Incremental equity investments: options for those sitting on the fence

There is a certain exposure to equity investments, say 50% or 70% of the portfolio, depending on risk appetite. (iStockphoto)
There is a certain exposure to equity investments, say 50% or 70% of the portfolio, depending on risk appetite. (iStockphoto)

Summary

  • For fresh inflows, investors may be in a dilemma due to the prevailing valuation levels.

There are certain investors who believe in the great India growth story, but are wary of taking incremental exposure. This is not about aversion to equity or timing the market. There is a certain exposure to equity investments, say 50% or 70% of the portfolio, depending on risk appetite. For fresh cash flows, there may be a dilemma due to the prevailing valuation levels. As any financial expert would tell you, invest with a long horizon, say 10 years or 15 years, and mark your entry with a systematic investment plan, or SIP.

That apart, there are three options where you can invest lump sum, with an answer to the dilemma on the extent of equity exposure for fresh deployments, for people wary of current market valuation levels.

Balanced Advantage Funds (BAFs): The construct of the fund is such that there is an apparent equity exposure, which we refer as long position. This is usually more than 65% of the portfolio, so that the fund is eligible for taxation in the nature of equity. Against the long equity exposure, the fund manager takes a short position in equities, which negates part of the long equity exposure. Net of the short positions, the effective long equity exposure is something decided by the fund manager. The decision on the net equity exposure would vary from one fund house to another but this is typically taken on the basis of an in-house model. The model would track multiple fundamental and technical aspects of the economy and markets. As an illustration, if the fund manager is relatively bearish on the equity outlook, net effective equity exposure would be say 40% of the portfolio. On a relatively bullish outlook, effective equity exposure would be say 60% of the portfolio. The relevance of this fund category in the current context is that when you are not sure, you may give to the fund manager to decide the effective equity exposure. To be noted, the equity exposure is a dynamic decision, reviewed regularly by the fund manager.

Market Linked Debentures (MLDs): This is a kind of debenture where there is no coupon (interest) payout. The returns you get, which is called pay-off, is linked to a variable defined in the terms of the product. The variable could be an equity index, e.g. Nifty or Sensex, or gold or a government bond.

In the context of equity-linked debentures, your pay-off would depend on the terms of the product and the movement of the variable. If the underlying variable is, say, Nifty and the terms of the product states that your payout will be based on how Nifty has moved up in the tenure of the product, you will get as much. If the terms say that you get 75% of Nifty upside and Nifty goes up say 20% in that period, you will get 15% returns over that period. The relevance of this product in the current context is that most of these products are principle protected (PP) structures. In a (PP) structure, you will get back your initial investment amount, irrespective of the movement of the underlying market. In a Nifty-linked PP structure, even if Nifty gives negative returns over the defined period, you will get back your initial investment. That answers your dilemma about the valuation levels: if equity market movement is positive, you get commensurate returns, as per terms, but you will not lose your money.

MLDs used to be a popular product earlier, till March 2023. These used to be put to tax at long term capital gains rate of 10% (plus surcharge and cess), for a holding period of more than one year for listed bonds. Since April 2023, MLDs have been made taxable as short-term capital gains, irrespective of holding period. That is, the tax rate has moved up from 10%to the marginal slab rate, which for most investors is 30% (plus surcharge and cess). When you take exposure to equity stocks directly, or through mutual funds, the long-term capital gains tax rate is 10%, for a holding period of more than one year.

Alternative Investment Fund (AIF) category III long-short fund: Regulations allow taking derivative exposure up to two times of the corpus. Depending on the mandate of the fund and its view on the market, the fund manager would either take long position of 100% of corpus, more than 100% of corpus or less than that. Here again, the fund manager is taking a call on the effective equity exposure. AIFs, though, require a minimum ticket size for investments.

Joydeep Sen is a corporate trainer (financial markets) and author.

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