The Mutual Fund Show: Why Nimesh Shah Has A Boring Portfolio
An asset management company must provide for any liquidity risk that may arise, says Nimesh Shah.
For Nimesh Shah, this is the season for “boring portfolios”—not chasing spectacular returns but picking stocks that are less volatile.
The verdict of the general election in May-end will be the biggest risk for debt and mutual funds alike, according to the Managing Director and Chief Executive Officer of ICICI Prudential Asset Management Company. “ICICI Prudential AMC is looking to make its portfolios as boring as possible to be less impacted by any uncertainty that may arise around elections.”
Diversification is the only way to mitigate risk, Shah said on BloombergQuint’s weekly series, The Mutual Fund Show. “If funds don’t want any risk, then all investments should be only in government papers.”
Mutual funds’ investments in debt triggered concerns after defaults by ‘AAA’-rated Infrastructure Leasing and Financial Services Ltd.
An asset management company must provide for any liquidity risk that may arise, Shah said, adding that it can be realised with a lower concentration of investors and distributors. India’s second-largest asset manager has an exposure of less than 3 percent to securities rated lower than ‘AA’ to curb risk. “Larger AMCs with better risk practices won’t encounter shocks because of any credit-related issue.”
An ideal asset manager, Shah said, also needs to have enough security of a good quality company as guarantee so that corporate or promoter debt issues—such as promoter standstills—won’t hurt. “Funds faltered in some of the worst cases in the industry because of their high exposure to a single security.”
Watch the entire conversation here:
Here’s the edited transcript from the interview:
There are comparisons being made of how the flows used to be in equity mutual funds and mutual funds at large in 2017 and 2018 too, compared to what is happening right now. Should an investor be worried?
Nimesh Shah: If you see the flows in last 10 years, till May 2014 whatever you do, the flows were negative. From August 2009 to May 2014 till April 2014, the mutual fund flows were negative. In those times, the markets went up and down. There was a phase where when foreigners would get money, market could go up and when foreigners would take out money, markets go down. In 2018, foreigners have taken $4billion a year. There have been months when foreigners have taken $2billion and there is no impact on markets because there was a counter lobby which was buying it out. Mutual funds gave a lot of stability.
One year earlier, I had said red to midcaps. But the maximum number of inflows which used to happen at that time was in midcaps. When there is a two-year negative return on mid-cap SIPs, some SIPs will stop. People who are not comfortable with it, they should stop. I am not seeing those signals coming. If you see in last three-four months, the number is steady. It is around Rs 8,100 crore to Rs 8,200 crore. The growth has stopped but it has not started coming down. Even if it comes down, I will not be extra worried because flows will slow down when a one-year return is negative, which is normal. Today one-year return is not that great. It is good that people think or re-think. In euphoria, people always make bad financial decisions. In this kind of environment, people are rethinking which is good. They are taking assessment that mutual funds are subject to market risk.
December data show that the SIP registration came off but also SIP closures picked up. What could be the reasons for the same?
Nimesh Shah: Mid-caps SIPs’ two-year returns are negative. If people are re-thinking, it is a good sense for people to take whether they want to continue with mid-cap SIPs or not. They are getting more units with same money now. It is like I came in an expensive market, when market became cheaper, I am getting more units for same money and then I will stop it. So, it is counter intuitive to do it. But people should do their risk assessment themselves. I can’t do it for everybody as I don’t know their allocation. If you have got 15 percent of money towards midcaps, you will continue. But if you are a primary investor and you have started investing. So, there is no one advice which you can give people. It depends on how much allocation you have done towards midcap, large cap, and how much overall allocation to equity. If somebody is coming fresh and investing in mid-cap SIP and not anything else, then I would say you have only got midcap and why don’t you go for large-cap SIP. I may not ask him to remove but switch to large-cap SIP.
Would the recency bias hurt the debt funds?
Nimesh Shah: There was a ‘AAA’-rated company which went to D in this country. Mutual funds have only Rs 3,000 crore - Rs 4,000 crore of exposure in it. Till date, no TV channel has complimented mutual fund industry on it. One lakh crore balance sheet goes into question mark and out of top five mutual funds in the country, four don’t have it.
In last 20 years, we didn’t have a single case of derail. When we buy equity stocks, not all 40 stocks go up. Some go up and some go down. For debt funds, there can be times when we buy ‘AA’ company which can become ‘AAA’ and there can be times when we buy a ‘AA’ debenture and it will become ‘A’ also. Crisil comes out with data of upgrades to downgrades ratio. If, as an AMC, ICICI Prudential has bought the bonds, so what percentage of bonds have upgraded and downgraded. Upgrading and downgrading is normal course of life. The minute you say that company is ‘AA’ and not ‘AAA’, then there is some probability of default. A single ‘A’ company has got more probability of default than ‘AA’. ‘AA’ has got more probability of default than ‘AAA’. Otherwise, we should invest all our money with Government of India if you don’t want risk. If you invest in a credit risk fund, there can be issues which have to be resolved.
We had a company in steel sector. In first three years, the steel sector will have a problem. If I give money for five years, after three years there was problem in that company. So, if we tell them give the money tomorrow, if we do that, we will never get the money. It is better to work with the company at that time and find a mutually-agreeable solution. It is in investors’ interest that you work out a solution at that point of time. That’s what bankers do. You have to work with those companies over a period of time and make sure that the money comes back. In Jindal Steel and Power Ltd., we have decreased the valuation. When it was rated down to ‘D’, my Rs 100 was valued in my book as Rs 67. Slowly, the valuation is coming back. The Rs 67 today may be Rs 94-95 and the repayments have been happening. There has not been a single day delay in that company. But there were some 40 media headlines which we have to answer. We are managing public money and we are answerable. It is not abnormal that when you give money to ‘A+’ or ‘AA-’ company, then you have to resolve the issues.
Investors who invest in balanced funds and credit risk funds believe that this is slightly better return-giving instrument compared to my fixed deposit and let me put it here as it is 100 percent safe. Do you think that messaging is clear?
Nimesh Shah: Mutual fund is not only about equity investing. Worldwide, it is about debt investing. Debt investing is much bigger than equity investing. In India, huge money is sitting in debt products. Equity investing is not even 10 percent of debt investing. So, we want to encourage people to invest in debt funds and that is why lot of communication is necessary. We are much better off in our equity communication than what we were five to 10 years back. We are essentially much more competitive than traditional instruments because we work on a very small margin. The margin charged to customer is 1.6-1.7 percent in credit risk fund. So, retail potential of debt funds is 10 times bigger than the retail potential of equity funds.
Would you believe that there could be certain schemes or houses which could have risk because they are not well diversified? Would you believe that the industry at large is insulated from any kind of liquidity risk in portfolios it has?
Nimesh Shah: In credit risk fund, when you invest in less than AAA or even AAA, then there is some probability of delays and defaults. Even when we invest in AAA, we can see there is risk. The risk will increase if you go lower the yield curve. AA, the risk is more than AAA. Single A, the risk is more than AA. The only way to ensure that the risk is managed in credit risk fund is, you will do credit check and assuming the fund house is doing it, one essential thing for investor is that the fund is diversified. The concentration risk should not be there in a debt fund. That is very important when you go lower in risk.
JP Morgan Mutual Fund had Amtek Auto Ltd. Out of Rs 100, Rs 84 were eventually paid. So, 15 percent was going bad. Suppose 25 percent goes bad. In 3 percent of my portfolio, 75 basis points go away. Instead of getting a return of 10 percent, we get a return of 9.25 percent. So, that is the difference. In JP Morgan, the exposure was 14-15 percent which created a problem. If you do not have concentration risk, it is not an issue. If out of Rs 100, you have given Rs 3, having challenges on the credit side is normal risk of life. The only way we can avoid that challenge is by diversifying and concentrating not concentration risk.
What about the questions around liquidity of paper being held by funds?
Nimesh Shah: The liquidity is not only in asset side, you should understand the liability side too. When we look at liquidity in fund, know what my vulnerable assets are. We assume all the assets are vulnerable. There is lot of diagnostics which happen on liability side. We don’t allow concentration of distributor and investor to happen.
Then there is another comfort whether it is completed three years or not. For taking tax advantage, you need three years. Vulnerable assets start from three years. Then there is a exit load, taxation, diversification of distributor, diversification by investors. Those are parameters from where I can know how much money can go out of fund. To that extent, I will have liquid assets in my portfolio. SEBI allows 20 percent of portfolio where I can do borrowings. There are various avenues available where I can keep sufficient liquidity.
Do you believe that mutual fund as an industry would not encounter any kind of shocks?
Nimesh Shah: I have seen the bigger funds, the funds which we are competing with, they have got their institutional set up which are managing the credit risk well. I am comfortable.
The yields currently are very high. For the same credit risk you take earlier the yields were lower. Today, I am getting better yields from same product. So, it is beautiful time to invest in credit risk fund. We are contra-investors. Last year, I told you don’t invest in midcap but invest in large cap. In the three-year paradigm, when the yields have gone beyond 10 percent, it is beautiful time to invest in credit risk fund from risk return point of view.
For mutual fund investor, equities, debt or a combined portfolio, what is the biggest risk?
Nimesh Shah: I go by fundamental thing that whether the profitability is coming back or not. In the short term, political risk is coming up in May. We are preparing our portfolio for any kind of situation. Whatever happens in May, I am not going to subject my investors to abnormal risk in May. I will be more neutral as we approach May.
In debt side, it is even more important that your portfolio would become as boring as possible as we approach May. In a uncertain environment, I don’t know there will be uncertainty or certainty. When I plan a portfolio, I plan for uncertain situation and in that uncertain situation too I should be okay.
Would you believe that uncertainty that could arise not necessarily out of the papers that has been in the schemes of funds, but because the promoter entities, the case that happened between Anil Ambani-led Reliance Group and Edelweiss or L&T Finance or the case with Zee and some of the others. Do you reckon that those issues will not be big issues by and large?
Nimesh Shah: Depends on what you have. As an AMC, say in a particular company, do I have sufficient security of good quality base company? Have we done advance against shares? We have been doing the bonds secured by shares of promoter company and it is one of the best business we have with not a single day delay till now.
The quality of securities which ICICI Prudential has is one of the best companies in India in media. If the base company is good and I have got security cover only on it. I am sufficiently covered on that. My break-even price is low. I feel that I have got more than 1.5-1.6 cover on the good quality on zero debt company. It depends on security cover which you have. I have got filters on doing advance against shares. One of the filters which we use is we should be very comfortable with base companies at current price. When we took it, we were comfortable with that company at that point at that price. I have 1.5-1.6 cover. With that cover, I would be comfortable with Rs 400, then I would be comfortable at Rs 250. So, it is comfort on zero debt company with which we have given advance.