Saturday, Jul 02, 2022

Deal With The Market Volatility Using Thematic Fund Of Funds

The market has moved from a bullish phase where most sectors were witnessing growth to a volatile phase, where only certain specific sectors are performing. This can just add to the confusion for many investors

Gibi George, Founder & Chief Executive, The Trinity International
Gibi George, Founder & Chief Executive, The Trinity International

The equity markets have witnessed significant volatility in the last few months, first due to an expectation of an interest rate hike by the US Federal Reserve and then due to the escalating geo-political tensions. This has taken many new investors, who entered the market after the crash of March 2020, by surprise. After all, the market more than doubled between April 2020 and October 2021.

Over this period, the market has moved from a bullish phase where most sectors were witnessing growth to a volatile phase, where only certain specific sectors are performing. This can just add to the confusion for many investors. It has also been observed that over a long term, different sectors perform differently in different years. For instance, the power sector was the top performing sector in 2021 with 68% returns, but it gave a paltry 7% in 2020 and a negative return in 2019.

 In such a situation what should an investor do? Afterall, studying and trying to figure out which sector could see an uptrend next is not something everyone can do. Even if someone manages to dedicate that kind of time and energy to figure that out, selling in one sector and then buying into some other sector time and again would lead to inefficient outcomes as the tax outgo can be sizeable. 

The answer then lies in finding an alternative that can offer expert sectoral selection and tax-efficient rebalancing. In other funds, a Fund of Funds is something you should explore.

What is a Fund of Funds?
The market regulator Securities and Exchange Board of India (SEBI) has permitted Asset Management Companies or Mutual Funds to have a specific category of mutual funds called Fund of Funds (FoFs). These schemes can invest in other domestic and international mutual fund schemes or exchange traded funds without any restrictions. Accordingly, this enables the fund managers to have a dynamic and diversified portfolio.

From an investor’s point of view, FoFs also offer a tax advantage. FoFs are treated at par with debt schemes for taxation purposes, even if the underlying investment is skewed towards equity. This means that the long-term gains from such funds get the indexation benefit, which can end up giving a substantial tax saving. 

Which FoF should you choose?
The ideal FoF should be one that chooses sectors or themes that are likely to witness an upward trend. Accordingly, a thematic FoF that takes exposure to multiple sectors, but keeps the allocation dynamic to take advantage of upcoming opportunities is something that will fit the bill here. 

If you an investor looking to invest in a fund which dynamically manages sector rotation, then ICICI Prudential Thematic Fund of Fund is one of the options that ticks all the right boxes. The fund managers for this FoF follow a refined process to identify the investment focus areas for the scheme.

Other than just macro-economic indicators, the fund managers also actively track sectoral valuation for different sectors to increase or decrease their exposure. For instance, this scheme had a 10% allocation to infrastructure theme as of December 2021, which was in stark contrast to the 55% allocation infra had in March 2021. Similarly, the weightage for healthcare and diagnostics sector too has come down from 29% in March 2020 to 14% in December 2021. 

This fund also has the flexibility to invest into international equities as well. In recent months, the scheme has identified opportunities across Asian and US equities too and has a near 10% allocation to foreign equity. 

As a result of the sectoral calls and the geographical diversity in the portfolio, this strategy has delivered excellent results over time. Compared to the broader market performance, indicated by the NIFTY 500, this FoF has outperformed the broader market over 1 and 2-year timeframes. After all, it is not just about entering the market, you also need an expert guidance to understand when to exit particular sectors.

To conclude, if you are unsure how to go about with sectoral allocation, or which sector to buy into or exit, then you can consider making this fund a part of your portfolio as it automatically addresses your challenge area while helping you reap gains over long term.