Portfolio Hedging-The Case of ICICI Value Fund Series 7(D) |
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EXCERPTS |
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The Indian mutual fund industry took root in india in 1963 with the formation of the Unit Trust of India, a joint initiative of the Government of India and the Reserve Bank of India, the country’s central bank. As on April 30, 2016, the AUM was INR 4.46 trillion in open-ended funds and INR 1.48 trillion in close-ended funds . The total AUM (Equity, Debt, and Hybrid combined) had registered a phenomenal growth of 250% from INR 6.75 trillion in 2010 to reach INR 16.93 trillion in 2016... |
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| ICICI PRUDENTIAL VALUE FUND – SERIES 7 – REGULAR PLAN (D) |
| This was a close-ended fund offered by the AMC. The fund was launched in May 2015 with a face value of INR 10.00. The size of the fund, as on December 31, 2016, was INR 0.1167 billion. The fund was being managed by Patel. The fund primarily focused on the equity class with 85.55% assets invested in it... |
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| INVESTMENT STRATEGY OF THE FUND |
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The objective of the fund was to provide an avenue for capital appreciation to its investors. The fund planned to fulfill this objective by investing in a diversified stock portfolio using fundamental analysis. It used a bottom-up approach for selection of stocks and chose those stocks which offered a long-term sustainable competitive advantage. It also used a top-down approach by ensuring representation of companies from a number of select sectors...
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| ASSET ALLOCATION PATTERN OF THE FUND |
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Under normal circumstances, the fund allocated a maximum of 100% and a minimum of 80% in equity and equity-related instruments. For debt, money market instruments and cash, the maximum and minimum value for asset allocation was 20% and 0%, respectively. The Fund manager could invest up to 50% of the net assets of the fund in derivatives. The fund could invest in derivatives to engage in permitted currency hedging transactions with an intention to reduce exchange rate fluctuations between the currency of the fund (INR ) and foreign currency exposure...
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| SIGNS OF TROUBLE |
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The NAV of the fund began experiencing a decreasing trend in the first week of September 2016, causing concern among investors and worry for the fund manager (Refer to Exhibit VII for the decreasing trend in NAV). Patel attributed this poor performance to market fluctuation and felt that the trend would reverse itself once the market began to improve...
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| WHAT NEXT? |
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Patel called for a meeting with his colleagues which lasted for about an hour. Though some of them raised several issues like changing the portfolio beta and calculating and monitoring the tracking error, monitoring of VaR, etc., most of them agreed that resorting to hedging through derivatives was the best strategy given the circumstances ..
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| QUESTIONS |
1.How do the fund managers measure the risk and return and style of a fund portfolio?
2. The fund manager was worried about the performance of the fund. Do you think that his concerns about fund performance were valid?
3. Since the portfolio was constructed with fundamentally strong stocks, what steps should be taken to protect the portfolio value from the vagaries of the market?
4.How do you use index futures to hedge the risk and what recommendations would you make to the fund manager? Justify your answer using the Minimum Variance Hedge (MVH) Ratio (Hint: Use Exhibit IX (A) to IX (D)).
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| EXHIBITS |
Exhibit I: Growth of Average Assets under Management of ICICI Prudential Asset Management Company
Exhibit II: Growth of Assets under Management in Indian Mutual Fund Industry*
Exhibit III: Asset Breakup as on December 30, 2016
Exhibit IV: Fact Sheet of ICICI Prudential Value Fund – Series 7
Exhibit V: Portfolio Holdings as on December 30, 2016
Exhibit VI: Detail List of Instruments Where the Fund Could Invest
Exhibit VII: Decreasing Trend in NAV of the Fund
Exhibit VIII: Portfolio Beta and Index Data
Exhibit IX(A): Adjusted Closing Values of BSE500 from June 8, 2015, to December 30, 2016(Partial Data)
Exhibit IX(B): NAV of the fund from June 8, 2015, to December 30, 2016 (Partial Data)
Exhibit IX(C): 91-Day T-Bill Rates from June 8, 2015, to December 30, 2016 (Partial Data)
Exhibit IX(D): Values of Adjusted Close Values of Nifty50 Index from June 8, 2015, to December 30, 2016 (Partial Data)
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