Kotak Twin Advantage Series III (KTA-Series III) is a close-ended debt scheme with a 3-Yr investment tenure. The mainstay of the fund is to generate income by investing primarily in debt and money market instruments. It also proposes to generate capital appreciation by investing in the equity derivatives market. Clearly, the fund works on the proposition of combining 'safety of returns' a trait associated with debt (particularly when yields are locked at higher levels) and payoff of equity (again, if invested wisely).
There are options associated with both, the index (index options) as well as individual stocks (stock options). Within options, there are call options and put options. As indicated by the fund house, KTA-Series III will invest in equity index options (upto 35% of net assets). The returns generated or losses incurred on index options largely depend upon the movement of the underlying index. Thus if the underlying index rises, then the buyer of the call option will make a profit, conversely the buyer of the put option will incur losses and visa-versa. Also, the risk (loss) for an option buyer is limited to the premium paid, whereas for the option writer (seller), the risk is unlimited; the latter's gain being limited to the premium earned.
The fund has indicated explicitly that it will invest in equity index options and not in stock options. This will help the fund manager gain from broader movements in the stock market (which over the long-term is likely to go up) rather than concentrating on individual stocks (that can be very volatile over short to medium term).
However, investors must factor in that the domestic derivatives market does not yet have the depth to allow investors to take a long-term view on the index. The longest contract in the options market is of a 3-month duration, while KTA-Series III seeks to take a 3-Yr view on stock markets. In case of a downturn in equity markets in the short-term, a premium will have to be paid to carry forward the position. The carry forward premium is effectively an expense for the fund.
Another significant feature of KTA-Series III is its mandate to avoid going short on options i.e., the fund will only buy and not sell options. This is a prudent investment strategy because the seller of an option is exposed to potentially unlimited losses. By only buying options, the fund has restricted its downside on the equity index options to the premium amount.
KTA-Series III offers a redemption option to investors during the liquidity window period (i.e. every year on 25th March, 25th June, 25th September and 25th December). Though there is no exit load, the proportionate unamortised initial issue expense will be recovered from the investors for an early redemption.
By having a majority of their investments in debt and adopting a relatively conservative approach on the equity side (investments in index options only and no selling options), KTA-Series III presents an attractive investment proposition for the low to moderate risk investor. Particularly interesting is the position of the debt markets at present. With 10-Yr bond yields reigning at over 8% levels, if locked at current levels, investments in debt markets could yield relatively higher returns going forward. Equity markets over a 3-Yr perspective look even more attractive after the recent correction, so index options taken over that period (with carry forward over the interim period) can prove to be lucrative investments.
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