Killol Ringwala
Managing Partner, Safe Assets

It’s a tough time for fixed deposit (FD) investors as the rate of return on this saving product, traditionally used by Indians to park their savings for years, has been witnessing a steep decline. The pre-tax return on the FD issued by the State Bank of India for the tenure of one year has dropped to 4.4 per cent from 8.5 per cent seen at the beginning of 2015. The post-tax return currently will be further less, around 3.37 per cent for individuals falling in the highest tax bracket. With the current retail inflation rate touching 7.3 per cent in September 2020, the real return on the FD remained negative for the sixth consecutive month.

The return on the FD has been moderating owing to the liquidity surplus environment led by lacklustre credit growth. The banks are lowering deposit rates in order to protect their margin. Typically, the negative real interest rate return results in higher allocation to physical assets as compared with financial assets. The investment in FD accounts for nearly 40 per cent of the total gross financial savings of India. According to the Reserve Bank of India (RBI) bulletin of June 2020, India has recorded total gross financial household assets worth Rs167.2 trillion at the end of March 2020, of which 56 per cent was contributed by bank deposits of Rs94.4 trillion.

This clearly shows that there is a large part of the population which is dependent on FD returns to meet their financial needs. However, with the rates coming off, the future seems to be tough for this set of investors. It is high time these set of investors find a complimentary option to FD investing. Generally, fixed deposit investors have a low risk appetite and are not used to volatility in returns. Hence, an alternative investment option needs to have these two in-built features in order to make someone switch over.

Dynamic Asset Allocation Funds

Dynamic Asset Allocation Funds, also known as Balanced Advantage Funds, have a good mix of debt and equity instruments in their portfolio, thus bringing down volatility. They also have an automatic rebalance feature, thus reducing risk. Both of these make it an ideal option for a large number of investors, who would otherwise be rightfully averse to equities given the risk element. The total asset under management of such type of funds as of September 2020 was Rs86,751 crore and of these HDFC and ICICI Prudential Balanced Advantage Funds accounted for nearly 70 per cent of the total AUM.

One of the key focus areas of such a fund is to conservatively take exposure to equities such that there is not much room for capital erosion. At the same time, one can tap into the opportunities provided by equities in a limited manner. Because of all these reasons, this type of fund becomes ideal for any investor who is entering the equity space for the first time. In the theory of loss aversion, Israeli psychologist and economist Daniel Kahneman said that “the pain of losing is about twice as powerful as the pleasure of gaining.”

The dynamically managed funds, in case of certain fund houses are model-based. Here, the investment strategy is largely guided by what the model indicates and investments into equity or debt is finally arrived at. This approach helps in keeping emotions away from asset allocation decisions. What the fund does is that when the valuation of equity market is low, the equity allocation is increased and when the valuations are stretched, they tend to prune their equity exposure and shift the capital to debt. The automatic rebalance feature which is incorporated in the Dynamic Advantage Funds allows investors to stay away from drawdown pain.

This can be gauged from the fact that the industry’s assets under management for the Balanced Advantage Funds had outperformed the Equity Diversified Funds by 6 per cent when the market fell precipitously in March 2020 due to the effects of the global pandemic and the ensuing lockdowns. In short, these funds are designed in a way to offer lower portfolio volatility and curtail the extent of the drawdown, an imperative qualification for attracting FD investors. Such funds also hold the potential to substantially improve risk-adjusted return if an investor is ready to stay invested for the long-term.