How many times have we heard this before? Most fund managers and investment advisors have been saying this for some time now. However, the reason you need to accept equities as an integral part of your investment scheme of things is because you really don't have a choice. As income funds get accustomed to single digit growth rates and the RBI seems committed to pursuing a lower interest rate regime, there is a need to look beyond fixed income options like income funds and RBI Bonds.

For fixed income/debt fund investors equities are no longer an option, they have become something of a necessity. There are some fundamental reasons for that. Fixed income instruments aren't as attractive as they were until a few months ago. The Monetary Policy April 2003, virtually signaled the end of the so-called party in debt funds. In our meeting with Mr Nilesh Shah  CIO, Debt Franklin Templeton Investments, he put it more aptly when he confessed, The bull run in debt funds is over.

The realistic scenario going forward

Income (Long Term)	NAV (Rs)	1-Mth	6-Mth	1-Yr	3-Yr	Incep
ALLIANCE INC G	22.1	0.9%	4.7%	13.1%	14.3%	13.2%
PRINCIPAL INC G	14.8	0.8%	4.3%	13.9%	NA	15.3%
PRUICICI INC G	18.9	0.8%	4.3%	13.3%	14.2%	13.3%
TEMPLETON INC G	22.8	0.8%	4.1%	13.1%	14.1%	13.7%
BIRLA INC B	26.9	0.7%	4.0%	13.8%	14.5%	14.5%

(NAVs as on July 28, 2003. Growth over 1-yr is compounded annualised)

The 6-month growth in the above table reflects why debt funds are being written off asgrowth avenues and projected more as defensive and wealth protector avenues. Look at the NAV growth of debt funds over the last 1-Yr/3-Yr periods. That marked the growth era when debt funds even managed to outperform some diversified equity funds with the bull run in gilts/bonds. Look at the NAV growth of debt funds over the last 6 months. Its about one-third the growth posted over 12 months! This growth (or the lack of it) is not an aberration. Its the reality of a south-bound interest rate regime.

So what is the stimulus that can provide some much-needed growth to debt funds? If you haven't guessed it by now - its equities. Mention of equities need not scare the traditional fixed income/debt fund investor. We are not talking about a pre-dominant equity allocation, on the contrary, only a small, insignificant portion of the entire debt fund. To underscore this fact let us take a look at MIPs. MIPs have shown how a small percentage of equities can bring about a dramatic turn in fortunes.

Insignificant equity Significant impact

Monthly Income Plans (MIPs)	NAV (Rs)	1-Mth	6-Mth	1-Yr	3-Yr	Incep	Debt (%)	Equity (%)
Alliance Monthly Income (G)	17.8	1.4%	7.9%	15.1%	12.3%	15.0%	86.9	13.1
Templeton M I P (G)	14.2	1.5%	6.6%	12.6%	11.2%	10.7%	85.2	14.8
Birla MIP Plan C (G)	14.0	0.8%	5.4%	12.9%	NA	13.2%	86.9	13.1
Principal MIP (G)	11.7	1.3%	5.3%	13.9%	NA	14.4%	92.2	7.8
Pru ICICI MIP (Cum)	13.4	1.0%	5.2%	10.7%	NA	10.9%	89.1	10.9

(NAVs as on July 28, 2003. Growth over 1-yr is compounded annualized. Asset Alloc. as on June 30, 2003)

The above table says it all. The last 6 months have seen MIPs score over Income Funds (compare with 6-month growth in Income Funds from the same fund houses in the previous table). More importantly, MIP fund managers haven't gone over-board with equities. They have been sensible, rather the fund's regulations by putting a 20% cap on equities have ensured the fund manager remains sensible. Income funds on the other hand, with a 100% debt component, have struggled to maintain the tempo that they had set for themselves over the past few years.

MIPs have shown that while debt can be wealth preservers at best, a small (5-15%) equity allocation can shore up returns considerably. More importantly from the investor's perspective MIPs use equities as a tool to spruce up returns without exposing him to excessive risk. A 5-15% equity component is small, but potent, especially at a time like this when equity markets are witnessing a rally.

Speaking about the rally, it can be argued that MIPs make sense in the current scenario only because of the runup in equities. Nothing could be further from the truth. The beauty of the MIP is the flexibility it affords the fund manager. MIPs are attractive now because the fund manager can invest some assets in equities. When equities are no longer an attractive investment proposition, the fund manager has the flexibility to go completely in debt, thereby making it appear like any other debt fund. Either ways, the MIP fund manager is constantly trying to maximise gains for the investor between debt and equities, which is not the case with a plain vanilla income fund manager.

So where does all this leave the retail investor who had until now looked upon debt funds as an easy way to clock double-digit growth? That leaves him pondering over the future, which is a staid 7-8% growth that debt fund managers are talking about in this scenario. Can't the retail investor do anything better than that? With a 100% debt allocation he can't. However, if he is willing to venture even 5-10% into equities, he can alter his return profile considerably at very little risk.

 

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