The role of a fund manager is to stick to a clear mandate and the role of an advisor is to advice clients on suitability of various products, at different times, for different circumstances, for different investors. In this scenario, can a mutual fund product also offer an element of advice within the product itself? How can you embed advice into a mutual fund? What are embedded advice products? How do they work and how do they benefit investors?
The traditional view in the MF industry - in India and across the world - is that we expect AMCs to produce a diverse range of products across different asset classes - each with a clear, well defined mandate - the narrower / sharper, the better. It then becomes the advisor's job to decide which product to offer to which customer in what circumstances. The role of the product and the role of advice have traditionally been seen as distinct, with little or no overlap.
As the world experiences increasing volatility and as market cycles get shorter and less predictable, questions are being raised worldwide whether retail investors are actually being adequately served well enough. Do small investors, who may not have access to wealth managers, get the benefit of advice about when to buy and when to sell and when to invest in which asset class? Are retail investors getting adequate advice or is advice available only to affluent investors? If retail investors are not getting access to good advice (as it may not be remunerative for an advisor to individually advice small investors), is there merit in embedding advice within the mutual fund product itself?
If advice can be embedded in the product, all you need is a distribution function to reach the product to the investor. After that, the product will continue doing its job, without the need for frequent advisory inputs. What are the kinds of products which have advice embedded in them and how do they work? Lets consider a few popular examples in the Indian context and then look at other products that are popular in developed markets, but are yet to catch fancy here.
Asset allocation funds / multi-asset funds
These are hybrid funds that invest across different asset classes. In India we have a number of asset allocation funds that invest across different combinations of equity, debt and gold. By sticking to a mandate of auto-rebalancing at daily/weekly/monthly intervals, these products automatically perform the critical function of rebalancing investor portfolios to maintain the stated asset allocation. Rebalancing has the effect of buying low and selling high, as we all know.
Valuation based asset allocation funds
We have a few P/E ratio based funds in our market. These funds have a pre-defined algorithm that specifies the proportion to be invested in equity and debt, at various levels of market P/E. As the market P/E levels keep increasing, the proportion invested in equity will automatically keep reducing and as market P/E levels keep falling, the proportion of equity investment in the fund will keep rising. Here again, the fund effectively executes a buy low - sell high mandate, without allowing investors' emotions to come into play, which often stall re-balancing efforts of many advisors.
We have a few funds in our market where the fund managers are given a mandate to move between 65% - 100% in equity, based on their own parameters. This is a departure from a strict algorithm based product, where there is no discretion given to the fund manager.
On the fixed income side, the entire set of dynamic bond funds are in a sense embedded advice products, as the funds give mandates to the respective managers to arrive at a balance between a duration strategy and an accrual strategy, depending on market conditions and their outlook. The investor and distributor are not expected to move from short term funds to income funds and back based on rapidly changing market outlooks - that mandate is given to...
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