‘True Beacon Two’ Hedge Fund Review—Should You Invest in This AIF?

True Beacon Two is the latest AIF from True Beacon launched in August 2021.

The company says this is a multi-asset fund investing in both equities and fixed income instruments.

It is the second AIF from True Beacon made for Indian HNI & UHNI investors following its flagship AIF—the ‘TrueBeacon One’. In the previous article, we published a detailed review of the True Beacon One.

We analyzed the fund on all aspects, from strategy and Returns to Charges and Taxation.

You can read that article here: True Beacon One AIF Review.

Table of Contents:

1.) What Kind of AIF is True Beacon Two?

2.)Features of The ‘True Beacon Two’ Fund

3.)True Beacon Two: Review of Investment Strategy

4.)True Beacon Two: Review of Fee Structure

5.)Taxation of the ‘True Beacon Two’:

6.)The Triple Filter Test For ‘True Beacon Two’:

• Filter1: Is The ‘True Beacon Two’ Well Regulated?
• Filter2: Does The ‘True Beacon Two’ Have A Good Track Record?
• Filter3: Is The ‘True Beacon Two’ Simple & Transparent?

7.) Verdict

What Kind of AIF is True Beacon Two?

You may already know that Alternative Investment Funds are unconventional complicated investment instruments. 

It pools a huge sum of money from HNI & UHNI investors and invests them as per the fund’s investment policy. Some might even say that AIFs are a combination of Mutual Funds and PMS. 

Earlier we have seen that the SEBI categorizes the AIFs into three categories,

• Category I
• Category II
• Category III

Each AIF comes under any of these categories based on its investment policy. It is declared by the fund manager at the time of fund registration with SEBI. 

Like the True Beacon One, the True Beacon Two is also a Category III AIF. 

Even though they both belong to the same category, True Beacon Two takes a different approach in its investment strategy. 

In comparison, the True Beacon Two is less risky than its predecessor. It is because the ‘True Beacon Two’ invests in both public equities and fixed income instruments. 

Before we further analyse and understand the True Beacon Two AIF’s investment strategy, here are the features of this AIF. 

Features of The ‘True Beacon Two’ Fund:

True Beacon by Zerodha fame Nikhil Kamath came into the AIF scene to “Disrupt the Status Quo”. 

Compared to the other traditional AIFs, the True Beacon takes a relatively lesser fee. In addition, True beacon also allows some flexibility to its investors that is not available in other AIFs. 

The table below shows the features of ‘True Beacon Two’ and its fee structure. 

Like all other AIFs, True Beacon Two requires the standard minimum of ₹1 Crore to invest in this fund. 

The other notable feature of this fund is the 48 hour redemption time. 

But the most important of these is the fund’s asset allocation ratio and its equity allocation benchmark. These will play an important role in the ‘True Beacon Two’ Investment Strategy and ultimately the return it generates. 

Let’s see how this asset allocation enables the fund’s investment strategy in detail. 

True Beacon Two: Review of Investment Strategy

“Dynamic Equity and Fixed Income Fund” is the official description given to the ‘True Beacon Two’.

The ‘True Beacon Two’ will have an approximate asset allocation of 65% towards equity and 35% towards debt instruments. With this strategy, ‘True Beacon Two’ aims to deliver a 9%-10% return. 

To achieve this, True Beacon specifies two different investment strategies to follow in each of the asset classes. 

I’ll explain the two below, starting with the Equity investment strategy. 

In The Equity Component:

True beacon Two has chosen the NIFTY200 as the benchmark for its equity component. 

The Nifty200 is a wide benchmark of large and midcap companies. 

Even though the fund plans to hold ~15 core growth stocks, the wide benchmark may be an indicator of an aggressive investment approach. 

The fund may also include ~25 additional stocks in its equity portfolio. 

In The Debt Component:

The debt component of the True Beacon Two is probably the investor attraction in this AIF. 

True Beacon Two says that in its ~35% debt allocation, it will invest in tax-free bonds offered by the Govt. of India. 

You know that the fund will have a 65%-35% asset allocation ratio. But this is only an approximation, and the fund manager will rebalance between them dynamically. 

In short, the True Beacon Two is very similar to an aggressive hybrid mutual fund scheme. Although, the fund’s operation, charges, and taxation are much different from a mutual fund scheme—and far more complicated. 

With that being said, we can still assess whether you should invest in this AIF by analysing the other fundamental factors. One of the reliable strategies is to subject the ‘True Beacon Two’ to a triple filter test. 

But before that, let’s take a look into the fee structure of the True Beacon Two.

True Beacon Two: Review of Fee Structure

True Beacon follows the same fee structure it follows in its flagship fund for the True Beacon Two fund as well. 

True Beacon Two does not charge any management fee. Also, there is no entry or exit fee in this fund. 

Along with the ‘no lock-in period’ feature, it aims to provide flexibility to the investors that is absent in the other AIFs. 

However, it is not entirely free of cost. And the fee structure is still complicated. 

True Beacon Two comes with a 10% Carry Fee. 

A Carry Fee, also called the performance fee, is the fee charged by the fund manager on the profit of the fund. 

For example, let’s say the fund has a total value of ₹530 Crores—out of which ₹30 Crore is the profit for the year. Here, the fund manager will charge ₹3 Crore—10% of ₹30 Crores—as the performance fee. 

In the table, you may also notice that the ‘True Beacon Two’ does not have any Hurdle Rate. 

A Hurdle Rate is the threshold of profit for the fund manager. The investors will pay the performance fee only if the fund delivers a return above this Hurdle Rate.  

Taking the previous example, let’s say that the fund has a hurdle rate of 8%. In that case, the ₹30 Crore profit of the fund comes to only a 6% return. And since this 6% return is lesser than the 8% hurdle rate, the fund manager won’t charge any performance fee. 

In the case of ‘True Beacon Two’, since there is no Hurdle Rate, the fund manager will charge the 10% Carry Fee regardless of the fund’s return rate. 

However, the ‘True Beacon Two’ has also set a high watermark. 

High-watermark in AIFs denotes the highest value a fund has ever reached. 

In a high-watermark fund, investors will pay the performance fee only if the fund value crosses the high watermark. If the fund value falls after touching a peak, there will be no performance fee until the fund value crosses the high-watermark again. 

From the investors’ perspective, a high-watermark looks fair. But looks can be deceiving. 

We’ll see more about it in detail later in the Triple Filter Test for the True Beacon Two. 

Taxation of the ‘True Beacon Two’:

Taxation is probably the last thing an investor will look for in an investment—unless the purpose of the investment itself is for tax benefits. 

AIFs are subject to different tax treatments depending on the underlying investments. And are one of the highest tax attracting investment products. 

The table below shows the different tax rates for a Category III AIF.

Since the ‘True Beacon Two’ invests in tax-free Govt. Bonds, the fund will have tax implications only on the equity allocation. 

AIFs incur 12% tax for LTCG, and 18% on STCG. Relative to the returns and the cost, the net return in the hands of an investor will be significantly lesser than from an equity mutual fund. Also, if any of the returns is a business income, the investor will be liable to pay a 42.74% tax on that return. 

The conventional equity mutual funds, on the other hand, incur 10% LTCG tax, with a 4% cess. So, in an equity mutual fund scheme, an investor will pay an LTCG tax of 10.4% in any scenario. In addition, equity mutual funds also have a tax exemption for the first ₹1Lakh capital gains realised in a financial year. 

Hence, despite the tax-free debt portion, the ‘True Beacon Two’ may still not be tax efficient for an investor.

The Triple Filter Test For ‘True Beacon Two’:

While the ‘True Beacon One’ took the high risk-high return route, the ‘True Beacon Two’ has taken the route of stability and growth. 

Also, the ‘True Beacon Two’ is taking a relatively less-complicated investment strategy for an AIF. However, the product itself is complicated by nature. 

And, if you choose to invest, you still need to invest a minimum of ₹1 Crore in this fund. From an investor’s perspective—HNI or UHNI—it is a huge sum. 

It would be only wise to subject the ‘True Beacon Two’ to the triple filter test before you make your investment call.

Filter1: Is The ‘True Beacon Two’ Well Regulated?

From the regulation perspective, the ‘True Beacon Two’ is not different from the ‘True Beacon One’. 

It is not different from any other Category III AIF. 

The ‘True Beacon Two’ is an AIF registered with the SEBI. But it is not as stringently regulated by SEBI as an equity mutual fund. 

For example, in equity mutual funds, SEBI requires all the AMCs to appoint a trustee. A trustee will monitor the activities of the fund and the AMC to protect the interest of the retail investors. 

Even though the AMC appoints the trustee, a trustee is an independent body and should be approved by SEBI. 

In any non-compliance to the SEBI Regulations, the trustee holds the right to intervene and take action. 

But when it comes to AIFs, there is no such defined internal independent regulatory mechanism. And such roles are often left to the sponsors of the fund—not an independent body. 

Note: In India, trust funds are considered as AIF. And only they will have a trustee.

Even though AIFs are regulated by SEBI, their regulation extends only to a limit. Hence they can never be considered a well-regulated investment product.

Filter2: Does The ‘True Beacon Two’ Have A Good Track Record?

The True Beacon says that this fund will aim to deliver returns at a rate of 9%-10% p.a. 

But the ‘True Beacon Two’ is a new fund with only two months of performance history. 

In any case, it is not enough to assess the performance potential of any fund. There is no way to know how this fund will perform in times of crisis and market swings.

It is true, even with a 35% debt component in this fund.

Filter3: Is The ‘True Beacon Two’ Simple & Transparent?

Indeed, we saw that the investment strategy of ‘True Beacon Two’ is a simple one. 

True Beacon Two will invest in Nifty200 stocks and the tax-free Govt. Bonds. 

However, it does not change the fact that AIFs are complicated products by nature. And complication is always a mask to hide transparency. 

Let’s take the high-watermark principle of the ‘True Beacon Two’ for example. 

In the Fee Structure review earlier, we discussed how it makes sure that no fee is paid by the investor in case of poor performance. 

It sounds fair and good to an investor—but does it matter? 

More importantly, should it matter to an investor?

High-watermark is Only a Selling Point:

The high watermark in AIFs is a mechanism to avoid double payment of performance fees. 

For example, if the ‘True Beacon Two’ earns 8% profit in year 1, the investor will pay a 10% Carry Fee on that 8% profit. In year2, if the fund makes a -10% loss, the investor will not pay any performance fee. 

In year 3, if the fund makes a 10% profit, the investor should pay a 10% performance fee. That is if the fund has no high-watermark. 

Since the ‘True Beacon Two’ has a high watermark, there will be no performance fee. It is because, in year3, the fund manager has merely recovered the losses of year 2. No new profit is earned. 

Let’s say an investor invests ₹10 Crores in the ‘True Beacon Two’ fund. After a year, the fund has touched a high-watermark of ₹10.08 Crores. The profit from the fund is ₹8 lakh at 8%. The fund manager will charge a 10% Carry Fee of ₹80,000 on the ₹8 lakh profit. 

From there, the fund manager will charge the Carry Fee only if your fund value goes over and above the ₹10.08 Crore high-watermark. 

It should not be hard, since the ‘True Beacon Two’ has ~35% fixed income allocation. It will give the fund steady growth, even if it is very little. 

On the other hand, the fund’s equity allocation benchmark is Nifty200. As seen already, it is a wide benchmark with large and midcap companies. 

With this allocation and flexibility, any average-performing fund can generate a positive return y-o-y, even if it is only 2%. 

Should the high-watermark matter to an investor? 

Well, it depends. 

If you are comparing among AIFs, those with high-watermark have a competitive edge over those without it. 

But that is only if you turn a blind eye to other simpler, better investment instruments and limit yourself to AIFs alone. 

To any goal-focused investor, a clever product feature is the least concern. Efficiently achieving your financial goal will take precedence over any well-crafted product feature. 

“Complexity Masks Transparency”

Let’s consider similar but simpler equity mutual funds. They have a simpler fee structure (Total Expense Ratio-TER) compared to the AIFs. 

For example, SEBI has set a cap on the TER for the equity mutual fund schemes. 

Equity mutual funds can have a maximum expense ratio of only 2.5% of the Assets under Management (AUM). It is only for the first ₹500 Crores of the fund. For assets over and above this, the TER further reduces as the AUM of the fund increases. 

The stringent regulations of SEBI keep the equity mutual funds remain simple and transparent.

Verdict:

The “True Beacon Two” is an AIF counterpart of aggressive hybrid mutual funds. 

The only exception is that the “True Beacon Two” is complicated, less regulated, and has no track record. 

Meanwhile, the tax efficiency and the flexibility gives the hybrid funds a practical advantage over the “True Beacon Two”. 

The Triple Filter Test shows that there is no conceivable reason to invest in this AIF.  Especially when there is already a far efficient product to deliver similar returns with lesser risk. 

To put it lightly, the ‘True Beacon Two’ is like a Rube Goldberg machine. 

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