SEBI's new life-cycle funds: should you invest? ICICI Prudential's Manish Banthia decodes the details

When you invest for a long-term goal such as your child’s education or retirement, deciding where to invest is only half the job. The bigger challenge is knowing how much equity you should hold today and when you should start reducing that exposure as the goal gets closer.

What Are Life Cycle Funds?

This is where Life Cycle Funds come in. It is a new mutual fund category in India which was introduced by Sebi this year on 20th March. These funds follow a predetermined maturity year and a glide path, gradually reducing equity exposure as the goal approaches. SEBI’s framework allows Life Cycle Funds with maturities ranging from five to 30 years. ICICI Prudential Mutual Fund has launched three such funds - Life Cycle Fund 2031, 2036 and 2041- with 5, 10- and 15-year maturity periods. To understand life cycle funds, moneycontrol speaks to Manish Banthia, CIO Fixed Income at ICICI Prudential Mutual Fund.

What problem do Life Cycle Funds solve for retail investors?

Since Life Cycle Funds are a new category introduced by SEBI, what are they and what is the biggest problem they are trying to solve for retail investors? Mutual funds are very good investment vehicles, and the industry offers different kinds of products. One of the products the industry is launching today is the Life Cycle Fund, a category that the industry has been trying to introduce for a very long time. Finally, we have been able to launch this category. What makes this product different is that, for the first time, it introduces time-based investing. Until now, the way people invested was largely by choosing asset classes and deciding on asset allocation based on prices and the attractiveness of different asset categories. Time was never really a key piece of information when deciding which category to invest in. Here, we are clearly recognising that people have different financial goals that are defined by a time horizon. Some may have a five-year or 10-year goal, while others may have a much longer horizon. These could include planning for a child’s education, retirement, buying a house or building a contingency fund. There can be many reasons, but the point is that you need to have a certain amount of money available at a particular point in time. Life Cycle Funds provide a solution to this kind of requirement. This need has existed in the market for a long time. In fact, advisors and people like us have been getting queries from investors asking, for example, whether there is a suitable fund if they need to invest for the next 10 years. Normally, when you give advice for such a 10-year period, the recommendation keeps changing. I may initially tell an investor that a particular category is suitable. As time progresses, I would then have to continuously tell that investor which category they should move into. The good part about a Life Cycle Fund is that the fund does this for the investor. It determines how the asset allocation should evolve over the next 10 years. The allocation is systematically structured throughout the life of the fund, making it more predictable in terms of what the fund will do for the investor over that period.

Are Existing Child and Retirement Plans Being Replaced by Life Cycle Funds?

What happens to existing child plans and retirement plans? Do they continue to exist or are they being replaced by Life Cycle Funds? No, they continue to exist. There is no change to those particular products. Think about a retirement product. A retirement product is a long-term product for an investor, but it does not necessarily have a defined timeline. For example, if I am 47 years old and want to plan for my retirement, I can invest in a retirement product. At the same time, a 25-year-old can also choose to invest in the same retirement fund. The investment horizon is therefore different. The 25-year-old may have 35 years until retirement, while I may have only 15 years. However, what the retirement fund does is that, irrespective of the age of the investor, its investment style does not change. It follows a particular investment style and the asset allocation does not change. So, if it is an equity-based retirement fund, it will remain an equity-based retirement fund over the next 20 years.

Life Cycle Funds vs Retirement Funds

Life Cycle Funds are different. If it is a 10-year goal-based fund, the asset allocation will change over those 10 years. That is the key difference compared with a retirement fund. So, those existing fund categories will continue to exist; they are not being replaced by Life Cycle Funds.

How Should Investors Choose Between Life Cycle Funds?

You have launched three funds with different maturity dates—2031, 2036 and 2041. How should an investor choose between them? The choice will depend on the investor’s requirement. The flexibility here is that you have different broad time categories. The investor has to decide what their requirement is and plan accordingly. They need to determine how much money they will need and at what point in time. It could be a five-year, 10-year or 15-year requirement. Based on that, the investor can allocate money to the appropriate fund. The timeline has to be decided by the investor at the start of the investment.

Are SIP, STP and SWP Facilities Available in Life Cycle Funds?

Are SIP, STP and SWP facilities available in these funds? Yes. These are open-ended funds, so, like any other open-ended fund, these facilities are available. The only difference is that the maturity date of the fund is predetermined. So, the fund will mature on a particular date, but otherwise, the features remain similar to those of an open-ended fund.

What Happens If You Invest Close to the Maturity Date?

What happens if I invest closer to maturity? For example, if I choose the 2041 fund but invest five years later, I would be only five years away from maturity. How would that work? That is the interesting part. In a 15-year maturity product, after one year, it becomes a 14-year product. After five years, it becomes a 10-year product. After 10 years, it becomes a five-year product. So, you can choose to invest at any point in time. The remaining maturity is the life of the product at that point, and your goals should be aligned with that remaining period.

What Happens to Life Cycle Funds After Maturity?

What happens to the funds after maturity? Can an investor continue to stay invested after the maturity date? After the maturity date, the money will be returned to the investor. The idea is that this is not a fund that will run in perpetuity. The structure of the fund is designed in such a way that, as it approaches maturity, the money has to be paid back. That is also something the fund manager will keep in mind while managing the portfolio. At maturity, the investor will get the money back. The fund will not simply be rolled over or extended for a longer period.

How Frequently Will Life Cycle Funds Be Launched?

Since the remaining maturity reduces every year, what will be the frequency of such funds from the AMC’s perspective? Will new funds be launched every year? Since it is an open-ended fund, even if you have a five-year goal and the product has, say, six or seven years remaining, you can choose to invest closer to maturity because you can redeem at any point in time. Even if you need the money one year before the maturity date, you can choose to redeem it. Since there are various options available across different timelines, the products will generally be available at five-year intervals. Every five years, you have the option of choosing a particular product and deciding how long the investment should remain in the fund.

Is There a Lock-in Period or Exit Load in Life Cycle Funds?

Is there a lock-in period or an exit load in these Life Cycle Funds? There is no lock-in. It is an open-ended fund, which means you can enter and exit at any point; there is no restriction on that. However, from an exit-load perspective, there is a tiered structure. In the first year, there is a 3% exit load. In the second year, it is 2%, and in the third year, it is 1%.

Why Do Life Cycle Funds Have an Exit Load?

The reason for having an exit load is to create some deterrence for investors because the fund is meant to be held until maturity. However, in case of an emergency or an exigency, investors can still choose to withdraw at any point in time.

What Is the Expense Ratio of Life Cycle Funds?

How much is the expense ratio in these funds? The expense ratios will be similar to those of existing hybrid schemes. The expense ratio is not expected to be very different. Both direct and regular options are available to investors.

What Is the Glide Path Strategy in Life Cycle Funds?

One interesting feature of these funds is the glide path strategy. The 2041 fund starts with 65-80% equity exposure, while the 2036 fund starts with 50-65%. Why does the starting equity allocation change so significantly with the investment horizon? And could you explain the glide path strategy to our viewers?

Price-Based Asset Allocation

When you do asset allocation, there can be two broad strategies. One is a price-based strategy. We have several funds that follow price-based asset allocation. Essentially, when one asset becomes cheaper relative to another, you allocate more money to that asset. That is price-based asset allocation.

Time-Based Asset Allocation

The second strategy is time-based asset allocation. Life Cycle Funds follow this approach. What we mean by time-based asset allocation is that when the investment horizon is longer, the expected volatility of a particular asset category is lower. For example, if you have a 15-year horizon for equity, the expected volatility over that 15-year period is relatively lower. But if you ask me how the markets will behave over the next two years, it is much more difficult to predict the path of market returns. Therefore, as the investment timeline reduces, the volatility of an asset class, particularly equity, increases.

How Does Equity Exposure Change as Maturity Approaches?

So, the fund is designed in such a way that the longer the residual life of the fund, the higher the equity allocation. As the fund moves through its journey and the remaining life reduces, the equity allocation is also reduced. This is a time-based approach to asset allocation, and it helps reduce the risk in the fund significantly as the maturity date approaches.

Where Do Life Cycle Funds Invest?

Where will these funds invest, and what will be their benchmark? The funds will invest in equity markets and debt markets. They can also have residual investments in gold, silver and InvITs, but that will only be a residual allocation. The predominant allocation will be towards equity and debt markets.

Equity Investment Strategy

Within equity, it is a flexible strategy for the portfolio manager. The manager can decide the market-cap allocation and the investment style. The good thing is that the fund manager has a very long horizon over which to make investment decisions. This allows the manager to invest for the longer term rather than being overly concerned about short-term volatility and short-term movements in the equity market.

Debt Investment Strategy

As far as fixed income is concerned, the strategy is also flexible. The fund manager can decide what duration to run in the portfolio and what rating categories to invest in. That flexibility lies with the fund manager. The only significant change comes in the last three years of the product. At that stage, the debt strategy has to change and align with the maturity profile of the portfolio to ensure that the volatility of the product reduces as it approaches maturity.

Credit Rating During the Last Three Years

As far as credit rating is concerned, during the latter part- the last three years- you can invest only in AA and above-rated securities. This ensures that the credit quality of the portfolio remains very good towards the end of the fund’s life.

How Are Life Cycle Funds Taxed?

How will these funds be taxed? Taxation is also efficient. It follows one-year taxation, similar to an equity portfolio. The long-term capital gains tax after one year is 12.5% for this product.

Who Should Invest in Life Cycle Funds?

Who should consider a Life Cycle Fund? And, equally importantly, what kind of investor should stay away from it?

Who Should Avoid Life Cycle Funds?

This is not a fund in which you should invest for a very short period, say one or two years. If you are looking to invest for such a short period, there are other product categories that may be more suitable. Similarly, if you do not have a definitive timeline for your goal, there are other products available in the market.

Who Can Consider Life Cycle Funds?

But if you know your timeline and have to invest for a longer period, this can be a very suitable product for investors.