Fund Focus: Tata Regular Savings Equity Fund

Red signal has been flashed - first time in 6 years

Sonam Udasi, Fund Manager, Tata MF

7th November 2016

In a nutshell

High standard deviation from a dynamically computed historical average market PE is a statistically sound warning of impending mean reversion. The Tata Red Line Strategy uses this metric to decide when to substantially cut equity allocations. In the past, a 1.5 SD level was hit in 2000 just before the crash, in end 2007 before the 2008 meltdown and then in end 2010, before the 2011 bear market. For the first time since 2010, a red signal has been flashed by the Tata Red Line Strategy in September 2016, when the 1.5 SD level was again breached. True to label, the Tata Regular Savings Fund has cut equity allocations by half. Read on as Sonam takes us through this very interesting valuation marker and why he believes this is a superior model than the PE band based rebalancing strategies used by many other asset allocation funds.

WF: What is the Tata Red Line Strategy? What are the components that go into your valuation model?

Sonam: Tata Red Line Strategy is a proprietary equity allocation strategy. The strategy seeks to manage allocation to equity comparing the current trailing P/E of CNX Nifty with its long term average. The strategy is named 'Red Line Strategy' because it draws a Red Line (At 2 Standard Deviation PE levels from its Long Term Average) in terms of valuations. The strategy starts cutting equity exposure from 1.5 standard deviation levels and reinvests at long term average valuations. As such the strategy only works with trailing P/E of CNX Nifty and is a single factor model.

WF: What do your back testing results show in terms of utility of this model to time your rebalancing decisions between debt and equity?

Sonam: The model has proved effective in first allowing full participation in market till closer to peak valuations by remaining fully invested till 1.5 Standard deviation levels. Booking profits at this level helped protect the downside from the steep market corrections which followed over next one to two years post the rebalancing trigger as per the Tata Red Strategy.

In the earlier instances when the markets P/E breached the 1.5 standard deviation bands the rebalancing protected against the downside which followed.

Trigger was hit (leading to rebalancing out of equity) in January to March Quarter of the year 2000 (Just before Dotcom Crash). After trigger was hit in the year 2000, CNX Nifty corrected from level of 1713 to 1148 by next March.

Trigger was hit again after 7 years (leading to rebalancing out of equity) in the year Oct -Dec 2007 (Just prior to Global Financial Crisis) followed by CNX Nifty correcting from 6139 levels to 2959 levels one year down the line.

During Oct to Dec 2010 after the trigger was hit, CNX Nifty corrected from 5960 levels during Dec 2010 to 4624 levels by December 2011.

WF: In what ways do you believe your Red Line Strategy is superior to the P/E based model that is widely understood and used for auto-rebalancing in asset allocation funds?

Sonam: There are two major differences between Tata Red Line Strategy and other P/E based models.

First, instead of using PE bands, this model works with standard deviation of PE from its long term average. This way the model is dynamic in nature and evolves with the market instead of basing the proposition to absolute PE levels. As the CNX Nifty's mean P/E changes; the model realigns itself.

Another difference with exiting PE based models is that Tata Red Line Strategy does not use a laddered approach to managing equity allocations. Typical P/E based models start cutting equity exposure at every leg up on P/E. Tata Red Line Strategy on the other hand remains fully invested till close to peak valuations. The allocation so rebalanced out of equity at around peak valuations is also invested at long term average valuations instead of ploughing back at each step down on P/E levels, this structure allows full participation in market rally till peak valuations and protection from downside when markets correct from such steep valuations.

WF: Your Red Line Strategy has flashed a red signal recently, causing you to reduce equity allocations significantly. What were some of the occasions in recent years when the market breached the 1.5 SD mark that it breached last month and what direction did the market take in the ensuing 6-12 months?

Sonam: The earlier instances when the markets P/E breached the 1.5 standard deviation bands was in January to March Quarter of the year 2000 (Just before Dotcom Crash) then 7 years later in October to December 2007 (Just prior to Global Financial Crisis). These levels were breached again during October to December 2010 and just now in September 2016.

After trigger was hit in the year 2000, CNX Nifty corrected from level of 1713 to 1148 by next March. Later again after 7 years, the trigger was hit in the year 2007 and the CNX Nifty corrected from 6139 levels to 2959 levels one year down the line. During Oct to Dec 2010 after the trigger was hit, CNX Nifty corrected from 5960 levels during Dec 2010 to 4624 levels by December 2011.

WF: Is the Red Line Strategy used only in your Regular Savings Equity Fund or is it used across other equity oriented funds as well?

Sonam: The 'Red Line Strategy' is part of the mandate of Tata Regular Savings Fund as mentioned in the Scheme Information Document. The strategy is not used in any other equity fund by Tata Asset Management.

WF: What is the current asset allocation in the Tata Regular Savings Equity Fund and how has it changed in the last 12-18 months?

Sonam: Last year around July, Tata MIP Fund was restructured as Tata Regular Savings Equity Fund. Since that time till mid-September this year, the fund ran unhedged equity allocation of 35%, about 35% in Arbitrage positions and balance about 30% in debt component.

On September 15, 2016, the rebalancing trigger of 'Tata Red Line Strategy' got hit and the fund reduced its unhedged equity exposure from 35% to 17.50%. With this rebalancing, the fund's current asset allocation is as follows - Unhedged Equity about 17.50%, arbitrage exposure around 52% and balance about 30% in debt.

WF: How is the benchmark of this fund constituted? There seem to be multiple individual benchmarks that go into a composite one.

Sonam: In line with the asset allocation structure of the fund, the fund's benchmark is constituted of three benchmarks representing three different asset classes. The customised TRSEF benchmark (being calculated by Crisil) consisting of 35% weightage to Nifty representing Equity component, 30% is Crisil Liquid Fund Index representing arbitrage exposure (in the absence of an appropriate benchmark for arbitrage). The 35% debt component is represented by Crisil Short Term Bond Fund Index.

WF: How the fund performed vs has benchmark and versus its peer group of Equity Savings/Equity Income Funds (funds that do not cross 35% in unhedged equity exposure)?

Sonam: The fund has outperformed its benchmark on one year return parameter as on October 28, 2016. The fund has only recently completed one year since its restructuring last year. Different fund's performance within the 'Equity Savings' category may not be really comparable due to differential unhedged equity mandates of the schemes in the fund.

WF: Given that your Red Line Strategy has flashed a red signal on valuations, is your house view also very circumspect on equities now? Are you taking a cautious stance on equity at a fund house level now?

Sonam: As mentioned above, Tata Red Line Strategy is part of the mandate of Tata Regular Savings Equity Fund only and is not implemented in any other equity fund. As a fund house, we believe while markets may be trading at a premium compared to historical averages, long term outlook on the markets remains constructive.

Sonam Udasi (Fund Manager)

With inputs from Prashant Joshi (Head-Products)

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully

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