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Smart
Investing : Coffee & conversations
The country's five top fund managers discuss investment strategies
in an informal gathering at Cafe Mocha, a happening coffee shop in
a Mumbai's suburb.
The
Smart Investor Team
Excerpts
Haseeb
Drabu: Welcome ladies and gentlemen to Fund caf‚! We are
looking forward to an interesting session where we can chat informally
about investment strategies, the outlook for both equities and for
debt, the basic issues with investment in today's market and the kind
of things that an investor should look forward to when investing in
mutual funds. I would suggest that all of you let you hair down a
bit and talk as freely as you can. Let me now ask N Mahalakshmi who
heads our Smart Investor section to take you through this discussion.
Thank you.
Mahalakshmi: We have with us Dileep Madgavkar, chief investment
officer of Prudential ICICI Mutual Fund, the second largest mutual
fund in the country with assets of more than Rs 12,000 crore.
Prashant Jain, head of equities at HDFC Mutual Fund, was the chief
investment officer of Zurich Mutual Fund before it was taken over
by HDFC MF. Prashant was also the BS Fund Manger for 2002.
Rajiv Anand, head - investments, Stanchart Mutual Fund, the only mutual
fund in the country focused purely on the debt side. So, today Rajiv
will have to really mind his words - have to be really politically
correct while talking about the outlook for debt funds because a lot
is at stake!
S Naganath, chief investment officer of DSP Merrill Lynch Mutual Fund,
who comes with very valuable experience in the Indian and US markets.
Finally, we have Nilesh Shah, head of fixed income at Franklin Templeton,
who also happens to be the joint BS Fund Manager for 2003. He is a
gold medallist chartered accountant and comes across as a very articulate
fund manager with an amazing stock of knowledge.
The first and foremost question that comes to one's mind is: will
this year belong to equities or debt? In the last few years, we have
been saying that debt funds will disappoint, but every single year
they have defied that logic. Will this year be any different? Dileep,
can we have your take first?
Dileep: If one is talking about one asset class outperforming
the other, then I believe that this year equities will definitely
outperform debt as an asset class this year. But it will not be one
at the cost of the other, simply because they cater to different risk
profiles and categories. I am sure Rajiv will agree with me.
Rajiv: I agree. I think the big move, as far as debt is concerned,
is pretty much dull. I think interest rates may soften maybe another
25 or 50 basis points. But returns out of debt funds are going to
be very, very close to the normal (market) yields.
Unlike in previous years, where capital appreciation was considerable,
the focus of attention will now be towards accruals. The sad story
is that returns on debt funds will be nowhere near what we saw over
the last couple of years.
Naganath: I fully agree with what Dileep is saying. Certainly,
different asset classes have investors looking at them seriously,
but if you were simply to compare debt versus equity, then certainly
equities look very good this year.
Prashant: It is not entirely right to compare returns of two
asset categories because they are fundamentally different and the
returns they deliver over long periods of time will also be different.
But a couple of things stand out. The returns from equities over the
next three to five years are likely to be better than what they had
been in the past.
Debt is likely to be the other way around: the returns on debt funds
are likely to be significantly lower than the returns we have seen
in the last three to five years. So returns on equities may far outstrip
bond returns in the medium to long term. But I would not like to hazard
a guess on what would happen this year.
Mahalakshmi: What kind of returns can debt funds generate this
year? And even when returns are tempered, can mutual funds offer a
value proposition?
Rajiv: Debt fund returns will be in single digits. However,
relative to other fixed deposit products such as bank fixed deposits
- cash funds will outperform the savings account any day; a short-term
fund will outperform the 90-day fixed deposit any day; and the long-term
debt funds will outperform one-year fixed deposits.
If you throw in factors like tax benefits and liquidity that debt
funds offer, it is really no contest with the other fixed-income options.
Nilesh: For the last five years, we have been going to investors
saying that this time the debt funds have done exceptionally well,
but next year please be cautious. And every time we have fallen flat
on our face. And I won't be surprised if some category of debt funds
could still deliver a good return, obviously not comparable to equity
funds, but still it can deliver some sort of return which will give
an investor an edge over the other instruments.
Mahalakshmi: So all of us here are essentially saying that
the equity asset class will outperform debt funds this year. If you
were to suggest asset allocation for an investor with a moderate risk
appetite, who normally allocates about 30-40 per cent of his investible
funds into equities, what would you recommend?
Naganath: I would go with something like 50-60 per cent in
equity and the rest in debt, assuming that such an investor clearly
has that appetite for equity risks. Certainly, for the next 6-12 months,
I would recommend being overweight on equities.
Dileep: I would put it in a different way. All I would say
is that if an investor is putting in X per cent of his overall investible
funds into equities, today he can do X+20 per cent. So if he hitherto
was investing 5 per cent, he can put in 25 per cent; if he was putting
in 40 per cent, he can now put in 60 per cent and so on. That 20 per
cent extra in terms of asset allocation would be justified by the
relative attractiveness of equities today.
Nilesh: I would go by the thumb rule of making an equity allocation
equal to 100 minus your age. So if you are 30 years of age, I would
say put in 70 per cent in equity. Then depending upon your risk profile
- whether you want to be aggressive or conservative, you can reduce
your risk cover may be to 60:40.
Clearly as you move up on the maturity profile or age profile, your
ability to take risk will come down and then you will have to increase
your allocation to debt. So depending upon the investor's risk profile,
based on the normal thumb rule principle, he should slightly be overweight
on equity right now - i.e. 10-20 per cent depending upon his ability
to grasp the risk.
With equities you ought to be patient. So if you have the ability
to withstand small jerks, volatility, then concentrate on the big
picture with a suitable time horizon and be overweight on equities.
Mahalakshmi: Talking about the time horizon, what kind of time
horizon should a equity fund investor have?
Dileep: The longer, the better. Equity is an asset class where
your odds only increase as the time horizon becomes longer. But there
is no guarantee that you will actually make indicative or expected
returns.
But one thing has to happen over really long periods of time: the
returns from an index or a share have to be nearly equal to the profit
growth rates, otherwise the PE multiples will become unreasonably
low or unreasonably high. The longer the profits keep on growing and
longer the index does not perform, more are the chances that equities
will perform.
If you look at the last ten or eleven years, the index has not performed,
but it is also a reflection of the fact that between 1987 and 1992,
it went up ten times, way in excess of the profit growth rates.
But again like equities always behave, the correction in the other
direction has been extreme. Today at a price-earning multiple of 6-8
times, the economy continues to grow, profit growth is reasonably
secure. So, I would say that the chances of one making reasonable
money in equities over the next 3 to 5 years is very high.
Naganath: My own sense is that in the last ten years we have
been range bound and we should not use that as a template to judge
the next ten years. My sense is, as Dileep put it quite nicely, that
we are currently in an environment where things are slowly coming
together at the macro level. So all put together, I would say that
this decade will be one, when we look back perhaps, say in 2010, we
would have seen a far more steady uptrend than the choppy movements
in the last ten years.
Nilesh: Can I just add to that? As important as the tenure
of investment, which I believe is definitely between 3 and 5 years,
is the way the money is invested. It has to be invested gradually
and you have to exit the market gradually. It cannot be done in one
shot.
Invariably the one-shot investment is always because of fear of missing
out the boom that is supposedly going to happen. The mode of investment
in terms of a gradual increase and a gradual decrease is as important
as the 3 to 5 years time frame.
Another point is that everyone keeps talking about a market that has
gone nowhere over the last five years. Now if you look at all mutual
funds, even those offered by all of us in the last five years, all
the diversified equity funds have given decent returns, even though
the market has gone nowhere. So it is not as in an era where equity
as an asset class is supposed to have done absolutely nothing, equity
mutual funds have actually given decent returns. Some may be a little
less, some a little more. But they have all given pretty healthy returns.
Mahalakshmi: That's actually an interesting point. The fact
that many fund managers have outperformed the market when the index
has not risen much is perhaps because we never has a broad market
rally. Only pockets in the market did well and it was a easier job
to outperform (the markets) by loading the portfolio with certain
sectors/stocks or trading in a range bound market. Is that a sustainable
proposition?
Nilesh: Possibly, and many may differ with me. in this, I believe
that there will be much, much broader participation even in terms
of stocks going forward. That's more because over the last five or
six years, you have always seen one or two sectors being singled out
as being relative outperformers either in terms of fundamentals or
in terms of investor choice.
Going forward, I would believe, given the economic environment, given
the efficiency gains that we have seen, we are seeing many more sectors,
many more companies doing much better, spread across a vivid cross
section of sectors. Therefore you would see much wider participation
going forward and that, in turn, would make fund managers' life much
more difficult in terms of beating an index.
Mahalakshmi: Despite the bright prospects equities seems to
promise today, why isn't money flowing into equities? Even in the
recent rally, the gross sales of equity funds have been relatively
healthy but net sales has been poor due to redemptions...
Nilesh: Unfortunately, equity seems to be the only asset class
that no one wants when it is available at a quality price. It is one
asset class that every one wants to buy at peak prices! That seems
to be the trend. That is absolutely unfortunate because when you have
great quality investments, that are primarily fundamentals-driven,
as Rajiv said, herd mentality dictates that no one touches them.
The second reason for getting into equity is not the way that one
would look at investing in any other business. Even a businessman
who invests in his own business does not look at equities as a sort
of derivative representing an underlying business. It is not looked
upon like that. It is looked upon as either you are missing out a
great momentum opportunity and therefore getting in quick and getting
out quickly, or is looked at a means to earning a fast buck rather
than as an investment.
Equity is never looked upon as an investment. It is only a means to
make a fast buck. Paradoxically, whenever you look at it like that,
you never end up making money on it.
Rajiv: Speaking of paradoxes, the best one I have heard so
far is, investors looking for capital appreciation in debt funds and
they invest in dividend yield funds on the equity side. What can be
more paradoxical than that?
Mahalakshmi: Would anybody disagree on that - the idea of investing
in dividend yield funds? I thought it was a good, low-risk alternative
on the equity side. Also, I would like to believe that the paradox
that Rajiv is talking about is more to do with the state of the market
today than with the psyche of the investor. Because when markets are
upbeat no one talks about yields.
Nilesh, would you like to elaborate on the risk return profile of
dividend yield funds vis-…-vis debt funds?
Nilesh: A dividend yield fund is not a bad concept. There are
many markets internationally where the dividend yield on stocks is
far higher than the interest rates offered by the debt of those companies.
Even in India at today's stage where you want to convert people back
to the equity fold -I won't use the word "lure" but at least
guide them back into equity- you require a solid selling concept and
that is where the dividend yield comes handy: "Okay, you don't
get capital appreciation, but at least the current yield which you
are earning on the dividend of the stocks is reasonably good enough
to compare vis-…-vis the market interest rate. So it was more
a 'lure' or a 'guide' to get investors back into the equity fold.
Whereas the debt funds historically have given returns because of
huge capital appreciation and people are still coming into debt funds
looking at last years' performances, which we all know is not going
to be replicated. However, investors are unwilling to bite that.
Hence we are now in a paradox where dividend yield is now becoming
a kind of capital protected fund whereas debt fund is becoming a capital
appreciation fund. As we go over next two or three years, these concepts
are going to be revolutionised and you will suddenly feel that debt
is more capital-plus whereas equity affords real capital appreciation.
So hopefully things will fall in place and we will have better informed
investors who would not then blame fund managers or the mutual funds
for not delivering performance to their expectations but rather delivering
performance which is based on the risk profile of the asset classes
of those categories.
Mahalakshmi: Dileep, is it a good idea for the investors to
switch to dividend yield fund from a debt fund?
Dileep: While each investor's asset allocation is based on
his risk profile, he can choose a broad equity fund and a broad debt
fund. Now would I recommend to an investor to prefer one asset class
over another? No, it is a function of his risk profile. Will you switch
to a dividend yield fund from an income fund or gilt fund? No, that
again will be a disaster. You are trying to mix tea and coffee probably
in this environment to create a new drink. I don't know whether it
will be good or bad.
Prashant: Dividend yield, to my mind, is more of a packaging
issue. The risk of a dividend yield fund is pretty much the same as
that of diversified equity fund because high yields are common in
today's markets and most equity funds consequently have reasonably
high dividend yields. Basically, a higher dividend yield on a stock
may mean undervaluation and to that extent it might direct the fund
manager to buy lower P/E or higher yielding stocks.
If you look at the returns or the risks, regular diversified equity
funds and dividend yield funds actually bear the same risks.
In fact, if you carry that concept a little further, a dividend yield
fund might actually work to your disadvantage. Because if you are
constantly judging dividend yields as share prices go up, you might
be tempted to invest in lower and lower quality stocks which may actually
increase the risk beyond what is desired.
Mahalakshmi: Should investors switch from plain vanilla debt
funds to floaters given the way interest rates are poised today?
Rajiv: Let me make it a little wider. There are enough debt
fund products in the marketplace to really cater to every need within
that universe.
Floaters are a good asset class whether you are a risk averse investor
or an investor who thinks that interest rates have bottomed out now.
The investor does not want to take any risk. So whether it is the
floater or the cash or the short or the medium-term plan, the rule
of the thumb that we use for the debt fund side is very simple: Long-term
money goes into long-term funds, short-term money goes into short-term
funds.
We typically use a floater more as a defensive fund in the sense that
it is the only fund where actually returns will improve if and when
interest rates do turn upwards. One doesn't know when that is going
to happen. That hasn't happened for the last three years. But is this
a good time to invest in floaters? Perhaps yes.
Nilesh: Internally we had a long debate about launching a floating
rate fund and eventually after convincing my people for almost one-and-a-half
years, we could launch the first floating rate fund in India in February
2002. Again, if you see the different investors in that fund, some
had very good experience, while some others had a very bad experience.
That is like misunderstanding the product. A floating rate fund is
essentially a defensive product. It will try to deliver you the market
rate of return. If the market rate is 2 per cent or 20 per cent, whatever
it is, it will try to deliver that kind of return.
Now people have come into floating rate funds assuming that it will
be a liquid fund on its way down, and an income fund on its way up.
That is not going to happen. So it is most important for investors
to figure out why they want to invest in that fund. If the idea is
to get capital protection - with reasonable surety of getting market
rate of return - the floating rate fund is an ideal choice at any
point of time. Not just today, it will be the ideal even ten years
down the line. But if you want to invest for a short term, then floating
rate is not ideal for you. Try to remain in liquid funds or short
term funds.
Dileep: Just want to add a point. Taking a view on interest
rates would be counterproductive to the whole concept of a floater.
A floater is really for those who do not want to take a view on rates
of interest, whether it is going up or whether it is going down. A
floating rate product is exactly meant for that.
Unfortunately, like Nilesh said, the expectation is that it is non-linear
in nature. It is not non-linear, it does not bottom out at a liquid
fund rate and give you the upside of a possible capital gain. It is
not that sort of product at all. In fact. the type of investor who
gets into a floating rate product is someone who wants to remove himself
from either an appreciation or depreciation that can go into any asset.
Mahalakshmi: Could you hazard a guess as to what is the worst
that could happen to debt funds?
Rajiv: The worst that could happen is reasonable levels of
returns.
Mahalakshmi: That is being really optimistic and politically
correct!
Nilesh: You really want the worst scenario?
Mahalakshmi: Yes.
Nilesh: If Government of India defaults, what happens to that
debt fund? Today our fiscal deficit situation is as good or as bad
as that of Argentina's in some cases, though not on all parameters.
That is the worst case scenario, where your entire savings will disappear.
But what is the probability of that happening? 0.00001 per cent.
Mahalakshmi: All right, that's another perspective. My question
is now from a lay investor's point of view. While we have had lots
of funds which have outperformed the Sensex over the past five years,
the divergence in the performance of various funds have also been
quite huge. Some have even hugely underperformed. So how can an investor
go about choosing a fund? It's just as difficult as picking stock.
Nilesh: I still don't understand why should an investor look
at a mutual fund's portfolio. My portfolio does not tell anything
to the investor which he will be able to appreciate or understand.
All he needs to know is, what is my investment process and how rigorously
do I follow that. The results will come out of the investment process,
not out of the investment findings. But invariably, people would like
to second-guess the fundman.
Then we also have an army of distributors who probably want to do
their value addition by keeping the short-terms gains of the clients
in mind rather than their long-term interest.
Investors have to do only some simple things. One, start investing
early and have a discipline of investing based on their risk profile.
Don't try to outguess or outsmart the fund manager. Give the same
respect to the fund manager as you give to any other professional
like a doctor, or even a barber.
Prashant: I have a point to make. It is not as confusing to
select a fund. This is not my view, this is what the chairman of Vanguard
(the giant US fund), said and it makes lot of sense. He says, look
for three things while selecting equity funds. (1) Look for funds
which have always remained diversified by discipline. That reduces
the impact of a wrong decision by the fund manager. (2) Look for funds
which are largely focussed on large-caps because they are relatively
steadier. (3) Whereas past performance is not a guarantee for future,
it certainly is relevant. Look for consistency of performance. See
how many individual calendar or financial years have funds done better
than the market. That's probably a decent guide for us.
Nilesh: One point on that. When you go to a doctor, you don't
take a guarantee that you will survive. It is up to God finally. But
when you come to the portfolio manager, most people expect that he
will be able to predict the market correctly. For heaven's sake, if
I can predict the market that correctly, why the hell will I be sitting
here till 6 or 7 o'clock in the evening and giving this kind of lecture.
I would rather enjoy in the Bahamas. People expect fund managers,
like godmen, to give short cuts. But there is no short cut to success.
Mahalakshmi: I tend to agree with what Nilesh is saying. Prashant
has been telling me of late that he is managing expectations more
than funds these days!!!
So that brings us to the end of this discussion. What fund managers
are saying is simple.
- One, equity
as an asset class will outperform this year.
- Debt funds
may not be able to replicate their past performance, but may still
post decent returns
- Floating rate
funds are essentially for people who do not want to take a call
on interest rates even as they are looking for capital protection
plus some marginal returns.
- Equities are
not for people who lack patience. A 3-5 year time-frame should be
the investment horizon for plunging into equity funds. The longer
the duration the lesser are the chances of failure
- Investors should
not try to outguess fund managers. Select funds which are diversified
and show consistency in performance.
- Investors should
make investments based on their risk profile, and a 20 per cent
overweight to equities this year may be justifiable.
Thank you all.
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