subject to either long-term or short-term capital gains tax. So, rebalancing is a challenging exercise, especially, in terms of taxation.

Passively managed portfolio

A passively managed asset allocation scheme is one where the underlying will consist of ETF and index funds from across asset classes. For example, there are schemes which provide investors with a blend of all asset classes - domestic equity ETFs and index funds and debt ETFs. Although the fund invests in passive instruments, the fund manager here has an active involvement in identifying asset class and mix. Moreover, tactical calls taken by the fund manager from time to time are likely to help generate better risk-adjusted returns in the long run. Such a scheme is both cost and tax effective. Whenever the fund is rebalanced, the investor need not worry about any tax implications.

To sum up, a passively managed multi-asset scheme combines the ease of investing with the help of skilled fund managers who are always looking for ways to make the portfolio perform better. Given its exposure to diverse asset classes, the scheme is a one-stop low-cost investment for investors looking at asset-allocation-based solutions.

(The writer is the Head - Product Development & Strategy, ICICI Prudential AMC)