Anil Rego's mantra for investing in mutual funds

Anil Rego of Right Horizons spoke to CNBC-TV18 expressing his views on such mutual funds.

Elaborating the advantages of these mutual funds, Rego said, "The advantage is that it manages risk well. In extended periods of time, it has done pretty well versus equity funds."

"The negative is that it is tax inefficient versus an equity fund," he further adds.

Below is the edited transcript of the interview

Q: You have a couple of different type of mutual funds which you are recommending which are - the Dynamic PE Asset Allocation Fund and the other one is a Multi-Asset Fund. Take us through the advantages and disadvantages of both of these?

A: Most investors associate mutual funds with equity and risk. So, there are also funds which manage risk well. While both of these funds have some bit of equity component, these are funds which manage risk a lot better.

So, the first type of fund is the dynamic PE Asset Allocation Funds. It is basically a balance fund with a balance determined by the price-to-earnings ratio (P/E ratio). So, if the P/E ratio is higher, it goes more into debt.

If the P/E ratio is lower, then it skews more to equity. So, automatically it follows the principle of buy low, sell high. So, when markets undervalued, it gets into equity and when markets are picking, it becomes defensive.

The advantage is that it manages risk well. In extended periods of time, it has done pretty well versus equity funds. Right now, for most timeframes it would beat the Sensex returns itself.

What are the downsides of this? The negative is that it is tax inefficient versus an equity fund. It is treated as debt for tax purposes. Also, closer to the market peak while in the last leg of the bull market, it tends to underperform because it is that time moving more into debt.

Q: Can you give an idea as to how much it has outperformed the Sensex over three-five years? When does the outperformance come at all? Do you have to stay invested for three-five years or even less?

A: The outperformance can be significant in times like these. You can even see anywhere between 5% and 10% outperformance in volatile markets.

Even over longer period of time, right from inception it has done a little better than an equity fund and of course in that period, it will be probably a little marginally better maybe a 1-2%.

So, these types of funds typically in extremely volatile times would do much better. You should look at a horizon of anywhere between two years and five years.

Q: You were speaking about the Multi-Asset Fund and you said there are three examples of it, Asset Triple Advantage, Morgan Stanley Multi-Asset and ING Multi-Manager - what do they mean?

A: Multi-Asset funds I am talking about funds which have a combination of equity, it has a combination of bonds and it has a combination of gold. The benefit of this is diversification works very well because the underlying assets are also pretty complimentary.

Both bonds and gold does very well when equity markets are not doing so well. In fact in 2008 when the equity market was down, something like 52%. In that year, if you had a third into each of these assets, you would have probably seen a positive return.

In about the last seventeen years, you had probably one year of negative return if you had one-third each. So, it does again very well manage risk.

The downside there again is the tax inefficiency. It is again treated as a debt fund. The second is that I am looking at it from a longer-term perspective.

Gold has run up a reasonable bit. Maybe for the next two-three years, I still believe that gold has some bit of steam left but if I look at maybe a longer tenure, maybe a 10-15 years type of timeframe then I would believe that we will probably see the other cycle of gold also start unfolding at some point.

So, it could at that point start underperforming some of the equity funds. At this point again this fund has done very well versus an equity fund.

Q: Investor is looking for wealth creation over long-term. His time horizon is 20-30 period. What is a low risk option for long-term investment horizon? What would you recommend for the three-four year waiting period? How should investor push in money there and in what instrument? How should he plan for the 20 year wait?

A: In terms of three-four year timeframe and also it’s an important need for him. One needs to be a little conservative. So, I would suggest a combination of some of the longer term debt funds like let’s say the ICICI Prudential Regular Savings Fund, so that can be one option where he can put in some bit of lump sum money if he has right now.

The other one can be he can invest through SIPs - then the Templeton Dynamic PE Fund that we just covered now will also work well for this timeframe because it manages risk well. For his longer term need, he could look at taking a lot more risk. He can invest into midcap funds, HDFC Midcap.

He could also add to your large cap funds and have a good balance of them so that he is also able to achieve his retirement capital and manage his risk well also.