Reliance [Get Quote] Equity Fund (REF) is a rather innovative offering from Reliance Mutual Fund. REF has got the mandate to short sell in the derivatives segment, something of a first in the mutual fund industry.
REF works with the objective of maximising returns for the investor across stock market levels. As funds are managed today, it becomes relatively simpler to maximise growth for the investor at lower stock market levels, when well-managed companies are available at attractive prices. However, rising stock markets prove to be something of a challenge for the fund manager when attractive investment opportunities dry up and there are fewer stocks at reasonable valuations.
This is where REF's flexible investment mandate comes in. To begin with, REF can go short in the derivatives market. This flexibility will prove particularly useful during a bearish phase or during a stock market rally like the one that was witnessed in the early part of year 2000, for instance. It can go short in the derivatives segment upto Rs 15 bn (Rs 150 crores) or 10% of its portfolio whichever is lower.
While 'shorting' is a speculative activity which entails taking on a significantly high risk (the losses could be higher in case of futures) it can nevertheless turn in handsome returns in times where a fall in the market seems imminent. However, one needs to note that the Indian derivative markets are still very shallow in terms of the instruments available (futures for example do not have a tenure of more than 6 months). The fund manager therefore has little to choose from; he has to be very accurate in his calls as he stands to incur losses if the markets do not go his way in such a short time period (past experience suggests that the markets can remain mispriced for longer periods). The other alternative for the fund manager is to "roll - over" his short position to the next period, in which case there are transaction costs involved.
REF has the flexibility to hedge its portfolio in line with the stock market level. At a higher stock market level, the fund can hedge a higher proportion of its portfolio, with the option of hedging upto 100% of its equity assets.
While some equity funds do hedge their holdings, REF is probably the first fund to quantify the amount of hedging it will do as per a defined criterion. This feature will ensure that as the market valuations rise, the fund will gradually 'lock' in the gains by increasing the hedging component. While this seems to be a good strategy, investors need to take note of the fact that to the extent the portfolio is hedged, further upside is limited (a 100% hedged portfolio will not deliver any return - positive or negative).
In our view, while REF does have an interesting investment proposition, there is considerable risk involved if the fund manager goes wrong on some of his 'short' calls. Moreover, indications are, its only a matter of time before other equity funds (both NFOs and existing funds) are extended the mandate to go short in the derivatives segment. In the event of such a move, REF will lose its value proposition in favour of diversified equity funds with well-established track records and the flexibility to short-sell.
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