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Suresh Krishnamurthy

Class A units: Invest

BENCHMARK Mutual Fund, which specialises in the management of cost-effective, passively-managed, funds, has now come out with Split Capital Fund.

The fund attempts to bring together two sets of investors — risk-averse and -bearing — under one umbrella.

Split Capital is a three-year close-ended fund. The investment by the risk-bearing would be restricted to one-fifth of the fund's total assets.

The risk-bearing investors would absorb the downside losses of their conservative counterparts, who would get only 40 per cent of the upside in the Nifty.

For the risk-bearing investors, they could lose up to 100 per cent of the capital invested.

Their upside potential is also capped. This type of risk-reward ratio is common for such contracts that are similar to risks faced by option writers.

Retail investors can opt to be either part of the conservative segment — Class A units — or the risk-bearing segment — Class B units.

As retail investors cannot hedge their risks, it may not be appropriate for them to invest in Class B units.

Institutional investors, who can hedge their risks, have already expressed willingness to invest in Class B units.

Class A may be more appropriate for retail investors, if it suits their requirements. Both Class A and Class B units will be listed on the National Stock Exchange.

Class A: Preferred units

Class A offers investors 40 per cent of the upside to the Nifty Index without exposure to any downside. That is, if Nifty declines in value, it will get back the amount invested after three years.

If the Nifty rises by 10 per cent, then 40 per cent of the upside (which is 4 per cent) will be the return on the investment.

Class A investment is a combination of a three-year call option and a debt investment. Is the implied cost for the three-year call option attractive?

Given an expected return range of between 10 per cent and 20 per cent for the Nifty at the end of three years from now, the implied costs work out to between 8 per cent and 25 per cent of the amount invested.

This is attractive because the alternative of buying index-traded calls and rolling them over several times at maturity would prove to be relatively costly.

Suitability: Class A would be suitable to investors looking for a longer-term exposure to equities now, but are worried about the possible downside. Investments in these units as part of their portfolio would provide the necessary exposure at a reasonable cost.

These units, however, are not suitable for those intending to invest only 10-20 per cent of their assets in equities; such an exposure in an actively managed fund would be more appropriate.

The risk-reward profile would be superior to an investment in this fund.

Class A units would be appropriate only for those interested in investing about 40-50 per cent in equities. For such investors, this fund could become a valuable part of the portfolio.

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