Increase equity exposure in falling markets and reduce exposure in rising markets - that's what you would want every client to do. ICICI Pru BAF does just that, and also uses arbitrage intelligently to maintain equity taxation during challenging phases in the market when a traditional 65-35 allocation may otherwise prove restrictive. Read on as Manish Gunwani explains what went into delivering top quartile performance for the last 3 years, what's led to relative underperformance this year, and his strategy going forward to maintain his winning ways in this fund.

What do percentiles and their colours signify?

Fund performance is typically measured against benchmark (alpha) and against competition. Performance versus competition is measured through percentile scores - ie, what percentage of funds in the same category did this fund beat in the particular period?

If a fund's rank in a year was 6/25 it means that it stood 6th among a total of 25 funds in that category, in that period. This means 5 funds did better than this fund. In percentile terms, it stood at the 80th percentile - which means 20% of funds did better than this fund, in that particular period. If, in the next year, its rank was 11/26, it means 10 other funds out of a universe of 26 did better than this fund - or 38% of funds did better than this one. Its percentile score is therefore 62% - which signifies it beat 62% of competition.

Most fund managers aim to be in the top quartile (75 percentile or higher) while second quartile is also an acceptable outcome (beating 50 to 75% of competition). What is generally not acceptable is to be in the 3rd or 4th quartiles (beating less than 50% of competition). Accordingly, we have given colour codes aligned with how fund houses see their own percentile scores. Green colour signifies top quartile (percentile score of 75 and above), yellow or amber signifies second quartile (percentile scores of 50 to 74) and red signifies 3rd and 4th quartile performance. A simple visual inspection of colour codes can thus give you an idea of how often this fund has been in the top half of the table and how often it slips to the bottom half. A great fund performance is one which has only greens and yellows and no reds - admittedly a tall ask!

WF : Your fund has had a very impressive run over the last 3 calendar years, delivering considerable alpha as well as posting a top quartile performance. What were the key factors that have contributed to this performance?

Manish : The underlying model itself has contributed to the performance of the fund. The model seeks to capture the upside in a rising market by reducing equity allocation while aims to limit the downside risk during a falling market, by increasing equity allocation.

Another factor which contributed to outperformance is a blend of midcaps and large caps based on relative valuation. While the large cap stocks represent established enterprises selected from the Top 100 stocks by market capitalization and aim to provide stability, the midcaps are smaller business entities with long-term growth potential. The allocation is decided on a tactical basis based on the prevailing market conditions. Further, a part of the fund utilizes futures and options for the arbitrage strategy which yields return.

WF : 2014 is so far proving to be a more challenging year for you. Although alpha is positive, on a competitive scale, your performance has dropped to 4th quartile. What are some of the issues that have impacted near term performance and what actions have you taken to correct this?

Manish : As the fund increases cash holdings when the market goes up, when the market return is high the fund tends to underperform peers. Also in an environment where smallcaps outperform a lot, the proportion of small caps in the portfolio is very low keeping in mind the conservative nature of investors and also due to the significant size of the fund.

Having said that, the scheme seeks to provide investors a reasonable opportunity to benefit out of market volatility while maintain fair equity allocation levels based on market valuations and is suitable for investors seeking to participate in equity markets with conservative approach.

WF : How have you been using F&O strategies to deliver alpha in this fund? What is the current stance in terms of your F&O strategies?

Manish : We are using F&O for arbitrage and to manage equity allocation of the fund. Currently, also it is being used primarily for these uses.

WF : Which are the sectors and themes you are overweight on now in the equity component of your fund?

Manish : We continue to be overweight on financials and auto ancillaries. The valuation gap between cyclicals and defensives is narrower now given the rally in cyclicals in the first half of the calendar year.

Manish The risk parameters globally have gone up a bit with the dollar strengthening which has also led to sectors like IT and Pharmaceuticals doing relatively well in the last few weeks.

We believe going forward importance of sectoral stance can reduce compared to bottom up stock picking.

WF : What is your portfolio stance vis-à-vis the debt component of the fund?

Manish : ICICI Prudential Balanced Advantage Fund's Debt Portion is actively managed based on the view of the debt market. Currently, with inflation moving towards the downward trajectory and our outlook on interest rates and thereby on Debt is positive. Therefore, the fund has increased allocation towards duration to benefit from the potential fall in interest rates.

WF : There is renewed interest in balanced funds ever since debt fund taxation was changed. Do you see balanced funds now becoming a core allocation in all mutual fund portfolios, given their tax advantage?

Manish : Investors usually invest in equity when the markets are surging high, while pull out money when the markets are underperforming. However, ICICI Prudential Balanced Advantage Fund seeks to capture upside by increasing allocation to equity when the markets are declining, and protects downside by reducing exposure to equities when markets are rising which is completely reverse of what retail investors normally do.

It offers equity taxation, as we ensure that minimum 65% of portfolio remains equity and equity linked instruments at any point of time. It is ideal for investors with a moderate risk profile and investment horizon of over three years. On the equity side the fund is managed actively based on valuations in the market, as the portfolio is constructed keeping in mind the conservative risk profile of investors.

This could also be a product for maiden investors to start off with, owing to lower volatility and tax benefits. Being an evergreen product that works across market cycles, and offering the benefits of asset allocation, this product could form part of investor's core portfolio.

Private and Confidential for reading and understanding only for Distributors and Advisors of ICICI Prudential Mutual Fund.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

The information contained herein is only for the reading/understanding of the registered Advisors/Distributors. All data/information used in the preparation of this material is specific to a time and may or may not be relevant in future post issuance of this material. ICICI Prudential Asset Management Company Limited (the AMC) takes no responsibility of updating any data/information in this material from time to time. The AMC (including its affiliates), the Fund, ICICI Prudential Trust Limited (the Trust) and any of its officers, directors, personnel and employees, shall not liable for any loss, damage of any nature, including but not limited to direct, indirect, punitive, special, exemplary, consequential, as also any loss of profit in any way arising from the use of this material in any manner.

Nothing contained in this document shall be construed to be an investment advise or an assurance of the benefits of investing in the any of the Schemes of the Fund. Sectors/stocks mentioned in the article do not constitute any recommendation and the Fund through its schemes may or may not have any future position in these sectors/stocks. Recipient alone shall be fully responsible for any decision taken on the basis of this document.

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