Guided Investing

HDFC Prudence Fund

Category : Asset Allocation, Mutual Fund · by May 13th, 2018

Dear Friend,

Following SEBI’s diktat on Categorization and Rationalization of Mutual Fund Schemes, HDFC Mutual fund has proposed the merger of these two schemes:
a) HDFC Growth Fund and
b) HDFC Prudence Fund
into a new entity called – HDFC Balanced Advantage Fund.

The investment objective of the fund now says “To provide long term capital appreciation / income from a dynamic mix of equity and debt investments.” The proposed asset allocation of the new entity is:

The changes in asset allocation model are:
a) Equity allocation changed from 80-100 to 0-100 and debt allocation changed from 0-20 to 0-100
b) Units issued REITs and InvITs and
c) Non-convertible preference shares.

Let us understand each one and try to ascertain how it can affect us.
a) Change in allocation % to Equity and Debt: The erstwhile prudence fund was essentially a balanced fund. The allocation was skewed towards equity to give the fund equity tax advantage. The new provisions make it amply clear, that it will now be a “dynamic” fund, where fund attribute can change from equity to debt and vice-versa. In other words – it need not remain an equity fund forever. If the composition of underlying changes, the fund will become a debt fund. If that happens, unitholders will have to pay tax as per debt mutual fund provisions.

b) Units issued REITs and InvITs: These are Real Estate Investment Trusts and Infrastructure Investment Trusts respectively. They are essentially securitized trading instruments of an SPV (special purpose vehicle) with assurance of paying out about 90% of cashflows to its unit-holders. The keyword here is – assurance. This is not a guaranteed return. Just like anything else in a free economy, these expected returns are performance driven.

Now that we have understood the basics of what REITs and InvITs are, let us now see how these have fared so far. We have two such products available for investment. They are listed on the exchange and can be bought and sold just like equity shares. It has been over an year since they got listed but have been quoting below listing price. It does not mean they are bad investment. Just that, they are not doing good as of now. Can they improve – why not. But that will be forecasting and similar to looking into the crystal ball. Below is the snapshot of performance of these two.

If you notice, they have a decent dividend yield. But buying something for dividend yield and suffering capital loss doesn’t make great investing sense.

Apart from these two, few others are in SEBI approval pipeline. Once the regulatory and taxation hurdles are overcome, they too might get listed and the market depth of such products will increase. But as of now, these are the only two instruments available for investment in this sub-category.

b) Non-convertible preference shares: Corporates are always on the lookout to raise money for growth/expansion. However, they are also wary of diluting stake of existing shareholders. Preference shares is a means meeting both the objectives.

These too are listed on the exchange and can be bought and sold just like equity shares. Then why are they deemed low risk investments? Preference shares give a fixed return for a fixed period of time and are then extinguished after maturity. In simple words, they are like fixed deposit but in terms of equity holding. So, they give the best of fixed return plus the possibility of capital gains.

My take on the proposed merger:

a) Fund Category: With the new asset allocation matrix, the fund can be an equity fund or a debt fund, depending on the majority holding. The following line is taken from the proposal document

in the event the equity allocation falls below the threshold of 65% over a prolonged period, the Scheme may be regarded as an ‘other than equity-oriented fund”.

The wordings are little ambiguous about “prolonged period”. How long is prolonged? Now consider this scenario: One invests in this fund and after an year, the fund’s majority holding are debt securities. When the investor redeems, taxman considers it a debt fund and you are asked to pay tax @ 30% rather than the 10% applicable for equity fund. Is it fair? Yes – as per the law of the land and terms of offer document. Can it happen? Yes and No. Let us look at those possibilities in detail.

b) This is the snapshot of both the funds as on 30th Apr 2018:

From the table above, we notice that about 80% and 72% of funds in Growth and Prudence Fund respectively are garnered by IFAs. Of this, 75% and 67% is contributed by HNIs and retail investors. We will understand the scenario better if we look at the growth of AUM to HDFC Prudence fund.

Here are the calendar year numbers:

It is evidently clear that HDFC prudence fund gets majority of the money when the equity markets are doing good. Investors pumped in money with an implicit trust that this is essentially an equity fund with a sprinkling of debt. My personal opinion is that HDFC AMC will continue to operate the new fund on those same principles. They will try with all their might not to break the trust of thousands of investors. But technically and legally, nothing is stopping them from changing the structure of the fund from equity to debt if market situation demands.

c) As on 30th Apr 2018, HDFC Growth and Prudence fund had AUM of 1162 Crore and 37,604 Crore respectively. The proposed entity falls in the new category of Balanced Advantage Fund. Needless to say, HDFC MF has ample experience in managing balanced category MF of this size. Size per se will not be a constraint for the fund to grow and perform well in future.

d) Asset Allocation: It is advisable to allocate funds, as per your allocation style, into pure equity and pure debt funds. Reason being, a) it becomes easy to track performance of each asset class on its own, and/or do re-allocation and b) the performance could then be compared against a benchmark. With varying allocation in a hybrid fund, measuring performance is very difficult task.

e) The addition of REITs and InvITs is a risky gambit. Not necessary that the AMC will invest the said % of corpus in these instruments, but the new guidelines give the mandate to the fund manager. It might payoff in future but doesn’t look promising as of now.

Considering the above pros and cons, it appears that exiting might be the prudent choice. The exit window provided by the AMC is between 3rd May 2018 to 1st June 2018. If redeemed in this period, the AMC will not charge any exit load. The funds can meanwhile be parked in a liquid fund while we look for a suitable investment avenue.

If not exited, the AMC will assume that you have accepted the merger terms and units in the new entity will be allotted.


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