The newly-launched lifecycle fund category comes with a built-in mechanism for adjusting risk as the investment nears maturity. Structured to ensure that investors stay put for the long haul, these schemes however take away from fund managers the power to take tactical calls, writes Kushan Shah.
l What are lifecycle funds?
Lifecycles funds are a new category of mutual funds launched by the Securities and Exchange Board of India (Sebi). These are open-ended funds with pre-determined maturity and will follow a “glided path strategy” to invest across asset classes. The schemes can be launched with a maturity ranging from five to 30 years at an interval of five years and are aimed to help investors achieve goal-based investing. Each fund house can have a maximum of six schemes in this category active at any point in time. The schemes can merge with another scheme when their time to maturity is less than one year, with the permission of its unit holders. These funds will follow a benchmark framework which includes multiple asset classes, similar to the framework followed by multi asset allocation funds.
l Which asset classes can these invest in?
The lifecycle funds can invest in equity, debt (in instruments rated AA and above which mature before the scheme itself matures), gold and silver ETFs, InvITs (Infrastructure Investment Trusts), gold/silver based ETCDs (Exchange Traded Commodity Derivatives). Schemes with remaining time to mature less than five years can take exposure in equity arbitrage up to 50% in addition to the allocation range specified for equity, while maintaining a total equity exposure of 65-75%.
l Rationale for this mutual fund category
Lifecyle funds provide more clarity to investors in terms of asset allocation in equity, debt and others (commodities, InvITs, etc.).The schemes will also minimise the risk of encountering a market downturn at the time of maturity by minimising the exposure to equity in the final years. This makes such schemes suitable for goal-based planning and retirement planning. Investment in multiple asset classes also provides the benefit of diversification. The category also aims to promote financial discipline among investors through asset allocation and levy of exit loads on early redemptions.
How glided path startegy works
The glided path strategy changes the allocation of funds in a folio in equity and debt based on the remaining time to maturity. For schemes across maturity periods, the allocation in equity will be highest in the years following investment and will reduce as the investment approaches maturity. For instance, the corpus of an investor investing in a lifecycle fund with a
five-year maturity period will have 35-50% of its assets allocated to equity in the first two years, which will come down to 20-35% in the next two years and will be lowest at 5-20% in the final year as the investment approaches maturity. Conversely, investment in debt securities rated AA and above will increase from 25-50% in the first four years to 25-65% in the last year. This is aimed at reducing volatility in returns provided by the scheme at maturity, thereby making it suitable for goal-based investment.
l Who is the target investor?
Lifecyle fund schemes are suitable for investors with a long-term investment horizon who want to plan for a financial goal like retirement or children’s education. For those who have been investing in existing solution-oriented funds such as retirement funds or children’s funds (Sebi has mandated a stop to fresh subscriptions) but found these to be sub-optimal, the new lifecycle funds should provide a better alternative for their long-term goal-based investments. Since these funds will adjust risk automatically as time passes by reducing equity allocation, these will be especially beneficial for investors who are not market-savvy enough to track their portfolio and take calls to switch funds as they age. It is also suitable for investors who want a diversified exposure to various asset classes and do not want to manually rebalance their portfolio among asset classes.
l Are there any drawbacks?
Lifecycle funds give investors as well as fund managers limited flexibility in deciding the asset allocation or taking a tactical call based on market conditions. A fixed maturity also has a potential disadvantage of an investor reinvesting the final corpus in underwhelming market conditions or falling interest rates, if the scheme does not merge with another lifecycle fund scheme of the fund house. Additionally, these funds levy an exit load for early redemptions (3% in the first year, 2% in the second year and 1% in third year), which can eat into returns in case of an emergency redemption. Lack of restrictions on redemptions beyond three years may lead to premature redemptions in form of panic selling during market downturns impacting alignment with the goal of investment. The allocation in various asset classes may also differ from one fund manager to the other and could vary from investor’s expectations. Clarity is still not there on how the final corpus will be taxed since the equity allocation will fall to 5-20% in the final year. Finally, the new category will not have a long track record making it difficult for initial investors to have a clear idea of their performance over the medium-to-long term.